HERON THERAPEUTICS, INC. /DE/ (HRTX) FY 2023 MD&A

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

The following discussion and analysis of our financial condition and results of operations should be read together with our audited financial statements and the related notes and other financial information included elsewhere in this Annual Report on Form 10-K. Some of the information contained in this discussion and analysis or set forth elsewhere in this Annual Report on Form 10-K, including information with respect to our plans and strategy for our business, include forward-looking statements that involve risks and uncertainties. You should review the “Risk Factors” included in Item 1A of this Annual Report on Form 10-K for a discussion of important factors that could cause our actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.

Introduction

Management’s discussion and analysis of financial condition and results of operations is provided as a supplement to the Consolidated Financial Statements and Notes, included in Item 8 of this Annual Report on Form 10-K, to help provide an understanding of our financial condition, the changes in our financial condition and our results of operations. Our discussion is organized as follows:

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Overview. This section provides a general description of our business and operating expenses.

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Critical accounting estimates. This section contains a discussion of the accounting estimates that we believe are important to our financial condition and results of operations and that require significant judgment and estimates on the part of management in their application. In addition, all of our significant accounting policies are summarized in Note 2 to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.

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Results of operations. This section provides an analysis of our results of operations presented in the accompanying consolidated statements of operations and comprehensive loss by comparing the results for the year ended December 31, 2023 to the results for the year ended December 31, 2022.

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Liquidity and capital resources. This section provides an analysis of our cash flows and a discussion of our outstanding commitments and contingencies that existed as of December 31, 2023. Included in this discussion is our financial capacity to fund our future commitments and a discussion of other financing arrangements.

Overview

We are a commercial-stage biotechnology company focused on improving the lives of patients by developing and commercializing therapeutic innovations that improve medical care. Our advanced science, patented technologies, and innovative approach to drug discovery and development have allowed us to create and commercialize a portfolio of products that aim to advance the standard of care for acute care and oncology patients.

ZYNRELEF® (bupivacaine and meloxicam) extended-release solution (“ZYNRELEF”) is approved in the United States (“U.S.”) for the management of postoperative pain. APONVIE® (aprepitant) injectable emulsion (“APONVIE”) is approved in the U.S. for the prevention of postoperative nausea and vomiting. CINVANTI® (aprepitant) injectable emulsion (“CINVANTI”) and SUSTOL® (granisetron) extended-release injection (“SUSTOL”) are both approved in the U.S. for the prevention of chemotherapy-induced nausea and vomiting.

Net Product Sales

Net product sales include revenue recognized for sales of ZYNRELEF, APONVIE, CINVANTI, and SUSTOL (collectively, our “Products”) to a limited number of specialty distributors and full line wholesalers (collectively, “Customers”), less applicable sales allowances. See the “Critical Accounting Estimates” section of this Annual Report on Form 10-K for further details on our revenue recognition policy.

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Cost of Product Sales

Cost of product sales relates to the costs to produce, package and deliver our Products to our Customers. These costs include raw materials, labor, manufacturing and quality control overhead, and depreciation of equipment, as well as shipping and distribution costs. See the “Critical Accounting Estimates” section of this Annual Report on Form 10-K for further details on our inventory policy.

Research and Development Expense

All costs of research and development are expensed in the period incurred. Research and development expense primarily consists of salaries, stock-based compensation expense and other related costs for personnel in manufacturing, clinical and preclinical development, regulatory, quality and medical affairs. Other research and development expense includes professional fees paid to outside service providers and consultants, facilities costs and materials used in the clinical and preclinical trials and research and development.

General and Administrative Expense

General and administrative expense primarily consists of salaries, stock-based compensation expense and other related costs for personnel in executive, finance and accounting, information technology, legal and human resource functions. Other general and administrative expense includes professional fees for legal, investor relations, accounting and other general corporate purposes, facility costs and insurance not otherwise included in research and development expense.

Sales and Marketing Expense

Sales and marketing expense primarily consists of salaries and related costs for personnel, stock-based compensation expense and other related costs for sales operations, marketing and market access. Other sales and marketing costs include professional fees and commercialization costs related to our Products.

Other Income (Expense), Net

Other income (expense), net primarily consists of interest expense, income earned on our cash, cash equivalents and short-term investments, the amortization of debt issuance costs related to our convertible notes payable, the amortization of a debt discount related to our working capital line of credit, and write-off of property and equipment.

We expect total operating expenses to decrease on a year-over-year basis in 2024 as a result of our cost reduction efforts. Our expectations are subject to various risks and assumptions, including but not limited to those listed under the section entitled “Risk Factors” in this Annual Report on Form 10-K. Additional uncertainties are identified in the section entitled “Forward-Looking Statements” in this Annual Report on Form 10-K. We continue to monitor the factors which may impact our business and as of the filing date of this report, we do not believe they are material.

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Critical Accounting Estimates

A summary of the significant accounting policies is provided in Note 2 to our Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.

The discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We evaluate our estimates on an ongoing basis, including those related to revenue recognition, investments, inventory, accrued clinical and manufacturing liabilities, income taxes and stock-based compensation. We base our estimates on historical experience and on assumptions that we believe to be reasonable under the circumstances, the results of which form the basis of making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ materially from these estimates under different assumptions or conditions.

Management considers an accounting estimate to be critical if: it requires a significant level of estimation uncertainty, and changes in the estimate are reasonably likely to have a material effect on our financial condition or results of operations.

We believe the following critical accounting estimates describe the most significant judgments and estimates used in the preparation of our consolidated financial statements.

Revenue Recognition

Revenue is recognized in accordance with the Financial Accounting Standards Board Accounting Standards Codification Topic 606, Revenue from Contracts with Customers (“Topic 606”). Topic 606 is based on the principle that revenue should be recognized to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services.

Product Sales

Our Products are distributed in the U.S. through a limited number of Customers that resell to healthcare providers and hospitals, the end users of our Products.

Revenue is recognized in an amount that reflects the consideration we expect to receive in exchange for our Products. To determine revenue recognition for contracts with customers within the scope of Topic 606, we perform the following 5 steps: (i) identify the contract(s) with a customer; (ii) identify the performance obligations of the contract(s); (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract(s); and (v) recognize revenue when (or as) we satisfy the performance obligations. We recognize revenue from product sales when there is a transfer of control of the product to our Customers. We typically determine transfer of control based on when the product is delivered, and title passes to our Customers.

Product Sales Allowances

We recognize product sales allowances as a reduction of product sales in the same period the related revenue is recognized. Product sales allowances are based on amounts owed or to be claimed on the related sales. Such variable consideration includes estimates that take into consideration the terms of our agreements with Customers, historical product returns, rebates or discounts taken, the shelf life of the product and specific known market events,

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such as competitive pricing and new product introductions. If actual future results vary from our estimates, we may need to adjust these estimates, which could have an effect on product sales and earnings in the period of adjustment.

We believe our estimated allowances for distributor fees, group purchasing organization (“GPO”) rebates and administrative fees, Medicaid rebates and prompt pay discounts do not require a high degree of judgment because the amounts are settled within a relatively short period of time.

We believe our estimated allowance for product returns and GPO discounts requires a high degree of judgment and is subject to change based on our experience and certain quantitative and qualitative factors. We allow our Customers to return product for credit for up to 12 months after its product expiration date. As such, there may be a significant period of time between the time the product is shipped and the time the credit is issued on returned product. We estimate anticipated GPO discounts based on the applicable contractual terms. We regularly monitor our estimates and record adjustments when trends, contract terms or other significant events indicate that a change in estimates is appropriate. To date, our estimates have not differed materially from actuals. However, subsequent changes in estimates may result in a material change to our product sales allowances, which could materially affect our results of operations and financial position.

Investments

We invest in various types of securities, including U.S. treasury bills and government agency obligations, corporate debt securities and commercial paper. These securities have been initially valued at the transaction price and subsequently valued utilizing a third-party service provider who assesses the fair value using inputs other than quoted prices that are observable either directly or indirectly, such as yield curve, volatility factors, credit spreads, default rates, loss severity, current market and contractual prices for the underlying instruments or debt, broker and dealer quotes, as well as other relevant economic measures. We perform certain procedures to corroborate the fair value of these holdings, and in the process, we apply judgment and estimates that if changed, could significantly affect our statements of financial positions. To date, our estimates have not differed materially from actual values. However, subsequent changes in estimates may result in a material change to the value of our cash equivalents and short-term investments, which could materially affect our results of operations and financial position.

Inventory

Inventory is stated at the lower of cost or estimated net realizable value on a first-in, first-out, or FIFO, basis. We periodically analyze our inventory levels and write down inventory that has become obsolete, inventory that has a cost basis in excess of its estimated realizable value and inventory quantities that are in excess of expected sales requirements as cost of product sales. The determination of whether inventory costs will be realizable requires estimates by management. If actual market conditions are less favorable than projected by management, additional write-downs of inventory may be required, which would be recorded as cost of product sales.

Accrued Research and Development Expenses

We estimate certain costs and expenses and accrue for these liabilities as part of our process of preparing financial statements. Examples of areas in which subjective judgment may be required include, among other things, costs associated with services provided by contract organizations for preclinical and clinical development, and manufacturing of our Products and product candidates. We accrue for costs incurred as the services are being provided by monitoring the status of the services provided, and the invoices received from our external service providers. In the case of clinical trials, we rely on estimates of the progress of the clinical trials and related expenses incurred. Changes to estimates are recorded to research and development expense in the period in which the facts that gave rise to the revision become known. To date, our estimates have not differed materially from the actual costs incurred. However, subsequent changes in estimates may result in a material change to our accruals, which could also materially affect our results of operations and financial position.

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Income Taxes

We make certain estimates and judgments in determining income tax expense for financial statement purposes. These estimates and judgments occur in the calculation of certain deferred tax assets and liabilities, which arise from differences in the timing of recognition of revenue and expense for tax and financial statement purposes. As part of the process of preparing our consolidated financial statements, we are required to estimate our income taxes for each of the jurisdictions in which we operate. This process involves estimating our current tax exposure under the most recent tax laws and assessing temporary differences resulting from differing treatment of items for tax and financial statement purposes. At December 31, 2023, we established a valuation allowance to offset our deferred tax assets due to the uncertainty of realizing future tax benefits from our net operating loss carryforwards and other deferred tax assets. To date, our estimates have not materially changed. However, subsequent changes in estimates may result in a significant change to our deferred tax assets and liabilities, which could materially affect our results of operations and financial position.

Stock-based Compensation

We estimate the fair value of stock options granted using the Black-Scholes option pricing model and for market-based stock option grants using the Monte Carlo simulation model. This fair value is then amortized over the requisite service periods of the awards. The Black-Scholes option pricing model requires the input of subjective assumptions, including each option’s expected life and price volatility of the underlying stock. Expected volatility is based on our historical stock price volatility. The expected life of employee stock options represents the average of the contractual term of the options and the weighted-average vesting period, as permitted under the simplified method. To date, our assumptions used in our calculation of stock-based compensation expense has not significantly changed. However, subsequent changes in our assumptions could impact our stock-based compensation expense, which could materially affect our net loss and net loss per share.

Recent Accounting Pronouncements

See Note 2 to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.

Results of Operations

Years Ended December 31, 2023 and 2022

Net Product Sales

For the year ended December 31, 2023, net product sales were $127.0 million, compared to $107.7 million for the same period in 2022.

Net Product Sales – Acute Care

For the year ended December 31, 2023, net product sales of ZYNRELEF were $17.7 million, compared to $10.2 million for the same period in 2022. The increase in net product sales of ZYNRELEF was primarily due to an increase in units sold in 2023, as compared to 2022. For the year ended December 31, 2023, net product sales of APONVIE were $1.4 million. APONVIE became commercially available in the U.S. in March 2023.

Net Product Sales – Oncology Care

For the year ended December 31, 2023, net product sales of CINVANTI were $94.9 million, compared to $87.3 million for the same period in 2022. The increase in net product sales of CINVANTI was primarily due to an increase in units sold in 2023, as compared to 2022. For the year ended December 31, 2023, net product sales of SUSTOL were $13.0 million, compared to $10.2 million for the same period in 2022. The increase in net product sales of SUSTOL was primarily due to an increase in units sold in 2023, as compared to 2022.

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Cost of Product Sales

For the year ended December 31, 2023, cost of product sales was $65.1 million, compared to $54.9 million for the same period in 2022. The increase in cost of product sales was primarily due to an increase in inventory write-offs in 2023, as compared to 2022. For the years ended December 31, 2023 and 2022, cost of product sales included charges of $20.3 million and $8.9 million, respectively, resulting primarily from the write-off of ZYNRELEF inventory. The increase was also due to an increase in units sold in 2023, as compared to 2022, partially offset by a decrease in cost per units for CINVANTI and ZYNRELEF, as large-scale manufacturing was validated and approved in late 2022.

We began capitalizing raw materials, labor and overhead related to the manufacturing of APONVIE following FDA approval in September 2022. There were no commercial manufacturing costs incurred prior to FDA approval of APONVIE.

Research and Development Expense

Research and development expense consisted of the following (in thousands):

For the year ended December 31, 2023, research and development expense was $55.9 million, compared to $107.5 million for the same period in 2022. This decrease was primarily due to decreases in costs related to ZYNRELEF and CINVANTI, as product scale-up, validation activities and raw materials qualification were completed in 2022. In addition, the decrease in research and development expense was due to decreases in personnel and related costs as a result of the savings from our reorganizations, as well as a decrease in non-cash, stock-based compensation expense.

General and Administrative Expense

For the year ended December 31, 2023, general and administrative expense was $49.0 million, compared to $37.4 million for the same period in 2022. The increase was primarily due to severance and non-cash, stock-based compensation expense in connection with executive departures in the second and third quarters of 2023, and ongoing legal costs associated with the CINVANTI patent litigation.

Sales and Marketing Expense

For the year ended December 31, 2023, sales and marketing expense was $67.6 million, compared to $82.5 million for the same period in 2022. The decrease was primarily due to a decrease in costs to support the ongoing commercialization of ZYNRELEF, due to improved operational efficiencies.

Other Income (Expense), Net

For the year ended December 31, 2023, other income (expense), net was $0.1 million, compared to ($7.4) million for the same period in 2022. The change was primarily due to the write-off of property and equipment at a third-party manufacturing site in 2022, as well as an increase in interest income earned on our invested cash balances in 2023.

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Restructuring Plans

See Note 7 to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for discussion of the June 2022 and June 2023 Reorganizations.

Liquidity and Capital Resources

As of December 31, 2023, we had cash, cash equivalents and short-term investments of $80.4 million. Based on our current operating plan and projections, management believes that the Company’s existing cash, cash equivalents and short-term investments will be sufficient to meet the Company’s anticipated cash requirements for a period of at least one year from the date this Annual Report on Form 10-K is filed with the U.S. Securities and Exchange Commission.

Our net loss for the year ended December 31, 2023 was $110.6 million, or $0.80 per share, compared to a net loss of $182.0 million, or $1.67 per share, for the same period in 2022.

Our net cash used in operating activities for the year ended December 31, 2023 was $58.8 million, compared to $146.9 million for the same period in 2022. The decrease in net cash used in operating activities was primarily due to a decrease in operating expenses and changes in working capital.

Our net cash provided by investing activities for the year ended December 31, 2023 was $18.0 million, compared to net cash used in investing activities of $3.3 million for the same period in 2022. The increase in cash provided by investing activities was primarily due to net maturities of short-term investments of $19.5 million for the year ended December 31, 2023, compared to net purchases of short-term investments of $1.7 million for the same period in 2022.

Our net cash provided by financing activities for the year ended December 31, 2023 was $54.1 million, compared to $75.1 million for the same period in 2022. The decrease in cash provided by financing activities was primarily due to net proceeds of $54.1 million received from debt and equity financings completed in the third quarter of 2023, compared to net proceeds of $75.1 million received from an equity financing in 2022.

Historically, we have financed our operations, including technology and product research and development, primarily through sales of our common stock and debt financings.

Material Cash Requirements

As of December 31, 2023, we had an operating lease for 52,148 square feet of laboratory and office space in San Diego, California, with a lease term that expires on December 31, 2025. In October 2021, we entered into a sublease agreement to sublet 23,873 square feet of laboratory and office space. The space was delivered to the subtenant in March 2022. The sublease agreement expires on December 31, 2025 and is coterminous with the operating lease for the subleased space. In September 2023, we also entered into a sublease agreement to sublet 5,840 square feet of office space in Cary, North Carolina, with a lease term that expires on April 30, 2025. As of December 31, 2023, we had total operating lease obligations of $6.3 million, with $3.2 million due in one year and $3.1 million due within two to three years.

At December 31, 2023, purchase obligations primarily consisted of non-cancellable commitments with third-party manufacturers in connection with the manufacturing of our Products. Total purchase obligations of $60.2 million were not included in our consolidated financial statements for the year ended December 31, 2023, with $39.0 million due in one year and $21.2 million due within two to three years. We intend to use our current financial resources to fund our commitments under these purchase obligations.

As of December 31, 2023, $150.0 million aggregate principal amount of the convertible notes were outstanding (see Note 8 to the Consolidated Financial Statements included in this Annual Report on Form 10-K). The senior unsecured convertible notes mature on May 26, 2026, unless earlier converted, redeemed or repurchased.

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As of December 31, 2023, $25.2 million aggregate principal amount under the working capital facility was outstanding (see Note 8 to the Consolidated Financial Statements included in this Annual Report on Form 10-K). The working capital facility has a four year term, with a springing maturity date that is 91 days prior to the stated maturity of our existing senior unsecured convertible notes (if still outstanding at such time).

We enter into agreements with clinical sites and clinical research organizations for the conduct of our clinical trials and contract manufacturing organizations for the manufacture and supply of preclinical, clinical and commercial materials and drug product. We make payments to these clinical sites and clinical research organizations based in part on the number of eligible patients enrolled and the length of their participation in the clinical trials. In some of our agreements with contract manufacturing organizations, we are required to meet minimum purchase obligations. Under certain of these agreements, we may be subject to penalties in the event that we prematurely terminate these agreements. At this time, due to the variability associated with clinical site agreements, contract research organization agreements and contract manufacturing agreements, we are unable to estimate with certainty the future costs we will incur. We intend to use our current financial resources to fund our obligations under these commitments.

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