ZEVRA THERAPEUTICS, INC. (ZVRA) FY 2021 MD&A

Overview

We are a specialty pharmaceutical company focused on the discovery and development of treatments for central nervous system, or CNS, and rare disease indications that allow us to target high-value areas with significant unmet needs. Our core competency is the discovery and development of proprietary prodrugs to treat serious medical conditions through our proprietary Ligand Activated Therapy, or LAT®, platform technology. We utilize our proprietary LAT platform technology to generate improved prodrug versions of drugs approved by the U.S. Food and Drug Administration, or FDA, as well as to generate prodrug versions of existing compounds that may have applications for new disease indications. Our prodrug product candidate pipeline is currently focused on the high need areas of idiopathic hypersomnia, or IH, and other CNS/rare diseases. Our approved product, AZSTARYS®, formerly referred to as KP415, a new once-daily treatment for attention deficit hyperactivity disorder, or ADHD, in patients age six years and older contains our prodrug, serdexmethylphenidate, or SDX. AZSTARYS is being commercialized in the United States by Corium, Inc., or Corium, an affiliate of Gurnet Point Capital, L.P. Our lead clinical development product candidate, KP1077, is based on SDX, our prodrug of d-methlyphenidate, or d-MPH, and is in development for the treatment of IH and narcolepsy. Our prodrug product candidate for the treatment of stimulant use disorder, or SUD, is KP879.

Our strategic focus on CNS/rare disease indications guides our business development efforts to expand our development pipeline with the goal of accelerating value creation. We are considering external opportunities within neurology and neurodegenerative diseases, psychiatric disorders, and other rare diseases, along with adjacent or related therapeutic categories.  We are seeking assets that are undergoing Phase 2 clinical trials or Phase 3 clinical trials, subject to our specific evaluation criteria, that we can in-license or acquire. If we are successful, expanding our development pipeline could be accretive to our value proposition by potentially adding new clinical data catalysts and the potential to create incremental long-term value for shareholders. In addition, we believe that a multi-channel development program with several product candidates addressing various CNS/rare disease indications will diversify risk and potentially create an impactful portfolio of commercial-stage products in the future.

We expect that our sources of revenues will be through payments arising from our license agreements with Commave Therapeutics SA (formerly known as Boston Pharmaceuticals S.A.), or Commave, an affiliate of Gurnet Point Capital, L.P., and KVK-Tech, Inc., or KVK, our consulting agreement with Corium and through other consulting arrangements and any other future arrangements we might enter into related to one of our product candidates. To date, we have generated revenue from the KP415 License Agreement (as defined below), reimbursement of out-of-pocket third-party costs, and performance of consulting services.

In May 2021, we announced that SDX, our proprietary prodrug of d-MPH and the primary active pharmaceutical ingredient, or API, in AZSTARYS, was classified as a Schedule IV controlled substance by the U.S. Drug Enforcement Administration, or DEA. AZSTARYS is classified as a Schedule II controlled substance as it includes a 70:30 mixture of SDX (Schedule IV) and d-MPH (Schedule II), respectively.

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In March 2021, we announced that the FDA approved the New Drug Application, or NDA, for AZSTARYS, a once-daily product for the treatment of ADHD in patients ranging from six years and older. Commave has licensed the commercial rights for AZSTARYS as provided by the KP415 License Agreement, and has tasked Corium with leading all commercialization activities for AZSTARYS in the United States. Corium commercially launched AZSTARYS in the United States during the third quarter of 2021. In December 2021, Commave sublicensed commercialization rights for AZSTARYS in greater China to Shanghai Ark Biopharmaceutical Ltd.

We have historically had negative cash flows from operations. Our cash flows provided by (used in) operations for the years ended December 31, 2021, and 2020 were $10.4 million and ($1.9) million, respectively.

We expect to continue to incur significant expenses and minimal positive net cash flows from operations or negative net cash flows from operations for the foreseeable future, and those expenses and losses may fluctuate significantly from quarter-to-quarter and year-to-year. We anticipate that our expenses will fluctuate substantially as we:

Recent Financial Developments

In January and February 2021, we undertook a series of transactions to regain our Nasdaq Capital Market listing and improve our balance sheet. These included a reverse stock split, an underwritten public offering, or the Public Offering, a restructuring of our debt and ultimately a payoff of all remaining debt and a transaction in which we induced the holders of some of the warrants we issued in the public offering to exercise those warrants for cash.

Reverse Stock Split and Nasdaq Relisting

Effective May 21, 2020, our common stock had been delisted from the Nasdaq Capital Market and we began listing on the OTC Markets Venture Market under the symbol “KMPH”. In anticipation of the Public Offering, we determined we would need to regain our Nasdaq listing.

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In order to relist our common stock on the Nasdaq Capital Market, our common stock was required to satisfy the initial listing standards of the Nasdaq Capital Market, which included among others, that we have stockholders’ equity of at least $5.0 million, a market value of unrestricted publicly held shares of at least $15.0 million, at least 1.0 million unrestricted publicly held shares, at least 300 unrestricted round lot stockholders, at least three market makers and a bid price of at least $4.00 per share, or, collectively, the Nasdaq Listing Requirements. Accordingly, on December 23, 2020, we effectuated a 1-for-16 reverse stock split of our common stock in order to satisfy the bid price component of the Nasdaq Listing Requirements.

On January 7, 2021, our common stock was approved for listing on the Nasdaq Capital Market. Our common stock began trading on the Nasdaq Capital Market on January 8, 2021, under the ticker symbol “KMPH”.

On October 19, 2021, our common stock was approved for listing on the Nasdaq Global Select Market. Our common stock began trading on the Nasdaq Global Select Market on that date, under the ticker symbol “KMPH”.

Debt Restructuring

In anticipation of the Public Offering, and to meet the Nasdaq Listing Requirements, we agreed in December 2020 to restructure our outstanding senior secured convertible notes issued in December 2019 and January 2020, or the Senior Secured Notes, in the aggregate principal amount of $60.8 million and the senior secured convertible promissory note held by Deerfield Private Design Fund III, L.P., or Deerfield, in the principal amount of $7.5 million, or the Deerfield Note, and, collectively the Senior Secured Notes, the Facility Notes. The total outstanding principal and accrued interest under the Facility Notes was $69.4 million as of December 31, 2020.

Under the terms of the agreement we entered into with our lenders in connection with this debt restructuring, which we refer to as the December 2020 Exchange Agreement, on January 12, 2021, in connection with the closing of our Public Offering, we:

Each share of Series B-2 convertible preferred stock issued pursuant to the December 2020 Exchange Agreement has a stated value of $1,000 and is convertible into shares of our common stock at any time, subject to specified limits, at a conversion price of $6.4999. The shares of Series B-2 convertible preferred stock issued under the December 2020 Exchange Agreement are convertible into an aggregate of 4,842,690 shares of our common stock.

The Exchange Warrants have substantially the same terms and conditions as the warrants sold by us in our January 2021 underwritten offering.

Following the completion of these transactions, the aggregate balance of principal and accrued interest remaining outstanding under the Facility Notes was approximately $7.6 million. With respect to this remaining outstanding balance under the Facility Notes, the December 2020 Exchange Agreement amended the terms of that debt to provide that:

In connection with the closing of the transactions contemplated under the December 2020 Exchange Agreement, we filed an amended and restated certificate of designation with the Secretary of State of Delaware in order to modify the terms of our authorized, but unissued, shares of Series B-2 convertible preferred stock to reflect those contemplated under the December 2020 Exchange Agreement.

We also filed a registration statement to register for resale under the Securities Act the shares of common stock issuable upon conversion of the shares of Series B-2 convertible preferred stock and exercise of the Exchange Warrants.

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Public Offering

On January 8, 2021, we issued and sold 6,765,463 shares of our common stock, pre-funded warrants to purchase 926,844 shares of our common stock and warrants to purchase 7,692,307 shares of our common stock at an exercise price per share of $6.50 in the Public Offering. In addition, we granted the underwriter for the Public Offering an option to purchase, for a period of 45 days, up to an additional 1,153,846 shares of our common stock and/or warrants to purchase up to an additional 1,153,846 shares of our common stock. On January 8, 2021, the underwriter exercised its over-allotment option, in part, for warrants to purchase 754,035 shares of our common stock. On January 12, 2021, we closed the Public Offering. Further, on February 1, 2021, the underwriter again exercised its over-allotment option, in part, to purchase 374,035 shares of our common stock. On February 3, 2021, we closed the underwriter's partial exercise of its over-allotment option.

The aggregate gross proceeds to us from the Public Offering, including from the exercises by the underwriter of its over-allotment option, totaled $52.4 million, before deducting underwriting discounts and commissions and offering expenses payable by us.

On January 25, 2022, we filed an amendment to the registration statement on Form S-1 (File No. 333-250945) on Form S-3 covering the issuance of the shares of our common stock issuable upon the exercise of the warrants issued in the Public Offering and remaining unexercised as of the date of the amendment, which was declared effective on February 1, 2022.

December 2020 Exchange Agreement Amendment

On January 12, 2021, in connection with the transactions contemplated by the December 2020 Exchange Agreement, we entered into an Amendment to Senior Secured Convertible Notes and Amendment to Warrant, or the January 2021 Amendment, with Deerfield and Deerfield Special Situations Fund, LP, collectively the Deerfield Holders. The January 2021 Amendment modified certain specified terms of (i) the Facility Notes and (ii) the warrant held by Deerfield, issued on June 2, 2014, or the Deerfield Warrant, to, among other things, exclude the transactions contemplated by the December 2020 Exchange Agreement and issuance of securities pursuant to the Underwriting Agreement from the anti-dilution provisions of the Facility Notes and the Deerfield Warrant.

January 2021 Warrant Exercise Inducement Letters and Issuance of Warrants

On January 26, 2021, we entered into warrant exercise inducement offer letters, or the January 2021 Inducement Letters, with certain holders of warrants issued in the Public Offering, or the Existing Warrants, and collectively, the Exercising Holders, pursuant to which such holders exercised for cash their Existing Warrants to purchase 6,620,358 shares of our common stock in exchange for new warrants, or the January 2021 Inducement Warrants, on substantially the same terms as the Existing Warrants, except as set forth in the following sentence, to purchase up to 7,944,430 shares of our common stock, which was equal to 120% of the number of shares of our common stock issued upon exercise of the Existing Warrants, or the January 2021 Inducement Transaction. The purchase price of the January 2021 Inducement Warrants was $0.125 per share underlying each January 2021 Inducement Warrant, and the January 2021 Inducement Warrants have an exercise price of $6.36 per share. We received aggregate gross proceeds of $44.0 million from the exercise of the Existing Warrants by the Exercising Holders and the sale of the January 2021 Inducement Warrants.

We also filed a registration statement on Form S-3 covering the resale of the shares of our common stock issued or issuable upon the exercise of the January 2021 Inducement Warrants which was declared effective on February 16, 2021.

Payoff of Facility Agreement Notes and Termination of Facility Agreement

On February 8, 2021, we entered into a payoff letter with the Facility Note holders, pursuant to which we agreed to pay off and thereby terminate the Facility Agreement.

Pursuant to the payoff letter, we paid a total of $8.0 million to the Facility Note holders, representing the principal balance, accrued interest outstanding and a prepayment fee in repayment of our outstanding obligations under the Facility Agreement.

Pursuant to the payoff letter, all outstanding indebtedness and obligations owed by us to the Facility Note holders under the Facility Agreement have been paid in full. The Facility Agreement and the notes thereunder, as well as the security interests in the assets of us securing the Facility Agreement and note obligations, have been terminated.

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June 2021 Warrant Exercise Inducement Letters and Issuance of Warrants

On June 18, 2021, we entered into warrant exercise inducement offer letters, or the June 2021 Inducement Letters, with certain holders of the January 2021 Inducement Warrants, pursuant to which such holders exercised for cash their January 2021 Inducement Warrants to purchase 6,117,509 shares of our common stock in exchange for new warrants, or the June 2021 Inducement Warrants, on substantially the same terms as the January 2021 Inducement Warrants, except as set forth in the following sentence, to purchase up to 1,529,379 shares of our common stock, which was equal to 25% of the number of shares of our common stock issued upon exercise of the January 2021 Inducement Warrants, or the June 2021 Inducement Transaction. The purchase price of the June 2021 Inducement Warrants was $0.125 per share underlying each June 2021 Inducement Warrant, and the June 2021 Inducement Warrants have an exercise price of $16.50 per share and expire on December 31, 2026. We received aggregate gross proceeds of $39.1 million from the exercise of the January 2021 Inducement Warrants and the sale of the June 2021 Inducement Warrants.

We also filed a registration statement on Form S-3 covering the resale of the shares of our common stock issued or issuable upon the exercise of the June 2021 Inducement Warrants which was declared effective on July 7, 2021.

Equity Distribution Agreement

On July 2, 2021, we entered into an Equity Distribution Agreement with JMP and RBCCM, under which we may offer and sell, from time to time at our sole discretion, shares of our common stock having an aggregate offering price of up to $75.0 million through JMP and RBCCM as our sales agents. The issuance and sale, if any, of our common stock under the Equity Distribution Agreement will be made pursuant to a registration statement on Form S-3.

We filed a registration statement on Form S-3 covering the sale of the shares of our common stock up to $350.0 million, $75.0 million of which was allocated to the sales of the shares of common stock issuable under the Equity Distribution Agreement. The Form S-3 was declared effective on July 12, 2021. As of December 31, 2021, no shares have been issued or sold under the Equity Distribution Agreement.

Share Repurchase Program

On December 20, 2021, the Company initiated a share repurchase program, or the Share Repurchase Program, pursuant to which the Company may repurchase up to $50 million of shares of its common stock through December 31, 2023. Capital allocation to the Share Repurchase Program will be based on a variety of factors, including our business results, the receipt of royalties and sales milestones under the KP415 License Agreement, and potentially other sources of non-dilutive capital that may become available to the Company. Repurchases will be made in compliance with Rule 10b-18 of the Securities Exchange Act of 1934, as amended, subject to a variety of factors, including the market price of the Company’s common stock, general market and economic conditions and applicable legal requirements. The exact number of shares to be repurchased by the Company is not guaranteed and the program may be suspended, modified, or discontinued at any time without prior notice. As of December 31, 2021, the Company has repurchased 320,161 shares of its common stock for approximately $2.8 million under the Share Repurchase Program.

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Third-Party Agreements

KP415 License Agreement

In September 2019, we entered into the KP415 License Agreement with Commave. Under the KP415 License Agreement, we granted to Commave an exclusive, worldwide license to develop, manufacture and commercialize our product candidates containing SDX and d-MPH, including AZSTARYS, KP484, and, at the option of Commave, KP879, KP922 or any other product candidate developed by us containing SDX and developed to treat ADHD or any other central nervous system disorder, or the Additional Product Candidates and, collectively with AZSTARYS and KP484, the Licensed Product Candidates.

Under the terms of the KP415 License Agreement, we granted Commave an exclusive, worldwide license to commercialize and develop the Licensed Product Candidates; provided that such license shall apply to an Additional Product Candidate only if Commave exercises its option under the KP415 License Agreement related thereto. If Commave exercises its option related to any Additional Product Candidate under the KP415 License Agreement, the parties are obligated to negotiate in good faith regarding the economic terms of such Additional Product Candidate. We also granted to Commave a right of first refusal to acquire, license or commercialize any Additional Product Candidate, with such right of first refusal expiring upon the acceptance of a new drug application for such Additional Product Candidate. We also granted Commave a right of first negotiation and a right of first refusal, subject to specified exceptions, for any assignment of our rights under the KP415 License Agreement.

Pursuant to the KP415 License Agreement, Commave paid us an upfront payment of $10.0 million and agreed to pay up to $63.0 million in milestone payments upon the occurrence of specified regulatory milestones related to AZSTARYS, including FDA approval and specified conditions with respect to the final approval label, and KP484. In addition, Commave agreed to make additional payments upon the achievement of specified U.S. sales milestones of up to $420.0 million in the aggregate. Further, Commave will pay us quarterly, tiered royalty payments ranging from a percentage in the high single digits to the mid-twenties of Net Sales (as defined in the KP415 License Agreement) in the United States and a percentage in the low to mid-single digits of Net Sales in each country outside the United States, in each case subject to specified reductions under certain conditions as described in the KP415 License Agreement. Commave is obligated to make such royalty payments on a product-by-product basis until expiration of the Royalty Term (as defined in the KP415 License Agreement) for the applicable product.

In April 2021, we entered into Amendment No. 1 to the KP415 License Agreement, or the KP415 Amendment. Pursuant to the KP415 Amendment, we agreed to modify the compensation terms of the KP415 License Agreement. In addition, the KP415 Amendment increased the total remaining future regulatory and sales milestone payments related to AZSTARYS up to an aggregate of $590.0 million in payments upon the occurrence of specified regulatory milestones related to AZSTARYS and upon the achievement of specified U.S. net sales milestones. Further, Commave agreed to pay us quarterly, tiered royalty payments ranging from a percentage in the high single digits to the mid-twenties of Net Sales (as defined in the KP415 License Agreement) in the United States and a percentage in the low to mid-single digits of Net Sales in each country outside the United States, in each case subject to specified reductions under certain conditions, including with respect to the final approval label, as described in the KP415 License Agreement. Commave is obligated to make such royalty payments on a product-by-product basis until expiration of the royalty term for the applicable product.

Pursuant to the KP415 Amendment, we also agreed to modify Commave’s right of first refusal such that our product candidate, KP922, is no longer subject to Commave’ right of first refusal to acquire, license or commercialize any Additional Product Candidate. Commave’s right of first refusal shall only apply to any Additional Product Candidate which contains SDX, with such right of first refusal expiring upon the acceptance of an NDA for such Additional Product Candidate containing SDX.

Commave agreed to be responsible for and reimburse us for all of development, commercialization and regulatory expenses for the Licensed Product Candidates, subject to certain limitations as set forth in the KP415 License Agreement.

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The KP415 License Agreement will continue on a product-by-product basis (i) until expiration of the royalty term for the applicable Licensed Product Candidate in the United States and (ii) perpetually for all other countries. Commave may terminate the KP415 License Agreement at its convenience upon prior written notice prior to regulatory approval of any Licensed Product Candidate or upon prior written notice after regulatory approval of any Licensed Product Candidate. We may terminate the KP415 License Agreement in full if Commave, any of its sublicensees or any of its or their affiliate challenges the validity of any Licensed Patent (as defined in the KP415 License Agreement) and such challenge is not required under a court order or subpoena and is not a defense against a claim, action or proceeding asserted by us. Either party may terminate the KP415 License Agreement (i) upon a material breach of the KP415 License Agreement by the other party, subject to a cure period, or (ii) if the other party encounters bankruptcy or insolvency. Upon a Serious Material Breach (as defined in the KP415 License Agreement) by us, subject to a cure period, Commave may choose not to terminate the KP415 License Agreement and instead reduce the milestone and royalty payments owed to us. Upon termination, all licenses and other rights granted by us to Commave pursuant to the KP415 License Agreement would revert to us. During the term of the KP415 License Agreement, we may not develop or commercialize any Competing Product (as defined in the KP415 License Agreement).

APADAZ License Agreement

In October 2018, we entered into the APADAZ License Agreement with KVK pursuant to which we have granted an exclusive license to KVK to conduct regulatory activities for the manufacture and commercialization of APADAZ in the United States. We have retained the right to license the international commercial rights to APADAZ to one or more collaborators outside of the U.S.  We will be solely responsible for all development activities except for regulatory activities relating to APADAZ in the United States.

Pursuant to the APADAZ License Agreement, KVK has agreed to pay us certain payments and cost reimbursements of an estimated $3.4 million, which includes a payment of $2.0 million within 10 days of the achievement of a specified milestone related to the initial formulary adoption of APADAZ, or the Initial Adoption Milestone. In addition, KVK has agreed to make additional payments to us upon the achievement of specified sales milestones of up to $53.0 million in the aggregate. Further, we and KVK will share the quarterly net profits of APADAZ by KVK in the United States at specified tiered percentages, ranging from us receiving 30% to 50% of net profits, based on the amount of net sales on a rolling four quarter basis. We are responsible for a portion of commercialization and regulatory expenses for APADAZ until the Initial Adoption Milestone is achieved, after which KVK will be responsible for all expenses incurred in connection with commercialization and maintaining regulatory approval in the United States.

The APADAZ License Agreement also established a joint steering committee, which monitors progress of the commercialization of APADAZ.

Other Third-Party Agreements

Under our March 2012 termination agreement with Aquestive, Aquestive has the right to receive a royalty amount equal to 10% of any value generated by AZSTARYS, KP484, KP879 or KP1077, and any product candidates containing SDX, including royalty payments on any license of AZSTARYS, KP484, KP879 or KP1077, the sale of AZSTARYS, KP484, KP879 or KP1077 to a third party, the commercialization of AZSTARYS, KP484, KP879 or KP1077 and the portion of any consideration that is attributable to the value of AZSTARYS, KP484, KP879 or KP1077 and paid to us or our stockholders in a change of control transaction.

In July 2020, we entered into the Corium Consulting Agreement under which Corium and Commave, respectively, engaged us to guide the product development and regulatory activities for certain current and potential future products in their portfolio, as well as continue supporting preparation for the potential commercial launch of AZSTARYS. Under the Corium Consulting Agreement, we are entitled to receive payments from Corium of up to $15.6 million, $13.6 million of which will be paid in quarterly installments through March 31, 2022. The remaining $2.0 million was conditioned upon the approval by the FDA of the NDA for Corium's product candidate, ADLARITY. This $2.0 million was earned in the first quarter of 2022. Corium also agreed to be responsible for and reimburse us for all development, commercialization and regulatory expenses incurred as part of the performance of the consulting services.

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Components of our Results of Operations

Revenue

Our commercial revenue is, and will be, primarily derived from sales of AZSTARYS, APADAZ or any of our product candidates for which we obtain regulatory approval. We expect that our only source of revenues will be through payments arising from our license agreements with Commave and KVK, and through any other future arrangements related to one of our product candidates. To date, we have generated revenue from the KP415 License Agreement, reimbursement of out-of-pocket third-party costs, and the performance of consulting services. We cannot guarantee that either Commave will be able to successfully commercialize AZSTARYS or our product candidates covered under the KP415 License Agreement, or KVK will be able to successfully commercialize APADAZ, or that we will ever receive any payments under the APADAZ License Agreement from commercial sales of APADAZ or any future payments under the APADAZ License Agreement. We also do not know when, if ever, any other product candidate will be commercially available.

Royalties and Direct Contract Acquisition Costs

The components of our royalties and direct contract acquisition costs are royalties and expenses directly attributable to revenue. To date, we have generated revenue from the KP415 License Agreement, reimbursement of out-of-pocket third-party costs and the performance of consulting services. In connection with the KP415 License Agreement, we paid Aquestive a royalty equal to 10% of the upfront license payment and all regulatory milestone and royalty payments. In addition, we capitalized incremental costs directly attributable to the KP415 License Agreement, these costs are amortized to royalties and contract costs as revenue is recognized.

Operating Expenses

We classify our operating expenses into three categories: research and development expenses, general and administrative expenses and severance expense. Salaries and personnel-related costs, including benefits, bonuses and stock-based compensation expense, comprise a significant component of each of these expense categories. We allocate expenses associated with our facilities, information technology costs and depreciation and amortization between research and development expenses and general and administrative expenses based on employee headcount and the nature of work performed by each employee.

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Research and Development Expense

Research and development expense consists of expenses incurred while performing research and development activities to discover and develop potential product candidates. This includes conducting preclinical studies and clinical trials, manufacturing development efforts and activities related to regulatory filings for product candidates. We recognize research and development expenses as they are incurred. Our research and development expense primarily consists of:

We typically use our employee, consultant and infrastructure resources across our development programs. We track outsourced development costs by product candidate or development program, but we do not allocate personnel costs, other internal costs or external consultant costs to specific product candidates or development programs.

The following table summarizes our research and development costs for the years ended December 31, 2021, and 2020 (in thousands):

We anticipate that our research and development expense will fluctuate for the foreseeable future as we continue our efforts to advance the development of our product candidates, subject to the availability of additional funding. In accordance with the KP415 License Agreement, Commave has also agreed to be responsible and reimburse us for all of development, commercialization and regulatory expenses for the Licensed Product Candidates, subject to certain limitations as set forth in the KP415 License Agreement.

The successful commercialization of AZSTARYS, APADAZ, and any of our product candidates that may be approved and the development of our product candidates is highly uncertain. At this time, we cannot reasonably estimate the nature, timing or costs required to commercialize AZSTARYS, APADAZ, or any of our product candidates, if approved, and complete the remaining development of any product candidates. This is due to the numerous risks and uncertainties associated with the commercialization and development of our products and product candidates.

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General and Administrative Expense

General and administrative expense consists primarily of salaries and personnel-related costs, including employee benefits and any stock-based compensation, for employees performing functions other than research and development. This includes personnel in executive, finance, human resources and administrative support functions. Other general and administrative expenses include facility-related costs not otherwise allocated to research and development expense, professional fees for auditing, tax and legal services, expenses associated with obtaining and maintaining patents, consulting costs and costs of our information systems.

We expect that our general and administrative expense will fluctuate as we continue to operate as a public reporting company and continue to develop our product candidates. We believe that these fluctuations will likely include costs related to the hiring of additional personnel and fees for outside consultants, lawyers and accountants. We also expect to continue to incur costs to comply with corporate governance, internal control, investor relations, disclosure and similar requirements applicable to public reporting companies.

Severance Expense

Severance expense in 2020 consisted of severance payments and stock-based compensation paid to our former chief business officer who ceased to serve in this role in February 2020. We had no severance expense in 2021.

Other (Expense) Income

Other (expense) income consists primarily of non-cash costs associated with fair value adjustments to our derivative and warrant liability, amortization of debt issuance costs and debt discount to interest expense and a net loss on extinguishment of debt arising primarily from the debt payoff in the first quarter of 2021. Other (expense) income also includes interest expense incurred on our outstanding borrowings as well as interest and other income consisting primarily of interest earned on investments. These items are unrelated to our core business and thus are recognized as other (expense) income in our statements of operations.

Income Tax (Expense) Benefit

Income tax (expense) benefit consists of refundable state income tax credits and adjustments to those credits. To date, we have not been required to pay U.S. federal or state income taxes because we have not generated taxable income. We have received state income tax credits related to our qualified research activities in Iowa. These refundable state income tax credits and adjustments to those credits are recognized as income tax expense (benefit) in our statements of operations, and to the extent the refundable state income tax credits are not collected as of period end, they are recognized as accounts receivable in our balance sheets.

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Results of Operations

Comparison of the Years Ended December 31, 2021 and 2020 (in thousands):

Net Loss

Net loss for the year ended December 31, 2021, was $8.6 million compared to net loss of $12.8 million for the year ended December 31, 2020. The change was primarily attributable to a change in income (loss) from operations of $13.3 million and a decrease in net interest expense and other items of $7.0 million, partially offset by a loss on extinguishment of debt of $16.1 million. In accordance with the January 2021 and June 2021 Inducement Transactions, for the year ended December 31, 2021, we recognized deemed dividends of $37.4 million and $16.9 million, respectively. These deemed dividends represent the difference between the grant date fair value of the respective inducement warrants and the purchase price of the respective inducement warrants. These deemed dividends are added to net loss to arrive at net loss attributable to common stockholders on the statements of operations.

Revenue

Revenue for the year ended December 31, 2021, was $28.7 million, an increase of $15.4 million compared to revenue of $13.3 million for the year ended December 31, 2020. The increase was primarily attributable to an increase in revenue from the KP415 License Agreement of approximately $13.3 million and an increase in revenue from the Corium Consulting Agreement of approximately $3.8 million, partially offset by a decrease in other consulting agreements of approximately $1.7 million.

Royalties and Contract Costs

Royalties and direct contract acquisition costs for the year ended December 31, 2021, was $2.1 million, an increase of $0.8 million compared to royalty and direct contract acquisition costs of $1.3 million for the year ended December 31, 2020. The increase was primarily attributable to an increase in royalty payments related to revenue from the KP415 License Agreement of approximately $1.5 million, partially offset by a decrease in the recognition of capitalized direct contract acquisition costs related to entering into the KP415 License Agreement of approximately $0.7 million.

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Research and Development

Research and development expenses increased by $1.3 million, from $8.8 million for the year ended December 31, 2020, to $10.2 million for the year ended December 31, 2021. This increase was primarily attributable to an increase in third-party research and development costs of $0.9 million, an increase in other research and development costs of $0.3 million and an increase in personnel-related costs of $0.1 million.

General and Administrative

General and administrative expenses increased by $0.8 million, from $7.9 million for the year ended December 31, 2020, to $8.7 million for the year ended December 31, 2021. This increase was primarily attributable to an increase in professional fees of $0.5 million and an increase in personnel-related costs of $0.3 million.

Severance Expense

Severance expense of $0.8 million was recognized for the year ended December 31, 2020, due to the termination of our chief business officer in February 2020. Severance expense is comprised of $0.4 million of personnel and other related charges and $0.4 million of stock compensation expense related to the acceleration of vesting on certain stock options upon employee termination. We had no severance expense for the year ended December 31, 2021.

Other (Expense) Income

Other (expense) income increased by $9.1 million, from $7.2 million for the year ended December 31, 2020, to $16.3 million for the year ended December 31, 2021. This period-to-period increase in expense was primarily attributable to a loss on extinguishment of debt of $16.1 million during the first quarter of 2021, partially offset by a decrease in net interest expense and other items of $7.0 million.

Liquidity and Capital Resources

Sources of Liquidity

Through December 31, 2021, we have funded our research and development and operating activities primarily through the issuance of debt, private placements of redeemable convertible preferred stock and the sale of common stock in our initial public offering, at-the-market offering, underwritten public offerings, through our purchase agreements with Lincoln Park Capital LLC, or Lincoln Park, and from revenue received under the KP415 License Agreement, the Corium Consulting Agreement and other consulting arrangements. As of December 31, 2021, we had cash, cash equivalents and long-term investments of $127.8 million.

To date, we have generated revenue from the KP415 License Agreement, reimbursement of out-of-pocket third-party costs, and the performance of consulting services.

In July 2020, we entered into the Corium Consulting Agreement under which Corium and Commave, respectively, engaged us to guide the product development and regulatory activities for certain current and potential future products in their portfolio, as well as continue supporting preparation for the potential commercial launch of AZSTARYS. Under the Corium Consulting Agreement, we are entitled to receive payments from Corium of up to $15.6 million, $13.6 million of which will be paid in quarterly installments through March 31, 2022. The remaining $2.0 million was conditioned upon the approval by the FDA of the NDA for Corium's product candidate, ADLARITY. This $2.0 million was earned in the first quarter of 2022. Corium also agreed to be responsible for and reimburse us for all development, commercialization and regulatory expenses incurred as part of the performance of the consulting services.

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In February 2020, we entered into the 2020 ELOC Agreement, with Lincoln Park, which provided that, upon the terms and subject to the conditions and limitations set forth therein, we may sell to Lincoln Park up to $4.0 million of shares of our common stock, from time to time over the 12-month term of the 2020 ELOC Agreement, and upon execution of the 2020 ELOC Agreement we issued an additional 19,289 shares of our common stock to Lincoln Park as commitment shares in accordance with the closing conditions contained within the 2020 ELOC Agreement. In May 2020, we reached the maximum allowable shares to be issued under the registration statement on Form S-3 covering the sale from time to time of up to $80.0 million of our common stock, preferred stock, and debt and/or warrants, which was declared effective by the SEC on April 10, 2020, of 579,260 shares and therefore we cannot issue additional shares under the 2020 ELOC Agreement. Through May 2020, we sold 559,971 shares of common stock (exclusive of the 19,289 commitment shares previously issued to Lincoln Park) under the 2020 ELOC Agreement for approximately $2.3 million in gross proceeds.

We have had recurring negative net operating cash flows and we anticipate that we may continue to incur minimal positive net cash flows from operations or negative net cash flows from operations for at least the next several years. We expect that our sources of revenue will be through payments arising from our license agreements with Commave and KVK, or through our Corium Consulting Agreement, and other potential consulting arrangements and any other future arrangements related to one of our product candidates.

In January 2021, we completed the Public Offering. The aggregate gross proceeds to us from the Public Offering, including from the exercises by the underwriter of its over-allotment option, totaled $52.4 million, before deducting underwriting discounts and commissions and offering expenses payable by us.

In January 2021, we entered into the January 2021 Inducement Letters. We received aggregate gross proceeds of $44.0 million from the exercise of the Existing Warrants by the Exercising Holders and the sale of the January 2021 Inducement Warrants.

In April 2020, we received proceeds of $0.8 million from a loan, or the PPP Loan, under the Paycheck Protection Program, or the PPP, of the Coronavirus Aid, Relief, and Economic Security Act, or the CARES Act, which we used to retain current employees, maintain payroll and make lease and utility payments. In May 2021, we received notice from the U.S. Small Business Administration that our PPP Loan was forgiven in full, including all principal and interest.

In June 2021, we entered into the June 2021 Inducement Letters. We received aggregate gross proceeds of $39.1 million for the exercise of the select January 2021 Inducement Warrants by the select warrant holders and the sale of the June 2021 Inducement Warrants.

In July 2021, we entered into the Equity Distribution Agreement with JMP and RBCCM under which we may offer and sell, from time to time at our sole discretion, shares of our common stock, having an aggregate offering price of up to $75.0 million through JMP and RBCCM as its sales agents. The issuance and sale, if any, of our common stock the Equity Distribution Agreement will be made pursuant to a registration statement on Form S-3.

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Convertible Debt

As of December 31, 2021, we had no convertible notes outstanding. During the first quarter of 2021 we repaid in full the convertible notes and terminated the Deerfield Facility Agreement.

Deerfield Facility Agreement

In June 2014, we entered into the Deerfield Facility Agreement as a $60.0 million multi-tranche credit facility with Deerfield. At the time we entered into the Deerfield Facility Agreement, we borrowed the first tranche, which consisted of a $15.0 million term note and the $10.0 million convertible note, or the Deerfield Convertible Note.

The Deerfield Convertible Note originally bore interest at 9.75% per annum but was subsequently reduced to 6.75%. Interest accrued on the outstanding balance under the Deerfield Convertible Note was due quarterly in arrears. We originally had to repay one-third of the outstanding principal amount of the Deerfield Convertible Note on the fourth and fifth anniversaries of the Deerfield Facility Agreement (June 2018 and June 2019). In June 2018, Deerfield agreed to convert approximately $3.3 million of the principal amount then due, plus approximately $0.2 million of accrued interest, into 37,410 shares of our common stock. In September 2019, we entered into an amendment with Deerfield in order to (i) reduce the interest rate applicable under the Deerfield Facility Agreement from 9.75% to 6.75%, (ii) provide for “payment in kind” of interest on the Loans (as defined in the Deerfield Facility Agreement), and (iii) defer the Loan payments due pursuant to the Deerfield Facility Agreement until June 1, 2020. In December 2019, we entered into another amendment with Deerfield in order to (i) defer the Loan payments due pursuant to the Deerfield Facility Agreement until March 31, 2021, and (ii) allow for the entries of additional debt and debt holders under the Deerfield Facility Agreement (as discussed in more detail below).

Pursuant to the Deerfield Facility Agreement, we issued to Deerfield 1,923,077 shares of our Series D redeemable convertible preferred stock, or Series D Preferred, as consideration for the loans provided to us thereunder. Upon closing of our initial public offering, these shares of Series D Preferred reclassified into 256,410 shares of our common stock (effected for the 16-for-1 reverse stock split in December 2020, this became 16,025 shares of our common stock).

We also issued to Deerfield the Deerfield Warrant to purchase 14,423,076 shares of our Series D Preferred at an initial exercise price of $0.78 per share. Upon closing of our initial public offering, this warrant converted into a warrant exercisable for 1,923,077 shares of our common stock at an exercise price of $5.85 per share (effected for the 16-for-1 reverse stock split in December 2020, this became a warrant exercisable for 120,192 shares of our common stock at an exercise price of $93.60 per share). Upon the closing of the January 2021 Inducement Transaction, in accordance with the anti-dilution provisions contained within the Deerfield Warrant, the exercise price of the Deerfield Warrant was reduced to $46.25 per share. Further, upon closing of the June 2021 Inducement Transaction, in accordance with the anti-dilution provisions contained within the Deerfield Warrant, the exercise price of the Deerfield Warrant was reduced to $38.34 per share.

2021 Notes

In February 2016, we issued our 5.50% Senior Convertible Notes due 2021, or the 2021 Notes, in aggregate principal amount of $86.3 million. The 2021 Notes were originally issued to Cowen and Company and RBCCM LLC as representatives of the several initial purchasers, who subsequently resold the 2021 Notes to qualified institutional buyers in reliance on the exemption from registration provided by Rule 144A under the Securities Act.

The 2021 Notes were issued pursuant to an indenture, dated as of February 9, 2016, between us and U.S. Bank National Association, as trustee. Interest on the 2021 Notes was payable semi-annually in cash in arrears on February 1 and August 1 of each year, beginning on August 1, 2016, at a rate of 5.50% per year. The 2021 Notes matured on February 1, 2021, unless earlier converted or repurchased.

In multiple exchanges occurring in October 2018, December 2019 and January 2020, all outstanding 2021 Notes were exchanged by the holders thereof for either shares of our common stock or the December 2019 Notes and January 2020 Note issued under the terms of the Deerfield Facility Agreement.

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2021 Note Exchange Effected in January 2020

In January 2020, we entered into a January 2020 Exchange Agreement, or the January 2020 Exchange Agreement, with M. Kingdon Offshore Master Fund, LP, or Kingdon. Under the January 2020 Exchange Agreement, we issued the January 2020 Note as a senior secured convertible note in the aggregate principal amount of approximately $3.0 million in exchange for the cancellation of an aggregate of approximately $3.0 million of principal amount and accrued interest of the 2021 Note then owned by Kingdon. Upon entering into the January 2020 Exchange Agreement, we agreed to pay Kingdon an interest payment of approximately $37,000, which represents 50% of the accrued and unpaid interest, as of January 13, 2020, on Kingdon’s 2021 Note. The remainder of such interest was included in the principal amount of the January 2020 Note.

The January 2020 Note was issued with substantially the same terms and conditions as the December 2019 Notes (as amended by the amendment described in more detail below).

In connection with entering into the January 2020 Exchange Agreement, we entered into an Amendment to Facility Agreement and December 2019 Notes and Consent, or the December 2019 Note Amendment, with the December 2019 Holders that, among other things, (i) amended the December 2019 Notes to (a) reduce the Conversion Price (as defined in the December 2019 Notes) from $273.76 to $93.60 per share, (b) increased the Floor Price (as defined in the December 2019 Notes) from $6.08 to $9.328 per share, and (ii) amended Deerfield Facility Agreement to (x) provide for Kingdon to join the Deerfield Facility Agreement as a Lender (as defined in the Deerfield Facility Agreement) and (y) provide that the 2020 Note and shall constitute a “Senior Secured Convertible Note” (as defined in the Deerfield Facility Agreement) for purposes of the Deerfield Facility Agreement and other Transaction Documents (as defined in the Deerfield Facility Agreement). As a result of the December 2019 Note Amendment, the December 2019 Notes were convertible, by their terms, into an aggregate of 11,753,016 shares of our common stock, assuming a conversion date of January 13, 2020 (effected for the 16-for-1 reverse stock split in December 2020, this became 734,562 shares of our common stock).

Debt Restructuring

In December 2020, we entered into the December 2020 Exchange Agreement, which was amended on December 24, 2020. Pursuant to the December 2020 Exchange Agreement, (a) we made the Debt Payment as a cash pre-payment of a portion of principal amount of the Senior Secured Notes and the Deerfield Note to the Deerfield Lenders, DSC and Kingdon, or, collectively, the Holders,  in an aggregate amount equal to approximately $30.3 million; and (b) we issued 31,476.98412 shares of our Series B-2 Preferred Stock and warrants exercisable for 3,632,019 shares of our common stock, or the Exchange Warrants, in exchange for the cancellation of a portion of the principal amount of the Senior Secured Notes and Deerfield Note owned by the Holders, with such transaction referred to as the Exchange. Immediately following the completion of the Exchange and Debt Payment, the aggregate balance of principal and accrued interest remaining outstanding under the Facility Notes was approximately $7.6 million.

The December 2020 Exchange Agreement amended the Senior Secured Notes to provide that the failure of our common stock to remain listed on an eligible securities market will not constitute a “Major Transaction” unless such failure occurs after March 31, 2023.

The December 2020 Exchange Agreement amended the Deerfield Facility Agreement in order to, among other things, (i) extend the maturity date of the Senior Secured Notes and the Deerfield Note to March 31, 2023, (ii) provide for cash payments of interest on the Loans (as defined in the Deerfield Facility Agreement) for the periods following July 1, 2021, and (iii) provide for specified prepayment terms on the Loans.

The December 2020 Exchange Agreement amended that certain Amended and Restated Investors’ Rights Agreement, dated as of February 19, 2015, or the IRA, by and among us, Deerfield and the other parties signatory thereto in order to, among other things, add Deerfield Special Situations Fund, L.P. as a party thereto and to give effect to the issuance of the Exchange Warrants and our registration obligations under the December 2020 Exchange Agreement (as described in more detail below).

The Exercise Warrants are subject to substantially the same terms and conditions as the Existing Warrants, with an exercise price equal to the exercise price per share of the Existing Warrants and will provide that the Holders will be limited from exercising such Exchange Warrants if, as a result of such exercise, such holders (together with certain affiliates and “group” members of such holders) would beneficially own more than 4.985% of the total number of shares of our common stock then issued and outstanding.

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Pursuant to the terms of the December 2020 Exchange Agreement, we also filed a registration statement to register for resale under the Securities Act the shares of common stock issuable upon conversion of the shares of Series B-2 Preferred Stock and exercise of the Exchange Warrants.

In connection with the December 2020 Exchange Agreement, we filed an Amended and Restated Certificate of Designation of Preferences, Rights and Limitations of Series B-2 Convertible Preferred Stock, or the Amended and Restated Series B-2 Certificate of Designation, with the Secretary of State of the State of Delaware, setting forth the preferences, rights and limitations of the Series B-2 Preferred Stock.

The shares of Series B-2 Preferred Stock were convertible into an aggregate of 4,842,690 shares of our common stock. Each share of Series B-2 Preferred Stock had an aggregate stated value of $1,000 and was convertible into shares of our common stock at a per share price equal to $6.4999 (subject to adjustment to reflect stock splits and similar events).

In March 2021, all shares of Series B-2 Preferred Stock converted into common stock.

In June 2021, we filed with the Secretary of State of the State of Delaware a Certificate of Elimination of Series B-2 Convertible Preferred Stock, eliminating from our Certificate of Incorporation the 31,480 shares designated as Series B-2 Convertible Preferred Stock.

December 2020 Exchange Agreement Amendment

On January 12, 2021, in connection with the transactions contemplated by the December 2020 Exchange Agreement, we entered into an Amendment to Senior Secured Convertible Notes and Amendment to Warrant, or the January 2021 Amendment, with the Deerfield Holders. The January 2021 Amendment modified certain specified terms of (i) the Facility Notes and (ii) the Deerfield Warrant to, among other things, exclude the transactions contemplated by the December 2020 Exchange Agreement and issuance of securities pursuant to the Underwriting Agreement from the anti-dilution provisions of the Facility Notes and the Deerfield Warrant.

Series B-2 Preferred Stock

On January 11, 2021, as a condition to the closing of the transactions contemplated by the December 2020 Exchange Agreement, we filed an Amended and Restated Certificate of Designation of Preferences, Rights and Limitations of Series B-2 Convertible Preferred Stock, or the Series B-2 Certificate of Designation, with the Secretary of State of the State of Delaware, setting forth the preferences, rights and limitations of the Series B-2 Preferred Stock.

Payoff of Facility Agreement Notes and Termination of Facility Agreement

On February 8, 2021, we entered into a payoff letter with the Facility Agreement Note Holders, pursuant to which we agreed to pay off and thereby terminate the Facility Agreement.

Pursuant to the payoff letter, we paid a total of $8.0 million to the Facility Agreement Note Holders, representing the principal balance, accrued interest outstanding and a prepayment fee in repayment of our outstanding obligations under the Facility Agreement.

Pursuant to the payoff letter, all outstanding indebtedness and obligations owed by us to the Facility Agreement Note Holders under the Facility Agreement have been paid in full. The Facility Agreement and the notes thereunder, as well as the security interests in the assets of us securing the Facility Agreement and note obligations, have been terminated. The Facility Agreement Note Holders will retain the warrants previously issued to them.

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Cash Flows

The following table summarizes our cash flows for the years ended December 31, 2021 and 2020 (in thousands):

Operating Activities

For the year ended December 31, 2021, net cash provided by operating activities of $10.4 million consisted of $19.4 million in adjustments for non-cash items, partially offset by a net loss of $8.6 million and $0.4 million in changes in working capital. The adjustments for non-cash items primarily consisted of a loss on extinguishment of debt of $16.1 million, stock-based compensation expense of $2.4 million, amortization of debt issuance costs and debt discount of $0.2 million, a change in the fair value adjustment related to derivative and warrant liabilities of $0.1 million and $0.6 million related to depreciation, amortization and other items. The changes in working capital consisted of $1.1 million related to a change in accounts payable and accrued expenses, $0.3 million related to a change in operating lease liabilities and $0.8 million related to a change in prepaid expenses and other assets, partially offset by $1.1 million related to a change in accounts and other receivables, $0.1 million related to a change in operating lease right-of-use assets and $0.7 million related to a change in other liabilities. Net loss was primarily attributable to a loss on extinguishment of debt and our spending on research and development programs and operating costs, partially offset by revenue received under the KP415 License Agreement and the Corium Consulting Agreement.

For the year ended December 31, 2020, net cash used in operating activities of $1.9 million consisted of a net loss of $12.8 million, partially offset by $0.4 million in changes in working capital and $10.4 million in adjustments for non-cash items. Net loss was primarily attributable to our spending on research and development programs and operating costs, partially offset by revenue received under the KP415 License Agreement and the Corium Consulting Agreement. The changes in working capital consisted of $0.9 million related to a change in accounts payable and accrued expenses, $0.2 million related to a change in prepaid expenses and other assets and $0.3 million related to operating lease right-of-use assets and other liabilities, partially offset by $0.7 million related to a change in accounts and other receivables and $0.3 million related to operating lease liabilities. The adjustments for non-cash items primarily consisted of stock-based compensation expense of $2.5 million, non-cash interest expense of $4.7 million, amortization of debt issuance costs and debt discount of $2.3 million, loss on sublease and disposal of property and equipment of $0.3 million, a change in the fair value adjustment related to derivative and warrant liabilities of $0.2 million and $0.4 million related to depreciation, amortization and other items.

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Investing Activities

For the year ended December 31, 2021, net cash used in investing activities was $15.5 million, which was attributable to purchases of property and equipment of $0.1 million and purchases of long-term investments of $15.4 million.

For the year ended December 31, 2020, net cash used in investing activities was $33,000, which was attributable to purchases of property and equipment.

Financing Activities

For the year ended December 31, 2021, net cash provided by financing activities was $113.1 million, which was primarily attributable to net proceeds from sales of our common stock in the Public Offering of $49.3 million, net proceeds from the January 2021 Inducement Transaction of $41.4 million, net proceeds from the June 2021 Inducement Transaction of $36.8 million and net proceeds from the exercise of common stock warrants of $30.8 million, partially offset by payment for repurchase of shares of $2.8 million, payment of offering costs of $1.3 million, repayment of principal on finance lease liabilities of $0.2 million, payment of debt issuance costs of $2.9 million, and repayment of principal on convertible notes of $37.9 million.

For the year ended December 31, 2020, net cash provided by financing activities was $2.7 million, which was primarily attributable to proceeds from sales of our common stock under the 2020 ELOC of $2.3 million and proceeds from the PPP loan of $0.8 million, partially offset by repayment of principal on finance lease liabilities of $0.2 million and payment of debt issuance and deferred offerings costs of $0.1 million.

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Future Funding Requirements

Based on our current operating forecast, we believe that our existing cash, cash equivalents and long-term investments will be sufficient to fund our operations through and beyond 2025. This estimate does not include our projected revenue, a portion of which is based on royalties from commercial sales and upon the achievement of milestones in the KP415 License Agreement and the APADAZ License Agreement. Certain of the milestones are associated with regulatory matters that are outside our control.

Potential near-term sources of additional funding include:

We cannot guarantee that we will be able to generate sufficient proceeds from any of these potential sources to fund our operating expenses.

To date, we have generated revenue from the KP415 License Agreement, reimbursements of out-of-pocket third-party costs and the performance of consulting services. We expect that, for the foreseeable future, our only sources of revenues will be through payments arising from the KP415 License Agreement, the APADAZ License Agreement, the Corium Consulting Agreement, or through other potential consulting arrangements and any other future arrangements related to one of our product candidates. While we have entered into the APADAZ License Agreement to commercialize APADAZ in the United States, and entered into the KP415 License Agreement to develop, manufacture and commercialize AZSTARYS and KP484, we cannot guarantee that this, or any strategy we adopt in the future, will be successful. For instance, we received milestone payments under the KP415 License Agreement, but we cannot guarantee that we will earn any additional milestone or royalty payments under this agreement in the future. We also expect to continue to incur additional costs associated with operating as a public company.

The COVID-19 pandemic has caused and continues to cause major disruptions to businesses and markets worldwide. We cannot predict what the long-term effects of this pandemic and the resulting economic disruptions may have on our liquidity and results of operations. The extent of the effect of the COVID-19 pandemic on our liquidity and results of operations will depend on a number of future developments, including the duration, spread and intensity of the pandemic, and governmental, regulatory and private sector responses, all of which are uncertain and difficult to predict. The COVID-19 pandemic may make it more difficult for us to enroll patients in any future clinical trials or cause delays in the regulatory approval of our product candidates. A portion of our projected revenue is based upon the achievement of milestones in the KP415 License Agreement associated with regulatory matters that may be impacted by the COVID-19 pandemic. As a result, we cannot predict what, if any, impact that the COVID-19 pandemic may have on our ability to achieve these milestones. The economic uncertainty surrounding the COVID-19 pandemic may also dramatically reduce our ability to secure debt or equity financing necessary to support our operations. We are unable to currently estimate the financial effect of the pandemic. If the pandemic continues to be a severe worldwide crisis, it could have a material adverse effect on our business, results of operations, financial condition, and cash flows.

We have based our estimates of our cash needs and cash runway on assumptions that may prove to be wrong, and we may use our available capital resources sooner than we currently expect and we cannot guarantee that we will be able to generate sufficient proceeds from the KP415 License Agreement, the APADAZ License Agreement, the Corium Consulting Agreement, and other potential consulting arrangements or other funding transactions to fund our operating expenses. To meet any additional cash requirements, we may seek to sell additional equity or convertible securities that may result in dilution to our stockholders, issue additional debt or seek other third-party funding, including potential strategic transactions, such as licensing or collaboration arrangements. Because of the numerous risks and uncertainties associated with the development and commercialization of product candidates and products, we are unable to estimate the amounts of increased capital outlays and operating expenditures necessary to complete the commercialization and development of our partnered product or product candidates, should they obtain regulatory approval.

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Critical Accounting Policies and Significant Judgements and Estimates

This management’s discussion and analysis of our financial condition and results of operations is based on our financial statements, which we have prepared in accordance with accounting principles generally accepted in the United States. The preparation of our financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of our financial statements, as well as the reported revenues and expenses during the reported periods. We evaluate these estimates and judgements on an ongoing basis. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgements about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

While our significant accounting policies are more fully described in Note B to our audited financial statements appearing elsewhere in this Annual Report on Form 10-K, we believe that the following accounting policies are critical to the process of making significant judgments and estimates in the preparation of our financial statements and understanding and evaluating our reported financial results.

Accrued Expenses

We enter into contractual agreements with third-party vendors who provide research and development, manufacturing, and other services in the ordinary course of business. Some of these contracts are subject to milestone-based invoicing and services are completed over an extended period of time. We record liabilities under these contractual commitments when an obligation has been incurred. This accrual process involves reviewing open contracts and purchase orders, communicating with our applicable personnel to identify services that have been performed and estimating the level of service performed and the associated cost when we have not yet been invoiced or otherwise notified of actual cost. The majority of our service providers invoice us monthly in arrears for services performed. We make estimates of our accrued expenses as of each balance sheet date based on the facts and circumstances known to us. We periodically confirm the accuracy of our estimates with the service providers and make adjustments if necessary. Examples of estimated accrued expenses include:

We base our expenses related to clinical trials on our estimates of the services received and efforts expended pursuant to contracts with multiple research institutions and CROs that conduct and manage clinical trials on our behalf. The financial terms of these agreements are subject to negotiation, vary from contract to contract and may result in uneven payment flows. Payments under some of these contracts depend on factors such as the successful enrollment of patients and the completion of clinical trial milestones. In accruing service fees, we estimate the time period over which services will be performed and the level of effort expended in each period. If the actual timing of the performance of services or the level of effort varies from our estimate, we will adjust the accrual accordingly. If we do not identify costs that we have begun to incur or if we underestimate or overestimate the level of these costs, our actual expenses could differ from our estimates.

Stock-Based Compensation

We record the fair value of stock options issued as of the grant date as compensation expense. We recognize compensation expense over the requisite service period, which is equal to the vesting period. Stock-based compensation expense has been reported in our statements of operations as follows (in thousands):

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Determination of the Fair Value of Stock-Based Compensation Grants

We calculate the fair value of stock-based compensation arrangements using the Black-Scholes option-pricing model. The Black-Scholes option-pricing model requires the use of subjective assumptions, including the expected volatility of our common stock, the assumed dividend yield, the expected term of our stock options, the risk-free interest rate for a period that approximates the expected term of our stock options and the fair value of the underlying common stock on the date of grant. In applying these assumptions, we considered the following factors:

We account for stock-based compensation arrangements with directors and consultants that contain only service conditions for vesting using a fair value approach. The grant date fair value of these options is measured using the Black-Scholes option pricing model reflecting the same assumptions as applied to employee options in each of the reported periods, other than the expected life, which is assumed to be the remaining contractual life of the option.

The following summarizes the assumptions used for estimating the fair value of stock options granted to employees for the periods indicated:

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Fair Value of Financial Instruments

We have a common stock warrant issued to Deerfield, put options embedded within those Deerfield warrants, and common stock warrants issued to KVK that meet the definition of derivative financial instruments and are accounted for as derivatives. The fair value of the common stock warrant issued to Deerfield, and put options embedded within the Deerfield Warrants are based on Monte Carlo simulations, while the common stock warrant issued to KVK is valued using a probability-weighted Black-Scholes option pricing model. These derivatives are fair valued at each reporting period.

The derivative liability for the Deerfield common stock warrant was $288,000 and $230,000 at December 31, 2021 and 2020, respectively. The derivative liability for the put options embedded within the Deerfield common stock warrant was $18,000 and $25,000 at December 31, 2021 and 2020, respectively. The derivative liability for the KVK common stock warrant was $24,000 and $49,000 at December 31, 2021 and 2020, respectively. A 10% increase in the enterprise value would result in an increase of $50,000 in the estimated fair value of the Deerfield common stock warrant, an increase of $3,000 in the estimated fair value of the put options embedded within the Deerfield common stock warrant and an increase of $4,000 in the estimated fair value of the KVK common stock warrant at December 31, 2021. Upon exercise of the warrants, we will adjust the associated derivative liability to fair value with any changes recorded in other (expense) income. At such time, such derivative liability will also be reclassified to additional paid-in capital, and no further revaluations will be necessary.

Utilization of Net Operating Loss Carryforwards and Research and Development Credits

As of December 31, 2021, we had federal net operating loss, or NOL, carryforwards of approximately $233.3 million, due to prior period losses, $138.1 million of which, if not utilized, will begin to expire in 2027 and $95.1 million with no expiration. We also had research and development credit carryforwards of $3.8 million with expiration dates ranging from 2027 to 2037 and $2.6 million with no expiration. As of December 31, 2021, we maintain a full valuation allowance over our deferred tax assets for financial reporting purposes.

In accordance with Section 382 of the Code, a change in equity ownership of greater than 50% within a three-year period results in an annual limitation on a company’s ability to utilize its NOL carryforwards created during the tax periods prior to the change in ownership. We performed a Section 382 ownership change analysis in 2017 and determined that we experienced an ownership change in 2010, which resulted in a portion of our net operating loss carryforwards being subject to an annual limitation under Section 382 through 2012. No other ownership changes or limitations on our historical net operating loss carryforwards were noted through the year ended December 31, 2017. In addition, we may have already experienced an ownership change, or may experience an ownership changes in the future, as a result of shifts in our stock ownership, including as a result of the conversion of our outstanding convertible debt or as a result of changes in our stock ownership. If we determine that an ownership change has occurred and our ability to use our historical net operating loss carryforwards is materially limited, it would harm our future operating results by increasing our future tax obligations.

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Recent Accounting Pronouncements

In June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326)—Measurement of Credit Losses on Financial Instruments, or ASU 2016-13, which replaces the incurred loss impairment methodology with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. This update applies to all entities holding financial assets and net investment in leases that are not accounted for at fair value through net income. The amendments affect loans, debt securities, trade receivables, net investments in leases, off-balance-sheet credit exposures, reinsurance receivables, and any other financial assets not excluded from the scope that have the contractual right to receive cash. This guidance is effective for financial statements issued for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. The adoption of ASU 2016-13 did not have a material impact on our financial statements and disclosures.

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820)—Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement, or ASU 2018-13, which modifies the disclosure requirements on fair value measurements in Topic 820, Fair Value Measurement, based on the concepts in the FASB Concepts Statement, Conceptual Framework for Financial Reporting—Chapter 8: Notes to Financial Statements, which the FASB finalized on August 28, 2018, including the consideration of costs and benefits. This update applies to all entities that are required, under existing U.S. GAAP, to make disclosures about recurring or nonrecurring fair value measurements. This guidance is effective for financial statements issued for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. The amendments on changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements, and the narrative description of measurement uncertainty should be applied prospectively for only the most recent interim or annual period presented in the initial fiscal year of adoption. All other amendments should be applied retrospectively to all periods presented upon their effective date. The adoption of ASU 2018-13 did not have a material impact on our financial statements and disclosures.

In August 2020, the FASB issued ASU 2020-06, Debt—Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging—Contracts in Entity’s Own Equity (Subtopic 815-40); Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity, or ASU 2020-06, which addresses issues identified as a result of the complexities associated with applying U.S. GAAP for certain financial instruments with characteristics of liabilities and equity. This update addresses, among other things, the number of accounting models for convertible debt instruments and convertible preferred stock, targeted improvements to the disclosures for convertible instruments and earnings-per-share, or EPS, guidance and amendments to the guidance for the derivatives scope exception for contracts in an entity’s own equity, as well as the related EPS guidance. This update applies to all entities that issue convertible instruments and/or contracts in an entity’s own equity. This guidance is effective for financial statements issued for fiscal years beginning after December 15, 2021, and interim periods within those fiscal years. FASB specified that an entity should adopt the guidance as of the beginning of its annual fiscal year. We do not believe the adoption of ASU 2020-06 will have a material impact on our financial statements and disclosures.

In May 2021, the FASB issued ASU 2021-04, Earnings Per Share (Topic 260), Debt— Modifications and Extinguishments (Subtopic 470-50), Compensation—Stock Compensation (Topic 718), and Derivatives and Hedging— Contracts in Entity’s Own Equity (Subtopic 815-40); Issuer’s Accounting for Certain Modifications or Exchanges of Freestanding Equity-Classified Written Call Options, a consensus of the FASB Emerging Issues Task Force, or ASU 2021-04, which aims to clarify and reduce diversity in issuer's accounting for modifications or exchanges of freestanding equity-classified written call options that remain equity classified after modification or exchange. This update applies to all entities that issue freestanding written call options that are classified in equity. This guidance is effective for financial statements issued for fiscal years beginning after December 15, 2021, and interim periods within those fiscal years. FASB specified that an entity should adopt the guidance as of the beginning of its annual fiscal year. We do not believe the adoption of ASU 2021-04 will have a material impact on our financial statements and disclosures.

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