UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-Q

 

For the quarterly period ended September 30, 2018

or

For the transition period from            to           

Commission File Number 001-36668

 

DERMIRA, INC.

(Exact name of registrant as specified in its charter)

 

 

 

275 Middlefield Road, Suite 150

Menlo Park, CA 94025

(Address of principal executive offices) (Zip Code)

(650) 421-7200

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).     Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes ☐    No ☒

As of October 31, 2018, the registrant had 42,120,870 shares of common stock outstanding.

 

 

 

 

 

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Dermira, Inc.

Quarterly Report on Form 10-Q

Index

 

 

 

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PART I. FINANCIAL INFORMATION

DERMIRA, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

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DERMIRA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

(unaudited)

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

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DERMIRA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(in thousands)

(unaudited)

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

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DERMIRA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

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DERMIRA, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

1. Organization

We are a biopharmaceutical company dedicated to bringing biotech ingenuity to medical dermatology by delivering differentiated, new therapies to the millions of patients living with chronic skin conditions. We are committed to understanding the needs of both patients and physicians and using our insight to identify, develop and commercialize leading-edge medical dermatology clinical programs. Our approved treatment, QBREXZA™ (glycopyrronium) cloth (“QBREXZA”), is indicated for pediatric and adult patients (ages nine and older) with primary axillary hyperhidrosis (excessive underarm sweating). We are also evaluating lebrikizumab in a Phase 2b clinical trial for the treatment of moderate-to-severe atopic dermatitis (a severe form of eczema) and have early-stage research programs in other areas of dermatology. We are headquartered in Menlo Park, California.

 

2. Summary of Significant Accounting Policies

Basis of Presentation

Our condensed consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles (“U.S. GAAP”) and applicable rules and regulations of the U.S. Securities and Exchange Commission (“SEC”) for interim reporting. As permitted under those rules and regulations, certain footnotes or other financial information normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted. These condensed consolidated financial statements have been prepared on the same basis as our annual consolidated financial statements and, in the opinion of our management, reflect all adjustments, consisting only of normal recurring adjustments, which are necessary for a fair presentation of our financial information. The results of operations for the three- and nine-month periods ended September 30, 2018 are not necessarily indicative of the results to be expected for the full year ending December 31, 2018 or any other future period. The condensed consolidated balance sheet as of December 31, 2017 has been derived from audited consolidated financial statements at that date but does not include all of the information required by U.S. GAAP for complete financial statements. See “Recent Accounting Pronouncements” below for discussion of our adoption of the new revenue recognition guidance.

The accompanying condensed consolidated financial statements include the accounts of our wholly owned subsidiary, Dermira Canada. All intercompany accounts and transactions have been eliminated in consolidation.

The accompanying condensed consolidated financial statements and related financial information should be read in conjunction with our audited consolidated financial statements and the related notes thereto for the year ended December 31, 2017 included in our Annual Report on Form 10-K, filed with the SEC on February 22, 2018.

Use of Estimates

The preparation of condensed consolidated financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the condensed consolidated financial statements and reported amounts of revenues and expenses during the reporting periods. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition and variable consideration, inventory, acquired in-process research and development, investments, accrued research and development expenses, goodwill, intangible assets, other long-lived assets, stock-based compensation and the valuation of deferred tax assets. We base our estimates on our historical experience and also on assumptions that we believe are reasonable; however, actual results could significantly differ from those estimates.

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Restricted Cash

Restricted cash primarily consists of letters of credit collateralized by a money market account pursuant to certain lease and sublease agreements. Cash and cash equivalents and restricted cash as reported within the condensed consolidated statements of cash flows for the nine months ended September 30, 2018 and 2017 consisted of the following (in thousands):

 

 

Inventory

Inventory consists of raw materials, work-in-process and finished goods. Inventory costs are determined using the lower of standard cost, which approximates the actual costs determined using the first-in, first-out basis, or net realizable value. Standard costs are reviewed and updated annually or as needed. We expense costs associated with the manufacture of our products prior to regulatory approval and capitalize the cost of inventory when there is a high probability of future economic benefit. We began capitalizing the cost of inventory related to QBREXZA in the second quarter of 2018, the period in which we received regulatory approval to market the product. We are expensing costs associated with the manufacture of our lebrikizumab product candidate.

We review all inventory balances on a quarterly basis for impairment and recognize any reduction in value as a current period expense with a reserve provision on the consolidated balance sheets. If the conditions that caused the impairment were to be resolved in a subsequent period, the reserve provision would not be reversed until the related inventory was sold or otherwise disposed.

Revenue Recognition

Effective January 1, 2018, we adopted Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606) (“Topic 606” or “ASU 2014-09”) using the modified retrospective method which consisted of applying and recognizing the cumulative effect of Topic 606 at the date of initial application. Topic 606 supersedes the revenue recognition requirements in Accounting Standards Codification (“ASC”) Topic 605, Revenue Recognition (“Topic 605”), including most industry-specific revenue recognition guidance throughout the Industry Topics of the ASC. All periods prior to the adoption date of Topic 606 have not been restated to reflect the impact of the adoption of Topic 606, but continue to be accounted for and presented under Topic 605.

The following paragraphs in this section describe our revenue recognition accounting polices under Topic 606 upon adoption on January 1, 2018. Refer to Note 2 to the consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2017 for revenue recognition accounting policies under Topic 605.

We recognize revenue when we transfer promised goods or services to customers in an amount that reflects the consideration to which we expect to be entitled in exchange for those goods or services. To determine revenue recognition for contracts with customers we perform the following five steps: (i) identify the contract(s) with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when (or as) we satisfy the performance obligations. At contract inception, we assess the goods or services promised within each contract and assess whether each promised good or service is distinct and determine those that are performance obligations. We then recognize as revenue the amount of the transaction price that is allocated to the respective performance obligation when (or as) the performance obligation is satisfied.

Product Sales

Our product sales consist of sales of QBREXZA within the United States. Following the approval of QBREXZA by the U.S. Food and Drug Administration (“FDA”) in June 2018 and, in advance of the availability of QBREXZA in pharmacies on October 1, 2018, we commenced shipments of QBREXZA in September 2018 to wholesalers and a preferred dispensing partner (together, “Customers”) for distribution to pharmacies and patients. We recognize revenue from product sales when our Customers obtain control of our product, which is generally upon delivery.

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Product sales are recognized at the transaction price, net of estimates of variable consideration, including commercial rebates, discounts related to a patient savings card program, distribution fees, trade discounts, government rebates and chargebacks and product returns. Variable consideration amounts are estimated at contract inception using the expected-value method and updated at the end of each reporting period as additional information becomes available. The amounts of variable consideration are included in the transaction price only to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is resolved. Estimates and assumptions are updated quarterly and if actual future results vary materially from estimates, we will record an adjustment, which could impact product sales and earnings in the period of adjustment.

The following items of variable consideration are recorded at the time of revenue recognition and require significant estimates and judgment.

Commercial rebates and savings card program. We contract with certain third-party payers for the payment of rebates with respect to the utilization of QBREXZA. Rebates to these payers are based on contractual percentages applied to the amount of QBREXZA prescribed to patients who are covered by the plan or the organization with which we have contracts. We estimate and record rebates as a reduction to the transaction price in the same period the related product sales are recognized. We estimate commercial rebates based on contractual terms, estimated payer mix, industry information and other third-party data. We also have a savings card program to provide assistance to eligible patients with out-of-pocket costs, such as deductibles, co-insurance and co-payments, for the patient’s usage of QBREXZA. Reductions to product sales for the savings card program are estimated based on actual and expected program utilization.

Distribution fees and trade discounts.  We pay our Customers certain fees for distribution services for QBREXZA. We determined that such distribution services are not distinct from our sales of QBREXZA and the related fees are recorded as a reduction to the transaction price in the period the related product sales are recognized. Distribution fees are recorded based on contractual terms. We also incentivize prompt payment from our Customers by providing a discount for payments made within a certain number of days.

Government rebates and chargebacks.  We are subject to discount obligations under state Medicaid programs, Medicare and other government programs. Reserves for these rebates and chargebacks are recorded as a reduction to the transaction price in the period the related product sales are recognized. Chargeback amounts represent credit we expect to issue to our Customers and are recorded as a reduction to trade and other receivables, net. Reductions to product sales for government managed programs are estimated based on statutorily-defined discounts, estimated payer mix, expected sales to qualified healthcare providers and expected utilization.

Product returns.  Our product return policy provides our Customers the right to return QBREXZA, generally based on its expiration date. The reserve for product returns is recorded as a reduction to the transaction price in the period the related product sales are recognized. We estimate product returns using third-party input and market data for products with characteristics similar to QBREXZA.

Collaborative Arrangements

We enter into collaborative arrangements with partners that typically include payment to us of one of more of the following: (i) license fees; (ii) milestone payments related to the achievement of developmental, regulatory, or commercial goals; and (iii) royalties on net sales of licensed products. Where a portion of non‑refundable up-front fees or other payments received are allocated to continuing performance obligations under the terms of a collaborative arrangement, they are recorded as deferred revenue and recognized as revenue when (or as) the underlying performance obligation is satisfied.

As part of the accounting for these arrangements, we must develop estimates and assumptions that require judgment to determine the underlying stand-alone selling price for each performance obligation which determines how the transaction price is allocated among the performance obligation. The stand-alone selling price may include items such as forecasted revenues, development timelines, discount rates, and probabilities of technical and regulatory success. We evaluate each performance obligation to determine if it can be satisfied at a point in time or over time. In addition, variable consideration must be evaluated to determine if it is constrained and, therefore, excluded from the transaction price.

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License Fees

If a license to our intellectual property is determined to be distinct from the other performance obligations identified in the arrangement, we recognize revenues from non-refundable, up-front fees allocated to the license when the license is transferred to the licensee and the licensee is able to use and benefit from the license. For licenses that are bundled with other promises, we utilize judgment to assess the nature of the combined performance obligation to determine whether the combined performance obligation is satisfied over time or at a point in time and, if over time, the appropriate method of measuring progress for purposes of recognizing revenue. We evaluate the measure of progress each reporting period and, if necessary, adjust the measure of performance and related revenue recognition.

Milestone Payments

At the inception of each arrangement that includes milestone payments (variable consideration), we evaluate whether the milestones are considered probable of being reached and estimate the amount to be included in the transaction price using the most likely amount method. If it is probable that a significant revenue reversal would not occur, the associated milestone value is included in the transaction price. Milestone payments that are not within our or our collaboration partner’s control, such as regulatory approvals, are generally not considered probable of being achieved until those approvals are received. The transaction price is then allocated to each performance obligation on a relative stand-alone selling price basis, for which we recognize revenue as or when the performance obligations under the contract are satisfied. At the end of each subsequent reporting period, we re-evaluate the probability of achievement of such milestones and any related constraint, and if necessary, adjust our estimate of the overall transaction price. Any such adjustments are recorded on a cumulative catch-up basis, which would affect license, collaboration or other revenues and earnings in the period of adjustment.

Royalties

For arrangements that include sales-based royalties, including milestone payments based on the level of sales, and for which the license is deemed to be the predominant item to which the royalties relate, we recognize revenue at the later of (i) when the related sales occur, or (ii) when the performance obligation to which some or all of the royalty has been allocated has been satisfied (or partially satisfied). To date, we have not recognized any royalty revenue resulting from any of our collaborative arrangements.

Under certain collaborative arrangements, we have been reimbursed for a portion of our research and development (“R&D”) expenses, including costs of drug supplies. When these R&D services are performed under a reimbursement or cost sharing model with our collaboration partner, we record these reimbursements as a reduction of R&D expense in our consolidated statements of operations.

Advertising Expenses

We expense the costs of advertising as incurred. Advertising expenses were $15.0 million and $36.5 million for the three and nine months ended September 30, 2018, respectively. Advertising expenses were immaterial for the three and nine months ended September 30, 2017.

Net Loss Per Share

Basic net loss per share is calculated by dividing the net loss by the weighted-average number of shares of common stock outstanding during the period, without consideration for dilutive potential shares of common stock. Diluted net loss per share is the same as basic net loss per share, since the effects of potentially dilutive securities are antidilutive for all periods presented.

The following common stock equivalent shares were not included in the computations of diluted net loss per share for the periods presented because their effect was antidilutive (in thousands):

 

 

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Recent Accounting Pronouncements

In August 2018, the Financial Accounting Standards Board (“FASB”) issued ASU 2018-13, Fair Value Measurement Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement (“ASU 2018-13”), which amends certain disclosure requirements over Level 1, Level 2 and Level 3 fair value measurements. ASU 2018-13 is effective for fiscal years beginning after December 15, 2019 and interim periods within those fiscal years. Early adoption is permitted. We are currently evaluating the impact of adopting ASU 2018-13, but do not anticipate it will have a material impact on our disclosures.

In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash (“ASU 2016-18”), which requires that the statement of cash flows explain the change in the total amount of restricted cash during the period and other additional disclosures. We adopted ASU 2016-18 in the first quarter of 2018 using the retrospective transition method by restating our condensed consolidated statements of cash flows to include restricted cash balances. Net cash flows for the nine months ended September 30, 2018 and 2017 did not change as a result of adopting ASU 2016-18.

In February 2016, the FASB issued ASU 2016-02, Leases (“ASU 2016-02”). ASU 2016-02 is aimed at making leasing activities more transparent and comparable, and requires lessees to recognize substantially all leases on their balance sheet as a right-of-use asset and a corresponding lease liability, including leases currently accounted for as operating leases. We will adopt ASU 2016-02 on January 1, 2019. We anticipate recognizing a right-of-use asset and a lease liability on our consolidated balance sheet for the discounted value of future lease payments from the adoption of this ASU. As of September 30, 2018, we had aggregate future minimum lease payments of approximately $20.4 million. We are currently evaluating the full impact that the adoption of ASU 2016-02 will have on our consolidated financial statements and related disclosures.

As noted above, effective January 1, 2018, we adopted Topic 606. Since ASU 2014-09 was issued, several additional ASUs have been issued and incorporated within Topic 606 to clarify various elements of the guidance. As part of our adoption efforts, we completed the assessment of our collaboration and license agreements under Topic 606. We adopted Topic 606 in the first quarter of 2018 using the modified retrospective method which consists of applying and recognizing the cumulative effect of Topic 606 at the date of initial application and providing certain additional disclosures as defined per Topic 606. On January 1, 2018, we recorded a cumulative adjustment to decrease deferred revenue and accumulated deficit by approximately $29.9 million, to reflect the impact of the adoption of Topic 606. The cumulative adjustment related primarily to our agreements with Maruho Co., Ltd. (“Maruho”) which are described further in Note 7 Collaboration and License Agreements.

Below is a summary of the affected line items of the condensed consolidated balance sheets upon adoption of Topic 606 (in thousands):

 

 

As a result of adopting Topic 606 on January 1, 2018 under the modified retrospective method, we did not revise the comparative financial statements for the prior years as if Topic 606 had been effective for those periods. Below is disclosure of what our collaboration and license revenue would have been in the three and nine months ended September 30, 2018 under Topic 605 (in thousands):

 

 

Our product sales revenue under Topic 606 would not have been materially different under Topic 605.

 

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3. Fair Value Measurements

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value should maximize the use of observable inputs and minimize the use of unobservable inputs. The accounting guidance for fair value establishes a three-level hierarchy for disclosure of fair value measurements, as follows:

Level 1—Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date.

Level 2—Inputs (other than quoted market prices included in Level 1) that are either directly or indirectly observable, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the instrument’s anticipated life.

Level 3—Unobservable inputs that are supported by little or no market activity and reflect our best estimate of what market participants would use in pricing the asset or liability at the measurement date. Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model.

A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

Where quoted prices are available in an active market, securities are classified as Level 1. When quoted market prices are not available for the specific security, then we estimate fair value by using quoted prices for identical or similar instruments in markets that are not active and model‑based valuation techniques for which all significant inputs are observable in the market or can be corroborated by observable market data for substantially the full term of the assets. Where applicable, these models project future cash flows and discount the future amounts to a present value using market‑based observable inputs obtained from various third‑party data providers, including but not limited to benchmark yields, reported trades and broker/dealer quotes. There were no transfers between Level 1 and Level 2 during the periods presented.

The following tables set forth the fair value of our financial assets, which consists of investments classified as available-for-sale securities, that were measured on a recurring basis (in thousands):

 

 

 

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As of September 30, 2018, we did not hold any investments with a maturity exceeding two years or that have been in a continuous loss position for 12 months or more. We do not intend to sell the securities that are in an unrealized loss position and we believe it is more likely than not that the investments will be held until recovery of the amortized cost bases. We have determined that the gross unrealized losses on our securities as of September 30, 2018 were temporary in nature.

The estimated fair value of our convertible notes was $238.6 million as of September 30, 2018 and was based upon observable, Level 2 inputs, including pricing information from recent trades of the convertible notes as of September 30, 2018.

See Note 7 for information relating to payments which were measured using unobservable, Level 3 inputs, including a discount rate.

 

4. Accrued Liabilities

Accrued liabilities consisted of the following (in thousands):

 

 

5. Impairment of in-process research and development

In connection with the acquisition of Valocor Therapeutics, Inc. (“Valocor”) in 2011, we acquired intangible assets that were associated with in-process research and development (“IPR&D”) projects relating to preclinical product candidates. These assets are considered to be indefinite‑lived and are not amortized, but are tested for impairment on an annual basis, as well as between annual tests if there are changes in circumstances that would indicate a reduction in the fair value of the IPR&D projects below their respective carrying amounts. If and when development is complete, the associated assets would be deemed finite‑lived and would then be amortized based on their respective estimated useful lives. In March 2018, we received results that the investigational treatment olumacostat glasaretil (formerly DRM01) did not meet the co-primary endpoints in its two Phase 3 pivotal trials (CLAREOS-1 and CLAREOS-2) in patients ages nine years and older with moderate-to-severe acne vulgaris. We determined that the intangible assets related to this product candidate were considered to be impaired and recorded an impairment charge of $1.1 million to IPR&D in the condensed consolidated statements of operations during the first quarter of 2018.

 

6. Convertible Notes

In May 2017, we sold $287.5 million aggregate principal amount of 3.00% Convertible Senior Notes due 2022 (“Notes”) in a private placement. We received net proceeds of $278.3 million, after deducting the initial purchasers’ discounts of $8.6 million and issuance costs of $0.6 million. The Notes were issued pursuant to an Indenture, dated as of May 16, 2017 (the “Indenture”), between us and U.S. Bank National Association, as trustee. The Notes are senior, unsecured obligations and bear interest at a rate of 3.00% per year, payable in cash semi-annually in arrears on May 15 and November 15 of each year, beginning on November 15, 2017. The Notes mature on May 15, 2022, unless earlier converted or repurchased in accordance with their terms.

The Notes are convertible into shares of our common stock, par value $0.001 per share, at an initial conversion rate of 28.2079 shares of common stock per $1,000 principal amount of the Notes, which is equivalent to an initial conversion price of approximately $35.45 per share of common stock. The conversion rate and the corresponding conversion price are subject to adjustment upon the occurrence of certain events, but will not be adjusted for any accrued and unpaid interest. Holders of the Notes who convert their Notes in connection with a make-whole fundamental change (as defined in the Indenture) are, under certain circumstances, entitled to an increase in the conversion rate. Additionally, in the event of a fundamental change, holders of the Notes may require us to repurchase all or a portion of their Notes at a price equal to 100% of the principal amount of Notes, plus any accrued and unpaid interest, including any additional interest to, but excluding, the repurchase date. Holders of the Notes may convert all or a portion of their Notes at their option at any time prior to the close of business on the business day immediately prior to May 15, 2022, in multiples of $1,000 principal amount.

As of September 30, 2018, there were unamortized issuance costs and debt discounts of $6.7 million, which were recorded as a direct deduction from the Notes on the condensed consolidated balance sheets.

 

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7. Collaboration and License Agreements

Maruho Agreements

In March 2013, we entered into a Right of First Negotiation Agreement with Maruho Co., Ltd. (“Maruho Right of First Negotiation Agreement”), pursuant to which we provided Maruho with certain information and the right to negotiate an exclusive license to develop and commercialize certain of our products in specified territories. In connection with the entry into this agreement, Maruho paid us $10.0 million (“Maruho Payment”), which would be credited against certain payments payable by Maruho to us if we were to enter into a license agreement for any of our products. Maruho’s right of first negotiation expired in December 2016 but the right to credit the Maruho Payment against certain payments under any future license agreement for our products remains. We concluded that there are no remaining performance obligations under Topic 606 as of the date of the adoption. As a result, a cumulative adjustment to reduce deferred revenue of $10.0 million was recorded upon the adoption of Topic 606 on January 1, 2018. As of September 30, 2018, we do not have a deferred revenue balance related to the Maruho Right of First Negotiation Agreement on the condensed consolidated balance sheets.

In September 2016, we entered into an Exclusive License Agreement with Maruho, which grants Maruho an exclusive license to develop and commercialize glycopyrronium tosylate for the treatment of hyperhidrosis in Japan (“Maruho G.T. Agreement”). Pursuant to the terms of the Maruho G.T. Agreement, we received an upfront payment of $25.0 million from Maruho in October 2016 and are eligible to receive additional payments totaling up to $70.0 million, contingent upon the achievement of certain milestones associated with submission and approval of a marketing application in Japan and certain sales thresholds, as well as royalty payments based on a percentage of net product sales in Japan. The Maruho G.T. Agreement further provides that Maruho will be responsible for funding all development and commercial costs for the program in Japan and, until such time, if any, as Maruho elects to establish its own source of supply of drug product, Maruho will purchase product supply from us for development and, if applicable, commercial purposes at cost. The Maruho G.T. Agreement is unrelated to, and the exclusive license of glycopyrronium tosylate in Japan to Maruho was not subject to the terms of, the existing Maruho Right of First Negotiation Agreement.

Under Topic 606, we evaluated the terms of the Maruho G.T. Agreement and the transfer of intellectual property rights (the “license”) was identified as the only performance obligation as of the inception of the agreement. We concluded that the license for the intellectual property was distinct from our ongoing manufacturing obligations. We further determined that the transaction price under the arrangement was comprised of the $25.0 million upfront payment. The future potential milestone amounts were not included in the transaction price, as they were all determined to be fully constrained. As part of our evaluation of the development and regulatory milestones constraint, we determined that the achievement of such milestones is contingent upon success in future clinical trials and regulatory approvals, each of which is uncertain at this time. We will re-evaluate the transaction price each quarter and as uncertain events are resolved or other changes in circumstances occur. Future potential milestone amounts would be recognized as revenue from collaboration arrangements, if unconstrained. Reimbursable program costs are recognized proportionately with the performance of the underlying services or delivery of drug substance and are accounted for as reductions to R&D expense and are excluded from the transaction price.

Unless earlier terminated, the Maruho G.T. Agreement will remain in effect until the later of: (1) expiration or abandonment of the last valid claim of the applicable patent rights in Japan; (2) expiration of any market exclusivity in Japan granted by the applicable regulatory authority; and (3) 15 years following the date of the first commercial sale of the drug product in Japan.

Under Topic 606, the entire transaction price of $25.0 million was allocated to the license performance obligation. The license was deemed to be delivered in 2016 in connection with the execution of the agreement and the performance obligation was fully satisfied. As a result, a cumulative adjustment to reduce deferred revenue of $19.6 million was recorded upon the adoption of Topic 606 on January 1, 2018. As of September 30, 2018, we do not have a deferred revenue balance related to the Maruho G.T. Agreement on the condensed consolidated balance sheet.

UCB Agreements

In March 2014, we and UCB Pharma S.A. (“UCB”), entered into a Development and Commercialisation Agreement, dated March 21, 2014 (“UCB Agreement”), which provided that we would (a) develop Cimzia (certolizumab pegol) for the treatment of psoriasis in order for UCB to seek regulatory approval from the U.S. Food and Drug Administration (“FDA”), the European Medicines Agency and the Canadian federal department for health, and (b) upon the grant of regulatory approval in the United States and Canada, promote sales of Cimzia to dermatologists and conduct related medical affairs activities in the United States and Canada. The UCB Agreement also provided either party with the right to terminate the agreement under certain terms. We expressed our intent to terminate the UCB Agreement in accordance with its terms.

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As a result, we and UCB entered into an agreement on November 6, 2017 to effect the termination of the UCB Agreement and an orderly transition of the development and commercialization activities under the UCB Agreement from us to UCB (“Transition Agreement”). The Transition Agreement, among other things, (a) terminated the UCB Agreement on February 15, 2018, (b) provided for the repurchase by UCB of all product rights, licenses and intellectual property relating to Cimzia, (c) specified the responsibilities and obligations of us and UCB in connection with the transition of certain activities under the UCB Agreement from us to UCB as a result of the termination of the UCB Agreement, (d) terminated UCB’s right to designate a director nominee to our board of directors and (e) provided for the resignation of UCB’s designee from our board of directors.

Pursuant to the UCB Agreement, there were no termination or penalty payments required by either party. In consideration for the repurchase of all product rights, licenses and intellectual property relating to Cimzia, UCB paid us $11.0 million in November 2017 and an additional $39.0 million in June 2018 upon FDA approval of Cimzia for the treatment of psoriasis. We were obligated to reimburse UCB for up to $10.0 million of development costs incurred by UCB in connection with the development of Cimzia between January 1, 2018 and June 30, 2018. If the aggregate development costs reimbursed by us to UCB during this six-month period were less than $10.0 million, we were obligated to pay UCB the difference between such aggregate costs and $10.0 million. These terms replaced the provisions of the UCB Agreement pursuant to which we would have been eligible to recoup our external development costs incurred related to the Cimzia program, net of milestones received, through a royalty on future net sales of Cimzia. As of September 30, 2018, we have fully reimbursed UCB the $10.0 million for development costs incurred by UCB.

Under Topic 606, we evaluated the terms of the Transition Agreement and the transition services were identified as the only performance obligation as of the inception of the agreement. We further determined that the transaction price under the arrangement was comprised of $1.0 million, representing the net consideration from the $11.0 million payment received from UCB and the $10.0 million refund liability due to UCB. The $1.0 million transaction price was fully recognized as revenue as of June 30, 2018. The $39.0 million milestone amount payable upon the approval of Cimzia for the treatment of psoriasis in the United States was initially not included in the transaction price, as it was determined to be fully constrained. Upon UCB’s receipt of FDA approval of Cimzia for the treatment of psoriasis in June 2018, the $39.0 million milestone payment was included in the transaction price and fully recognized during the three months ended June 30, 2018 as all performance obligations were satisfied. For the nine months ended September 30, 2018, we recognized $39.4 million in revenue in our condensed consolidated statement of operations related to UCB. No other revenue will be recognized from UCB in future periods pursuant to the Transition Agreement as all performance obligations have been satisfied and the entire transaction price has been recognized.

In-license Agreements

Roche Agreement

In August 2017, we entered into a licensing agreement (“Roche Agreement”) with F. Hoffmann-La Roche Ltd and Genentech, Inc. (together, “Roche”), pursuant to which we obtained exclusive, worldwide rights to develop and commercialize lebrikizumab, an injectable, humanized antibody targeting interleukin 13, for atopic dermatitis and all other indications, except Roche retained certain rights, including exclusive rights to develop and promote lebrikizumab for interstitial lung diseases, such as idiopathic pulmonary fibrosis (“Retained Field”), and rights to use lebrikizumab for internal research purposes and for in vitro diagnostic purposes. The Roche Agreement became effective in September 2017 upon the early termination of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended. Pursuant to the terms of the Roche Agreement, Roche relinquished its rights in the Retained Field effective July 13, 2018 and all of Roche’s rights and all of our obligations with respect to the Retained Field expired. Accordingly, we have exclusive, worldwide rights to develop and commercialize lebrikizumab for all indications. Roche’s rights to use lebrikizumab for internal research purposes and for in vitro diagnostic purposes remain.

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Under the terms of the Roche Agreement, we made an initial payment of $80.0 million to Roche in October 2017 and a $25.0 million payment to Roche in July 2018 upon the achievement of 50% enrollment in our Phase 2 clinical study of lebrikizumab, which was achieved in June 2018, and will make an additional payment to Roche in the fourth quarter of 2018 for $30.0 million related to the achievement of 100% enrollment in our Phase 2 clinical study of lebrikizumab in October 2018. We will also be obligated to make payments upon the achievement of certain milestones, comprising $40.0 million upon the initiation of the first Phase 3 clinical study, up to $210.0 million upon the achievement of regulatory and first commercial sale milestones in certain territories and up to $1.0 billion based on the achievement of certain thresholds for net sales of lebrikizumab for all indications. Upon regulatory approval, if obtained, we will make royalty payments representing percentages of net sales that range from the high single-digits to the high teens. Royalty payments will be made from the first commercial sale date in such country and end on the later of the date that is (a) ten years after the date of the first commercial sale of lebrikizumab in such country, (b) the expiration of the last to expire valid claim of the applicable licensed compound patent rights, our patent rights or joint patent rights in such country covering the use, manufacturing, import, offering for sale, or sale of lebrikizumab in such country, (c) the expiration of the last to expire valid claim of the applicable licensed non-compound patent rights in such country covering the use, import, offering for sale, or sale of the product in such country, or (d) the expiration of the last to expire regulatory exclusivity conferred by the applicable regulatory authority in such country for lebrikizumab.

We determined that the acquired IPR&D related to the Roche Agreement had no alternative future use and recorded an expense of $128.6 million during the year ended December 31, 2017 in the consolidated statements of operations as acquired in-process research and development expense. This expense was comprised of the initial payment of $80.0 million, which was made in October 2017, a $25.0 million milestone payment, which was made in July 2018, and an additional payment due in 2018 of $30.0 million. The payments due in 2018 were measured on a non-recurring basis using unobservable, Level 3 inputs, including a discount rate used to value the payments at present value as of the effective date of the Roche Agreement. As of September 30, 2018, on the condensed consolidated balance sheets, we recorded $29.7 million in accrued liabilities related to acquired in-process research and development for the $30.0 million payment which will be paid in the fourth quarter of 2018. The remaining milestone payments will be recognized when the contingency related to each milestone is resolved and the consideration is paid or becomes payable.

Rose U Agreement

In April 2013, we entered into an exclusive license agreement with Rose U LLC (“Rose U”) pursuant to which we obtained a worldwide exclusive license within a field of use including hyperhidrosis to practice, enforce and otherwise exploit certain patent rights, know‑how and data related to our hyperhidrosis program. The license agreement includes a sublicense of certain data and an assignment of certain regulatory filings which Rose U had obtained from Stiefel Laboratories, Inc., a GSK company (“Stiefel”). In connection with the license agreement, we also entered into a letter agreement with Stiefel pursuant to which we assumed Rose U’s obligation to pay Stiefel $2.5 million in connection with the commercialization of products developed using the licensed data and to indemnify Stiefel for claims arising from the use, development or commercialization of products developed using the Stiefel data.

As of September 30, 2018, we have paid or accrued license and other fees of $4.3 million to Rose U and Stiefel, including a $2.5 million accrual in connection with the first commercial sale of QBREXZA to be paid in the fourth quarter of 2018, and are required to pay Rose U additional amounts totaling up to $0.6 million upon the achievement of certain milestones. In addition, we are also obligated to pay Rose U low-to-mid single-digit royalties on net product sales and low double-digit royalties on sublicense fees and certain milestone, royalty and other contingent payments received from sublicensees, to the extent such amounts are in excess of the milestone and royalty payments we are obligated to pay Rose U directly upon the events or sales triggering such payments. We are entitled to credit the $2.5 million milestone against current and future royalty payments owed to Rose U in accordance with the terms of the license agreement.

 

8. Inventory

Inventory consists of the following (in thousands):

 

 

 

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9. Stock-Based Compensation

The following table reflects a summary of stock option activity under our 2010 Equity Incentive Plan (“2010 Plan”), 2014 Equity Incentive Plan (“2014 EIP”) and 2018 Equity Inducement Plan (“2018 Inducement Plan”) and related information for the period from December 31, 2017 through September 30, 2018:

 

 

The following table reflects a summary of restricted stock unit (“RSU”) activity under our 2014 EIP and 2018 Inducement Plan and related information for the period from December 31, 2017 through September 30, 2018:

 

 

Total stock-based compensation expense related to the 2010 Plan, the 2014 EIP, the 2018 Inducement Plan and the 2014 Employee Stock Purchase Plan was allocated as follows (in thousands):

 

 

Total stock-based compensation expense capitalized to inventory was not material for any of the periods presented.

 

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The interim financial statements included in this Quarterly Report on Form 10-Q and this Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2017, included as part of our Annual Report on Form 10-K for the year ended December 31, 2017, and our unaudited Condensed Consolidated Financial Statements for the three- and nine-month periods ended September 30, 2018 and other disclosures (including the disclosures under “Part II — Other Information, Item 1A. Risk Factors”) included in this Quarterly Report on Form 10-Q. In addition to historical information, this discussion and analysis contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (“Exchange Act”). These statements are often identified by the use of words such as “may,” “will,” “expect,” “believe,” “anticipate,” “intend,” “could,” “should,” “potential,” “predict,” “project,” “estimate,” or “continue,” and similar expressions or variations. Forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. Factors that could cause or contribute to these differences include those set forth elsewhere in this Quarterly Report on Form 10-Q, particularly in Part II — Other Information, Item 1A. Risk Factors below, that could cause actual results to differ materially from historical results or anticipated results. Except as may be required by law, we disclaim any obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.

Overview

We are a biopharmaceutical company dedicated to bringing biotech ingenuity to medical dermatology by delivering differentiated, new therapies to the millions of patients living with chronic skin conditions. We are committed to understanding the needs of both patients and physicians and using our insight to identify, develop and commercialize leading-edge medical dermatology clinical programs. Our management team has extensive experience in product development and commercialization, having served in leadership roles at several leading dermatology companies. Our approved treatment, QBREXZA™ (glycopyrronium) cloth (“QBREXZA”), is indicated for pediatric and adult patients (ages nine and older) with primary axillary hyperhidrosis (excessive underarm sweating). We are also evaluating lebrikizumab in a Phase 2b clinical trial for the treatment of moderate-to-severe atopic dermatitis (a severe form of eczema) and have early-stage research programs in other areas of dermatology.

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Our portfolio consists of:

Key Developments

Below is a summary of selected key developments affecting our business that have occurred since June 30, 2018:

QBREXZA

Lebrikizumab

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Financial Overview

For the three months ended September 30, 2018, net loss decreased 63% to $66.5 million from $179.2 million for the same period in 2017. The decrease is primarily due to our recognition in 2017 of acquired in-process research and development expenses of $128.6 million related to the Roche Agreement. We recognized revenue of $0.7 million for the three months ended September 30, 2018, comprised exclusively of net product sales of QBREXZA. We did not recognize any collaboration and license revenue for the three months ended September 30, 2018. Research and development expenses decreased 47% to $16.3 million for the three months ended September 30, 2018 compared to the same period in 2017, driven primarily by a reduction in clinical trial activities. Selling, general and administrative expenses increased 151% to $49.5 million for the three months ended September 30, 2018 compared to the same period in 2017, driven primarily by expenses related to the commercial launch of QBREXZA, as well as headcount growth and associated expenses.

For the nine months ended September 30, 2018, net loss decreased 39% to $149.7 million from $247.2 million for the same period in 2017. The decrease is primarily due to our recognition in 2017 of acquired in-process research and development expenses of $128.6 million related to the Roche Agreement. Product sales for QBREXZA were $0.7 million for the nine months ended September 30, 2018, related to the commencement of shipments of QBREXZA to our Customers in September 2018. Collaboration and license revenue was $39.4 million for the nine months ended September 30, 2018, an increase of $36.2 million compared to the same period in 2017, driven primarily by the $39.0 million revenue recognized pursuant to a transition agreement (“Transition Agreement”) that provided for an orderly transition of activities under the development and commercialisation agreement between us and UCB Pharma S.A. (“UCB”), dated March 21, 2014 (“UCB Agreement”), which provided for the development and commercialization of Cimzia, an injectable biologic tumor necrosis factor-alpha inhibitor for the treatment of psoriasis. Research and development expenses decreased 20% to $61.4 million for the nine months ended September 30, 2018 compared to the same period in 2017, driven primarily by a reduction in clinical trial activities. Selling, general and administrative expenses increased 170% to $120.8 million for the nine months ended September 30, 2018 compared to the same period in 2017, driven primarily by expenses related to the commercial launch of QBREXZA, as well as headcount growth and associated expenses. We also recorded an impairment charge of $1.1 million against intangible assets for the nine months ended September 30, 2018 related to our olumacostat glasaretil development program.

As of September 30, 2018, we had cash and investments of $389.7 million.

Since our inception, we have devoted substantially all of our efforts to developing our product candidates, including conducting preclinical and clinical trials and manufacturing activities, to commercializing QBREXZA, and to providing general and administrative support for our operations. We have financed our operations primarily through the sale of equity securities and convertible debt securities.

We have never been profitable and may never be profitable. As of September 30, 2018, we had an accumulated deficit of $673.2 million. We expect to incur significant costs to continue to commercialize QBREXZA and advance our lebrikizumab product candidate through clinical development. As a result, we will need substantial additional funding to support our operating activities. The timing and the amount of future funding we will require and the success of our business will be based in large part on the successful commercialization of QBREXZA and the outcome of the lebrikizumab Phase 2b clinical study. Adequate funding may not be available to us on acceptable terms, or at all. We currently anticipate that we will seek to fund our operations through public or private equity or debt financings or other sources, such as potential collaboration or license agreements. Our failure to obtain sufficient funds on acceptable terms as and when needed could have a material adverse effect on our business, results of operations and financial condition.

Critical Accounting Policies and Significant Estimates

Our management’s discussion and analysis of financial condition and results of operations are based upon our unaudited condensed consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On an ongoing basis, we evaluate our critical accounting policies and estimates. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions and conditions.

While our significant accounting policies are described in the notes to our condensed consolidated financial statements, we believe that the following changes to our critical accounting policies are most important to understanding and evaluating our reported condensed consolidated financial results, as these policies relate to the more significant areas involving management’s judgments and estimates.

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Inventory

Inventory consists of raw materials, work-in-process and finished goods. Inventory costs are determined using the lower of standard cost, which approximates the actual costs determined using the first-in, first-out basis, or net realizable value. Standard costs are reviewed and updated annually or as needed. We expense costs associated with the manufacture of our products prior to regulatory approval and capitalize the cost of inventory when there is a high probability of future economic benefit. We began capitalizing the cost of inventory related to QBREXZA in the second quarter of 2018, the period in which we received regulatory approval to market the product. We are expensing costs associated with the manufacture of our lebrikizumab product candidate.

We review all inventory balances on a quarterly basis for impairment and recognize any reduction in value as a current period expense with a reserve provision on the consolidated balance sheets. If the conditions that caused the impairment were to be resolved in a subsequent period, the reserve provision would not be reversed until the related inventory was sold or otherwise disposed.

Revenue Recognition

Effective January 1, 2018, we adopted Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606) (“Topic 606”) using the modified retrospective method which consisted of applying and recognizing the cumulative effect of Topic 606 at the date of initial application. Topic 606 supersedes the revenue recognition requirements in Accounting Standards Codification (“ASC”) Topic 605, Revenue Recognition (“Topic 605”), including most industry-specific revenue recognition guidance throughout the Industry Topics of the ASC. All periods prior to the adoption date of Topic 606 have not been restated to reflect the impact of the adoption of Topic 606, but continue to be accounted for and presented under Topic 605.

The following paragraphs in this section describe our revenue recognition accounting polices under Topic 606 upon adoption on January 1, 2018. Refer to Note 2 to the consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2017 for revenue recognition accounting policies under Topic 605.

We recognize revenue when we transfer promised goods or services to customers in an amount that reflects the consideration to which we expect to be entitled in exchange for those goods or services. To determine revenue recognition for contracts with customers we perform the following five steps: (i) identify the contract(s) with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when (or as) we satisfy the performance obligations. At contract inception, we assess the goods or services promised within each contract and assess whether each promised good or service is distinct and determine those that are performance obligations. We then recognize as revenue the amount of the transaction price that is allocated to the respective performance obligation when (or as) the performance obligation is satisfied.

Product Sales

Our product sales consist of sales of QBREXZA within the United States. Following the approval of QBREXZA by the FDA in June 2018 and, in advance of the availability of QBREXZA in pharmacies on October 1, 2018, we commenced shipments of QBREXZA in September 2018 to our Customers for distribution to pharmacies and patients. We recognize revenue from product sales when our Customers obtain control of our product, which is generally upon delivery.

Product sales are recognized at the transaction price, net of estimates of variable consideration, including commercial rebates, discounts related to a patient savings card program, distribution fees, trade discounts, government rebates and chargebacks and product returns. Variable consideration amounts are estimated at contract inception using the expected-value method and updated at the end of each reporting period as additional information becomes available. The amounts of variable consideration are included in the transaction price only to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is resolved. Estimates and assumptions are updated quarterly and if actual future results vary materially from estimates, we will record an adjustment, which could impact product sales and earnings in the period of adjustment.

The following items of variable consideration are recorded at the time of revenue recognition and require significant estimates and judgment.

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Commercial rebates and savings card program. We contract with certain third-party payers for the payment of rebates with respect to the utilization of QBREXZA. Rebates to these payers are based on contractual percentages applied to the amount of QBREXZA prescribed to patients who are covered by the plan or the organization with which we have contracts. We estimate and record rebates as a reduction to the transaction price in the same period the related product sales are recognized. We estimate commercial rebates based on contractual terms, estimated payer mix, industry information and other third-party data. We also have a savings card program to provide assistance to eligible patients with out-of-pocket costs, such as deductibles, co-insurance and co-payments, for the patient’s usage of QBREXZA. Reductions to product sales for the savings card program are estimated based on actual and expected program utilization.

Distribution fees and trade discounts.  We pay our Customers certain fees for distribution services for QBREXZA. We determined that such distribution services are not distinct from our sales of QBREXZA and the related fees are recorded as a reduction to the transaction price in the period the related product sales are recognized. Distribution fees are recorded based on contractual terms. We also incentivize prompt payment from our Customers by providing a discount for payments made within a certain number of days.

Government rebates and chargebacks.  We are subject to discount obligations under state Medicaid programs, Medicare and other government programs. Reserves for these rebates and chargebacks are recorded as a reduction to the transaction price in the period the related product sales are recognized. Chargeback amounts represent credit we expect to issue to our Customers and are recorded as a reduction to trade and other receivables, net. Reductions to product sales for government managed programs are estimated based on statutorily-defined discounts, estimated payer mix, expected sales to qualified healthcare providers and expected utilization.

Product returns.  Our product return policy provides our Customers the right to return QBREXZA, generally based on its expiration date. The reserve for product returns is recorded as a reduction to the transaction price in the period the related product sales are recognized. We estimate product returns using third-party input and market data for products with characteristics similar to QBREXZA.

Collaborative Arrangements

We enter into collaborative arrangements with partners that typically include payment to us of one of more of the following: (i) license fees; (ii) milestone payments related to the achievement of developmental, regulatory, or commercial goals; and (iii) royalties on net sales of licensed products. Where a portion of non‑refundable up-front fees or other payments received are allocated to continuing performance obligations under the terms of a collaborative arrangement, they are recorded as deferred revenue and recognized as revenue when (or as) the underlying performance obligation is satisfied.

As part of the accounting for these arrangements, we must develop estimates and assumptions that require judgment to determine the underlying stand-alone selling price for each performance obligation which determines how the transaction price is allocated among the performance obligation. The stand-alone selling price may include items such as forecasted revenues, development timelines, discount rates, and probabilities of technical and regulatory success. We evaluate each performance obligation to determine if it can be satisfied at a point in time or over time. In addition, variable consideration must be evaluated to determine if it is constrained and, therefore, excluded from the transaction price.

License Fees

If a license to our intellectual property is determined to be distinct from the other performance obligations identified in the arrangement, we recognize revenues from non-refundable, up-front fees allocated to the license when the license is transferred to the licensee and the licensee is able to use and benefit from the license. For licenses that are bundled with other promises, we utilize judgment to assess the nature of the combined performance obligation to determine whether the combined performance obligation is satisfied over time or at a point in time and, if over time, the appropriate method of measuring progress for purposes of recognizing revenue. We evaluate the measure of progress each reporting period and, if necessary, adjust the measure of performance and related revenue recognition.

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Milestone Payments

At the inception of each arrangement that includes milestone payments (variable consideration), we evaluate whether the milestones are considered probable of being reached and estimate the amount to be included in the transaction price using the most likely amount method. If it is probable that a significant revenue reversal would not occur, the associated milestone value is included in the transaction price. Milestone payments that are not within our or our collaboration partner’s control, such as regulatory approvals, are generally not considered probable of being achieved until those approvals are received. The transaction price is then allocated to each performance obligation on a relative stand-alone selling price basis, for which we recognize revenue as or when the performance obligations under the contract are satisfied. At the end of each subsequent reporting period, we re-evaluate the probability of achievement of such milestones and any related constraint, and if necessary, adjust our estimate of the overall transaction price. Any such adjustments are recorded on a cumulative catch-up basis, which would affect license, collaboration or other revenues and earnings in the period of adjustment.

Royalties

For arrangements that include sales-based royalties, including milestone payments based on the level of sales, and for which the license is deemed to be the predominant item to which the royalties relate, we recognize revenue at the later of (i) when the related sales occur, or (ii) when the performance obligation to which some or all of the royalty has been allocated has been satisfied (or partially satisfied). To date, we have not recognized any royalty revenue resulting from any of our collaborative arrangements.

Under certain collaborative arrangements, we have been reimbursed for a portion of our research and development (“R&D”) expenses, including costs of drug supplies. When these R&D services are performed under a reimbursement or cost sharing model with our collaboration partner, we record these reimbursements as a reduction of R&D expense in our consolidated statements of operations.

Results of Operations