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EX-32.1 - EX-32.1 - KalVista Pharmaceuticals, Inc.cbyl-ex321_7.htm
EX-31.2 - EX-31.2 - KalVista Pharmaceuticals, Inc.cbyl-ex312_8.htm
EX-31.1 - EX-31.1 - KalVista Pharmaceuticals, Inc.cbyl-ex311_6.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

 

(Mark One)

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the quarterly period ended September 30, 2015

OR

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the transition period from                      to                     .

Commission File No. 001-36830

 

CARBYLAN THERAPEUTICS, INC.

(Exact name of registrant as specified in its charter)

 

 

Delaware

 

20-0915291

(State or other jurisdiction of
incorporation or organization)

 

(I.R.S. Employer
Identification No.)

 

3181 Porter Drive, Palo Alto, California

 

94304

(Address of principal executive offices)

 

(Zip Code)

(650) 855-6777

(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 and 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  x    NO  o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files).    YES  x    NO  o

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

 

Large accelerated filer

o

Accelerated filer

o

 

 

 

 

Non-accelerated filer

x  (Do not check if a smaller reporting company)

Smaller reporting company

o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    YES  o    NO  x

As of October 31, 2015, the registrant had 26,322,494 shares of common stock, $0.001 par value per share, issued and outstanding.

 

 

 


Table of Contents

 

 

 

Page

PART I. FINANCIAL INFORMATION

 

 

 

Item 1.

Financial Statements

1

 

 

 

 

Condensed Balance Sheets (unaudited)

1

 

 

 

 

Condensed Statements of Operations and Comprehensive Loss (unaudited)

2

 

 

 

 

Condensed Statements of Cash Flows (unaudited)

3

 

 

 

 

Notes to Financial Statements

4

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

16

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

26

 

 

 

Item 4.

Controls and Procedures

26

 

 

PART II. OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

27

 

 

 

Item 1A.

Risk Factors

27

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

55

 

 

 

Item 3.

Defaults Upon Senior Securities

55

 

 

 

Item 4.

Mine Safety Disclosures

55

 

 

 

Item 5.

Other Information

55

 

 

 

Item 6.

Exhibits

55

 

 

 

Signatures

56

 

 

 


PART I. FINANCIAL INFORMATION

 

 

Item 1.

FINANCIAL STATEMENTS

Carbylan Therapeutics, Inc.

Condensed Balance Sheets

(in thousands, except share and per share amounts)

(Unaudited)

 

 

 

September 30,

 

 

December 31,

 

 

 

2015

 

 

2014

 

 

 

(unaudited)

 

 

 

 

 

Assets

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

59,878

 

 

$

3,897

 

Prepaid expenses and other current assets

 

 

1,571

 

 

 

690

 

Total current assets

 

 

61,449

 

 

 

4,587

 

Property and equipment, net

 

 

362

 

 

 

180

 

Restricted cash

 

 

50

 

 

 

50

 

Deferred public offering costs

 

 

 

 

 

1,648

 

Other assets

 

 

218

 

 

 

179

 

Total assets

 

$

62,079

 

 

$

6,644

 

Liabilities, Convertible Preferred Stock and Stockholders’ Equity (Deficit)

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

Accounts payable

 

$

1,527

 

 

$

1,024

 

Accrued expenses

 

 

1,272

 

 

 

1,605

 

Loans payable

 

 

965

 

 

 

4,435

 

Deferred licensing revenue

 

 

29

 

 

 

29

 

Total current liabilities

 

 

3,793

 

 

 

7,093

 

Loans payable, net of current portion

 

 

3,601

 

 

 

 

Convertible promissory notes

 

 

 

 

 

2,131

 

Derivative liability

 

 

 

 

 

1,495

 

Preferred stock warrant liability

 

 

 

 

 

463

 

Deferred licensing revenue, net of current portion

 

 

64

 

 

 

85

 

Deferred rent, net of current portion

 

 

 

 

 

2

 

Total liabilities

 

 

7,458

 

 

 

11,269

 

Commitments and contingencies (Note 5)

 

 

 

 

 

 

 

 

Convertible preferred stock, $0.001 par value;  no shares authorized as of September 30, 2015 and 34,371,305 shares authorized as of December 31, 2014; no shares issued and outstanding as of September 30, 2015 and 8,268,531 shares issued and outstanding as of December 31, 2014

 

 

 

 

 

39,556

 

Stockholders’ equity (deficit)

 

 

 

 

 

 

 

 

Preferred stock, $0.001 par value; 5,000,000 shares authorized as of September 30, 2015 and none authorized as of December 31, 2014: no shares issued and outstanding as of September 30, 2015

 

 

 

 

 

 

Common stock, $0.001 par value; 100,000,000 shares authorized as of

   September 30, 2015 and 45,000,000 shares authorized as of December 31, 2014;

   26,322,494 shares issued and outstanding as of September 30, 2015 and 691,312

   shares issued and outstanding as of December 31, 2014

 

 

27

 

 

 

1

 

Additional paid-in capital

 

 

121,556

 

 

 

3,593

 

Accumulated deficit

 

 

(66,962

)

 

 

(47,775

)

Total stockholders’ equity (deficit)

 

 

54,621

 

 

 

(44,181

)

Total liabilities, convertible preferred stock and stockholders’ equity (deficit)

 

$

62,079

 

 

$

6,644

 

 

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

 

 

1


Carbylan Therapeutics, Inc.

Condensed Statements of Operations and Comprehensive Loss

(in thousands, except share and per share amounts)

(Unaudited)

 

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

 

September 30,

 

 

September 30,

 

 

 

2015

 

 

2014

 

 

2015

 

 

2014

 

License Revenue

 

$

7

 

 

$

10

 

 

$

21

 

 

$

21

 

Operating Expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Research and development

 

 

3,533

 

 

 

2,088

 

 

 

11,939

 

 

 

5,263

 

General and administrative

 

 

1,373

 

 

 

1,490

 

 

 

3,549

 

 

 

2,618

 

Total operating expenses

 

 

4,906

 

 

 

3,578

 

 

 

15,488

 

 

 

7,881

 

Loss from Operations

 

 

(4,899

)

 

 

(3,568

)

 

 

(15,467

)

 

 

(7,860

)

Other Income (expense):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

 

2

 

 

 

1

 

 

 

4

 

 

2

 

Interest expense

 

 

(95

)

 

 

(357

)

 

 

(1,100

)

 

 

(520

)

Loss on extinguishment of convertible promissory notes

 

 

 

 

 

 

 

 

(3,177

)

 

 

 

Other income (expense), net

 

 

1

 

 

 

(71

)

 

 

553

 

 

 

(267

)

Net Loss and Comprehensive Loss

 

$

(4,991

)

 

$

(3,995

)

 

$

(19,187

)

 

$

(8,645

)

Net loss per share to common stockholders, basic

   and diluted

 

$

(0.19

)

 

$

(5.89

)

 

$

(1.12

)

 

$

(14.75

)

Weighted average common shares outstanding, basic and diluted

 

 

26,322,494

 

 

 

678,189

 

 

 

17,203,279

 

 

 

586,111

 

 

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

 

 

2


Carbylan Therapeutics, Inc.

Condensed Statements of Cash Flows

(In thousands, unaudited)

 

 

 

Nine Months Ended

 

 

 

September 30,

 

 

 

2015

 

 

2014

 

Cash Flows from Operating Activities

 

 

 

 

 

 

 

 

Net loss

 

$

(19,187

)

 

$

(8,645

)

Adjustments to reconcile net loss to net cash used in operating activities:

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

98

 

 

 

37

 

Stock based compensation expense

 

 

444

 

 

 

208

 

Change in fair value of preferred stock warrant liability and derivative liability

 

 

(520

)

 

 

267

 

Non-cash interest expense

 

 

192

 

 

 

(69

)

Amortization of loan and convertible promissory notes discount

 

 

773

 

 

 

 

Loss on extinguishment of convertible promissory notes

 

 

3,177

 

 

 

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

 

Prepaid expenses and other current assets

 

 

(881

)

 

 

(34

)

Other assets

 

 

(39

)

 

 

 

Accounts payable

 

 

503

 

 

 

367

 

Accrued expenses

 

 

(335

)

 

 

975

 

Deferred licensing revenue

 

 

(21

)

 

 

(22

)

Net cash used in operating activities

 

 

(15,796

)

 

 

(6,916

)

Cash Flows from Investing Activities

 

 

 

 

 

 

 

 

Purchase of property and equipment

 

 

(280

)

 

 

(83

)

Net cash used in investing activities

 

 

(280

)

 

 

(83

)

Cash Flows from Financing Activities

 

 

 

 

 

 

 

 

Proceeds from issuance of common stock upon exercise of options, net

 

 

149

 

 

 

228

 

Proceeds from issuance of common stock, net

 

 

67,908

 

 

 

 

Deferred public offering costs

 

 

 

 

 

(185

)

Proceeds from loans payable

 

 

 

 

 

2,208

 

Repayment of loans payable

 

 

4,000

 

 

 

5,000

 

Proceeds from convertible promissory notes

 

 

 

 

 

(708

)

Net cash provided by financing activities

 

 

72,057

 

 

 

6,543

 

Net increase/(decrease) in cash and cash equivalents

 

 

55,981

 

 

 

(456

)

Cash and cash equivalents at beginning of period

 

 

3,897

 

 

 

9,781

 

Cash and cash equivalents at end of period

 

$

59,878

 

 

$

9,325

 

Supplemental Cash Flow Information

 

 

 

 

 

 

 

 

Cash paid for interest

 

$

45

 

 

$

595

 

Supplemental Disclosures of Non-cash Financing Activities

 

 

 

 

 

 

 

 

Issuance of preferred stock warrants

 

$

 

 

$

103

 

Conversion of preferred stock warrants to common stock warrants

 

$

347

 

 

$

 

Conversion of preferred stock to common stock

 

$

39,556

 

 

$

 

Increase accrual of deferred public offering costs

 

$

 

 

$

945

 

Increase of derivative related to convertible promissory notes at issuance

 

$

1,196

 

 

$

1,067

 

Increase of beneficial conversion feature for convertible promissory notes

 

$

519

 

 

$

2,276

 

 

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

 

 

3


Notes to the Condensed Financial Statements (unaudited)

 

 

1.

Formation and Business of the Company

Carbylan Therapeutics, Inc. (the “Company”) is a clinical-stage specialty pharmaceutical company focused on the development and commercialization of novel and proprietary combination therapies that address significant unmet medical needs. The Company’s initial focus is on the development of Hydros-TA, its proprietary, potentially best-in-class intra-articular injectable product candidate to treat pain associated with osteoarthritis of the knee. The Company was incorporated in the state of Delaware on March 26, 2004 as Sentrx Surgical, Inc. The name of the Company was changed to Carbylan Biosurgery, Inc. on December 14, 2005. The name of the Company was changed to Carbylan Therapeutics, Inc. on March 7, 2014.

Since commencing operations in 2004, the Company has devoted substantially all of its efforts to identifying and developing product candidates for therapeutic markets, recruiting personnel and raising capital. The Company has devoted predominantly all of its resources to the preclinical and clinical development of, and manufacturing capabilities for, Hydros-TA. The Company has never been profitable and has not yet commenced commercial operations.

At September 30, 2015, the Company had an accumulated deficit of approximately $67.0 million. The Company expects to incur increased research and development expenses during the current Phase 3 trial of Hydros-TA and when the Company initiates the second Phase 3 trial of Hydros-TA. Management’s plans with respect to these matters include utilizing a substantial portion of the Company’s capital resources and efforts in completing the development and obtaining regulatory approval for Hydros-TA and expanding the Company’s organization.

In March 2015, the Company’s board of directors and stockholders approved a 4-for-1 reverse stock split of the Company’s common and preferred stock. The Company filed an amendment to its certificate of incorporation effecting the reverse stock split on March 13, 2015. All issued and outstanding common stock, convertible preferred stock, warrants for preferred stock, options for common stock and per share amounts contained in the condensed financial statements have been retroactively adjusted to reflect this reverse stock split for all periods presented.

On April 8, 2015, the Company’s registration statement on Form S-1 (File No. 333-201278) relating to the Initial Public Offering (“IPO”) of its common stock was declared effective by the SEC. The IPO closed on April 14, 2015 at which time the Company sold 14,950,000 shares of common stock, which included 1,950,000 shares of common stock purchased by the underwriters upon the full exercise of their option to purchase additional shares of common stock. The Company received cash proceeds of approximately $66.3 million from the IPO, net of underwriting discounts and commissions and IPO expenses paid by the Company.

Prior to the closing of the IPO, all outstanding shares of convertible preferred stock converted into 8,268,531 shares of common stock with the related carrying value of $39.6 million reclassified to common stock and additional paid-in capital. In addition, all convertible preferred stock warrants were converted into warrants exercisable for common stock and the convertible promissory notes were converted in to 2,287,120 shares of common stock.

On April 14, 2015, the Company filed its Amended and Restated Certificate of Incorporation, authorizing 105,000,000 shares of capital stock, including 100,000,000 shares of authorized common stock and 5,000,000 shares of authorized undesignated preferred stock.  Both the common stock and preferred stock have a par value of $0.001 per share.  There are no shares of preferred stock outstanding at September 30, 2015.

2.Summary of Significant Accounting Policies and Basis of Presentation

Basis of Presentation

The accompanying interim condensed financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and on a basis consistent with the annual financial statements, and in the opinion of management, reflect all adjustments, which include only normal recurring adjustments, necessary for a fair statement of the periods presented. These interim financial results are not necessarily indicative of the results to be expected for the year ending December 31, 2015, or for any other future annual or interim period. The accompanying unaudited condensed financial statements should be read in conjunction with the audited financial statements and the related notes thereto included in the Company’s Prospectus filed pursuant to Rule 424(b)(4) on April 8, 2015 with the SEC (the “Prospectus”).

4


Use of Estimates

The preparation of the interim condensed financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. On an ongoing basis, the Company evaluates its estimates, including those related to common stock, stock-based compensation expense, warrant liabilities, accruals, derivative liability, deferred tax valuation allowance and revenue recognition. Management bases its estimates on historical experience or on various other assumptions, including information received from its service providers, which it believes to be reasonable under the circumstances. Actual results could differ from those estimates.

Risks and Uncertainties

The product candidates developed by the Company require approvals from the U.S. Food and Drug Administration (“FDA”) or foreign regulatory agencies prior to commercial sales. There can be no assurance that the Company’s current and future product candidates will receive the necessary approvals. If the Company is denied approval or approval is delayed, it may have a material adverse impact on the Company’s business and its financial statements.

The Company is subject to risks common to companies in the pharmaceutical industry with no commercial operating history, including, but not limited to, dependency on the clinical and commercial success of its product candidates, ability to obtain regulatory approval of its product candidates, the need for substantial additional financing to achieve its goals, uncertainty of broad adoption of its approved products, if any, by physicians and consumers, significant competition and untested manufacturing capabilities.

The Company expects to incur substantial operating losses for the next several years and will need to obtain additional financing in order to launch and commercialize any products or product candidates for which it receives regulatory approval. There can be no assurance that such financing will be available or will be at terms acceptable by the Company.

Concentration of Credit Risk

Financial instruments that potentially subject the Company to a concentration of credit risk consist of cash and cash equivalents. The Company invests its excess cash in money market accounts. The Company’s cash and cash equivalents are held by a single financial institution and all cash is held in the United States. Such deposits may, at times, exceed federally insured limits. The Company has not recognized any losses during the periods presented and management does not believe that the Company is exposed to significant credit risk from its cash and cash equivalents.

Segment Reporting

The Company manages its operations as a single operating segment for the purposes of assessing performance and making operating decisions. The Company is a specialty pharmaceutical company focused on the development and commercialization of novel and proprietary combination therapies that address significant unmet medical needs. No product revenue has been generated since inception, and all assets are held in the United States.

Cash and Cash Equivalents

The Company considers all highly liquid investments purchased with an original maturity date of 90 days or less on the date of purchase to be cash equivalents. The Company invests its cash in bank deposits and money market funds.

Restricted Cash

The Company is required to guarantee the credit limit on its corporate credit card with a certificate of deposit of $50,000. The balance is included as restricted cash on the condensed balance sheets.  

Beneficial Conversion Feature

From time to time, the Company may issue convertible promissory notes that have conversion prices that create an embedded beneficial conversion feature on the issuance date. A beneficial conversion feature exists on the date a convertible promissory note is issued when the fair value of the underlying common stock to which the note is convertible into is in excess of the remaining unallocated proceeds of the note after first considering the allocation of a portion of the note proceeds to the fair value of any attached equity instruments, if any related equity instruments were granted with the debt. The intrinsic value of the beneficial conversion feature is recorded as a debt discount with a corresponding amount to additional paid-in capital. The debt discount is amortized to interest expense over the term of the note using the effective interest method.

5


Embedded Derivatives Related to Convertible Promissory Notes

Embedded derivatives that are required to be bifurcated from the underlying debt instrument (i.e. host) are accounted for and valued as a separate financial instrument. The Company evaluated the terms and features of the convertible promissory notes issued in September 2014 and February 2015 and identified embedded derivatives requiring bifurcation and accounting at fair value because the economic and contractual characteristics of the embedded derivatives met the criteria for bifurcation and separate accounting due to the conversion features (see Note 7 for a description of the conversion features).

Fair Value of Financial Instruments

Fair value accounting is applied for all financial assets and liabilities, and non-financial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually).

Property and Equipment, Net

Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is computed using the straight-line method over the estimated useful lives of the assets, which are as follows:

 

Computer equipment

 

3 years

Lab equipment

 

3 years

Furniture and fixtures

 

5 years

Machinery and equipment

 

3 years

Manufacturing equipment

 

7 years

 

Leasehold improvements are amortized over the lesser of their useful lives or the term of the lease. Upon sale or retirement of the assets, the cost and related accumulated depreciation are removed from the balance sheet and the resulting gain or loss is recognized in the accompanying interim condensed statement of operations and comprehensive loss in other income (expense), net. Maintenance and repairs are charged to operations as incurred.

Pre-clinical and Clinical Trial Accruals

The Company’s clinical trial accruals are based on estimates of patient enrollment and related costs at clinical investigator sites as well as estimates for the services received and efforts expended pursuant to contracts with clinical research organizations that conduct and manage preclinical and clinical trials on the Company’s behalf. If contracts are modified based upon changes in the clinical trial protocol or scope of work to be performed, the Company modifies the estimates of accrued expenses accordingly. To date, there have been no material differences from its estimates to the amount actually incurred.

Preferred Stock Warrant Liability

The Company accounts for its warrants as either equity or liabilities based upon the characteristics and provisions of each instrument. Warrants classified as derivative liabilities are recorded on the Company’s accompanying balance sheets at their fair value on the date of issuance and are revalued at each subsequent balance sheet date, with fair value changes recognized as increases or reductions to other income (expense), net in the statements of operations and comprehensive loss.

Research and Development Expenditures

Costs incurred to further the Company’s research and development include salaries and related employee benefits, stock-based compensation expense, costs associated with clinical studies, nonclinical research and development activities, regulatory activities, research-related overhead expenses and fees paid to external service providers and contract research and manufacturing organizations that conduct certain research and development activities on behalf of the Company.

Stock-Based Compensation

The Company maintains performance incentive plans under which incentive stock options and non-qualified stock options may be granted to employees and non-employees. The Company accounts for stock-based compensation arrangements with employees in accordance with ASC 718, Compensation — Stock Compensation. ASC 718 requires the recognition of compensation expense, using a fair value-based method, for costs related to all share-based payments including stock options.

6


The Company’s determination of the fair value of stock options on the date of grant utilizes the Black-Scholes option-pricing model, and is impacted by its common stock price as well as changes in assumptions regarding a number of subjective variables. These variables include, but are not limited to, expected term that options will remain outstanding, expected common stock price volatility over the term of the option awards, risk-free interest rates and expected dividends.

The fair value is recognized over the period during which an optionee is required to provide services in exchange for the option award, known as the requisite service period (usually the vesting period), on a straight-line basis. Stock-based compensation expense recognized at fair value includes the impact of estimated forfeitures. The Company estimates future forfeitures at the date of grant and revises the estimates, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

Income Taxes

The Company accounts for income taxes under the asset and liability method. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized.

The Company accounts for uncertain tax positions in accordance with ASC 740-10, Accounting for Uncertainty in Income Taxes. The Company assesses all material positions taken in any income tax return, including all significant uncertain positions, in all tax years that are still subject to assessment or challenge by relevant taxing authorities. Assessing an uncertain tax position begins with the initial determination of the position’s sustainability and is measured at the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement. As of each balance sheet date, unresolved uncertain tax positions must be reassessed, and the Company will determine whether (i) the factors underlying the sustainability assertion have changed and (ii) the amount of the recognized tax benefit is still appropriate. The recognition and measurement of tax benefits requires significant judgment. Judgments concerning the recognition and measurement of a tax benefit might change as new information becomes available.

Net Loss per Share to Common Stockholders

Basic earnings per share to common stockholders is computed by dividing net loss by the weighted average number of shares of common stock outstanding during the periods presented.  The computation of diluted earnings per share is similar to the computation of basic earnings per share, except that the denominator is increased for the assumed exercise of dilutive options and other potentially dilutive securities using the treasury stock method unless the effect is antidilutive.

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards update (“ASU”) 2014-09, “Revenue from Contracts with Customers,” requiring an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers.  The updated standard will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective and permits the use of either the retrospective or modified retrospective transition method.  In July 2015, the FASB voted to defer the effective date for annual reporting periods beginning after December 15, 2017 (including interim reporting periods within those periods) and permitted early adoption of the standard, but not before the original effective date of December 15, 2016.  The Company expects to adopt the updated standard in the first quarter of fiscal 2018.  The Company has not yet selected a transition method and is currently evaluating the effect that the updated standard will have on the financial statements and related disclosures.  

In August 2014, the FASB issued ASU NO. 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern, or ASU 2014-15.  ASU 2014-15 requires management to perform interim and annual assessments of an entity’s ability to continue as a going concern within one year of the date the financial statements are issued and provides guidance on determining when and how to disclose going concern uncertainties in the financial statements.  Certain disclosures will be required if conditions give rise to substantial doubt about an entity’s ability to continue as a going concern.  ASU 2014-15 applies to all entities and is effective for annual and interim reporting periods ending after December 15, 2016, with early adoption permitted.  The Company does not expect that the adoption of this guidance will have a material effect on its financial statements.  

7


3.

Fair Value Measurements

The Company follows ASC 820-10, Fair Value Measurements and Disclosures, which among other things, defines fair value, establishes a consistent framework for measuring fair value and expands disclosure for each major asset and liability category measured at fair value on either a recurring or nonrecurring basis. Fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, a three-tier fair value hierarchy has been established, which prioritizes the inputs used in measuring fair value 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 prices included in Level 1) are either directly or indirectly observable for the asset or liability through correlation with market data at the measurement date and for the duration of the instrument’s anticipated life.

 

Level 3

Inputs reflect management’s 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.

The Company’s investments in money market funds are measured at fair value on a recurring basis. These money market funds are actively traded and reported daily through a variety of sources.  The fair value of the money market fund investments is classified as Level 1.

The fair value of the certificates of deposit is classified as Level 2 due to the nature of a contractual restriction with a financial institution that requires the certificate of deposit to remain in place as collateral for the credit card, and therefore the ability to liquidate the investment is limited.

As of September 30, 2015, based on borrowing rates that are available to the Company for loans of similar terms and consideration of the Company’s credit risk, the carrying value of the loan payable approximates the fair value using Level 2 inputs.

There were no transfers between Level 1 and Level 2 during the periods presented.

In certain cases where there is limited activity or less transparency around inputs to valuation, securities are classified as Level 3. During 2014 and through the date of the IPO in April 2015, the Company estimated the fair value of the warrant liability. The Company used the Black-Scholes option-pricing method to calculate the fair value of the warrant liability. Generally, increases or decreases in the fair value of the underlying convertible preferred stock resulted in a similar impact in the fair value measurement of the warrant liability.

The fair value of the derivative of the September 2014 and February 2015 convertible promissory notes (see Note 7) was recorded as a derivative liability instrument that is measured at fair value at each reporting period. In connection with the IPO, the convertible promissory notes were converted in to shares of common stock, and the derivative liability is therefore not present at September 30, 2015.  At December 31, 2014, the Company remeasured the fair value of the derivative for the September 2014 convertible promissory notes by estimating the fair value of the convertible promissory notes with and without the conversion derivative. To calculate the fair value of the convertible promissory notes without the conversion derivative, the Company estimated the present value of the expected cash payments at an assumed discount rate. To calculate the fair value of the convertible promissory notes with the conversion feature, the Company calculated the present value of the convertible promissory notes upon conversion at an initial public offering, and the present value of the convertible promissory notes at an equity financing. The Company applied a probability of occurrence to all of the conversion scenarios and estimated a weighted value of the notes with the conversion feature. The difference between the fair value of the convertible promissory notes with and without the conversion features is the fair value of the derivative.

8


The following table presents the Company’s fair value hierarchy for assets and liabilities measured at fair value on a recurring basis:

 

 

 

Fair Value Measurements as of September 30, 2015 (in thousands)

 

 

 

Quoted Price

in Active

Markets for

Identical Assets

 

 

Significant

other

Observable

Inputs

 

 

Significant

Unobservable

Inputs

 

 

 

 

 

 

 

Level 1

 

 

Level 2

 

 

Level 3

 

 

Total

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Money market funds(1)

 

$

59,803

 

 

$

 

 

$

 

 

$

59,803

 

Certificate of deposit

 

 

 

 

 

50

 

 

 

 

 

 

50

 

 

 

$

59,803

 

 

$

50

 

 

$

 

 

$

59,853

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivative liability

 

$

 

 

$

 

 

$

 

 

$

 

Preferred stock warrant liability

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

 

 

$

 

 

$

 

 

$

 

 

 

 

Fair Value Measurements as of December 31, 2014 (in thousands)

 

 

 

Quoted Price

in Active

Markets for

Identical Assets

 

 

Significant

other

Observable

Inputs

 

 

Significant

Unobservable

Inputs

 

 

 

 

 

 

 

Level 1

 

 

Level 2

 

 

Level 3

 

 

Total

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Money market funds(1)

 

$

3,825

 

 

$

 

 

$

 

 

$

3,825

 

Certificate of deposit

 

 

 

 

 

50

 

 

 

 

 

 

50

 

 

 

$

3,825

 

 

$

50

 

 

$

 

 

$

3,875

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivative liability

 

$

 

 

$

 

 

$

1,495

 

 

$

1,495

 

Preferred stock warrant liability

 

 

 

 

 

 

 

 

463

 

 

 

463

 

 

 

$

 

 

$

 

 

$

1,958

 

 

$

1,958

 

 

 

(1)

Included in cash and cash equivalents in the Company’s condensed balance sheet.

The change in the fair value of the preferred stock warrant liability is summarized below:

 

Fair value as of December 31, 2014

 

$

463

 

Change in fair value recorded in other income (expense), net

 

$

(116

)

Conversion to common stock warrants at IPO date

 

$

(347

)

Fair value as of September 30, 2015

 

$

 

 

The following is a summary of the activity of the derivative liability for the nine months ended September 30, 2015:

 

Fair value as of December 31, 2014

 

$

1,495

 

Embedded derivative liability upon issuance of convertible

   promissory notes

 

 

1,196

 

Change in fair value recorded in other income (expense), net

 

 

(404

)

Automatic exercise of the derivative liability

 

 

(2,287

)

Fair value as of September 30, 2015

 

$

 

 

9


4.

Balance Sheet Components

Property and Equipment, Net

The following table represents the components of property and equipment (in thousands):

 

 

 

September 30,

 

 

December 31,

 

 

 

2015

 

 

2014

 

Computer equipment

 

$

30

 

 

$

30

 

Lab equipment

 

 

676

 

 

 

543

 

Furniture and fixtures

 

 

21

 

 

 

21

 

Machinery and equipment

 

 

173

 

 

 

26

 

Leasehold improvement

 

 

55

 

 

 

55

 

 

 

 

955

 

 

 

675

 

Less: Accumulated depreciation and amortization

 

 

(593

)

 

 

(495

)

Total property and equipment, net

 

$

362

 

 

$

180

 

 

Depreciation expense for the nine months ended September 30, 2015 and 2014, was $98,000, and $37,000, respectively.

Accrued Liabilities

(in thousands)

 

 

 

September 30,

 

 

December 31,

 

 

 

2015

 

 

2014

 

Accrued payroll and related expenses

 

$

706

 

 

$

723

 

Accrued legal expenses

 

 

48

 

 

 

159

 

Accrued research and clinical trial expenses

 

 

467

 

 

 

380

 

Accrued professional services

 

 

51

 

 

 

343

 

 

 

$

1,272

 

 

$

1,605

 

 

5.

Commitments and Contingencies

Operating Lease

The Company leases its facilities under a noncancelable operating lease which expires on February 29, 2016. The terms of the lease agreement require the Company to provide a security deposit of $69,000. The security deposit is included in other assets on the accompanying condensed balance sheets. The Company has a sub-lease agreement with a tenant for approximately thirty-seven percent of the square footage of the corporate headquarters. Under this agreement, the Company receives $16,000 per month as rental income which is accounted for as a reduction of rent expense. The sub-lease agreement continues until February 29, 2016.

Gross rent expense for the three months ended September 30, 2015 and 2014 was $110,000 and $107,000, respectively, and for the nine months ended September 30, 2015 and 2014 was $328,000 and $324,000, respectively. The rental expense is reduced by the sublease rental income amounts of $50,000 and $48,000, respectively, for the three months ended September 30, 2015 and 2014 and $147,000 and $143,000, respectively, for the nine months ended September 30, 2015 and 2014.

On July 13, 2015, the Company entered into a lease for an 18,704 square foot facility located in Newark, California (the “Newark Lease”), which will serve as the Company’s future headquarters, with office, R&D and laboratory space. The Company is in the process of remodeling the facility to support future operations. Under the Newark Lease, the landlord is providing an allowance of up to $599,000 to fund appropriate improvements to the facility.  The term of the Newark Lease commences when the landlord delivers possession of the facility to the Company, which is currently estimated to be February 2016.

Upon commencement of the Newark Lease, the initial term will be approximately six and a half years, with a monthly rental rate starting at $2.65 per square foot in the first year of the lease, escalating each year by 3.0%. The annual rent obligation is expected to be approximately $595,000 for the first year of the lease. The Company will also be responsible for certain other costs, such as insurance, taxes, utilities, maintenance and repairs, a property management fee, and reimbursement of certain expenses related to maintenance of common areas. The Company delivered a security deposit of approximately $149,000 in connection with the execution of the Newark Lease, and this amount is recorded in other assets on the condensed balance sheets.

10


The aggregate future minimum lease payments under the current and future operating lease are as follows:

Years ending December 31,

 

(in thousands)

 

2015

 

$

110

 

2016

 

 

618

 

2017

 

 

611

 

2018

 

 

629

 

2019

 

 

648

 

Remaining years

 

 

1,768

 

Total minimum lease payments

 

$

4,384

 

 

Indemnification

In the normal course of business, the Company enters into contracts and agreements that contain a variety of representations and warranties and provide for general indemnification. The Company’s exposure under these agreements is unknown because it involves future claims that may be made against the Company but have not yet been made. To date, the Company has not paid any claims or been required to defend any action related to its indemnification obligations. However, the Company may record charges in the future as a result of these indemnification obligations. No amounts associated with such indemnifications have been recorded to date.

From time to time, the Company may have certain contingent liabilities that arise in the ordinary course of business activities. The Company accrues a liability for such matters when it is probable that a liability has been incurred and that future expenditures can be reasonably estimated. There have been no contingent liabilities requiring accrual or disclosure at September 30, 2015.

6.

Loan and Security Agreement

In October 2011, the Company entered into a loan and security agreement (the “Loan and Security Agreement”) with a financial institution. In September 2014, the Loan and Security Agreement was amended.  The interest rate is 3.95% per annum and the loan is repayable in thirty-six equal monthly installments, following an eighteen-month interest only period. The final balloon interest payment is approximately $0.6 million and is accreted over the life of the loan. The amendment was accounted for as a modification, and the unamortized debt discount as of the date of the modification is being amortized over the new loan period, using the effective interest rate method.  

The Loan and Security Agreement contains customary representations and warranties, covenants, closing and advancing conditions, events of defaults and termination provisions. The Loan and Security Agreement provides that an event of default will occur if (1) the financial institution determines that it is the clear intention of the Company’s investors to not continue to fund the Company in the amounts and timeframe necessary to enable the Company to satisfy the Company’s financial obligations, (2) there is a material impairment in the financial institution’s security interest in the personal property that is the collateral, (3) the Company defaults in the payment of any amount payable under the agreement when due or (4) the Company breaches any negative covenant or certain affirmative covenants in the agreement (subject to a grace period in certain cases). The repayment of the loan is accelerated following the occurrence of an event of default or otherwise, which would require the Company to immediately pay an amount equal to: (i) all outstanding principal plus accrued but unpaid interest, (ii) the final payment, plus (iii) all other sums, that shall have become due and payable but have not been paid, including interest at the default rate with respect to any past due amounts. As of September 30, 2015, the Company was in compliance with all the covenants in the Loan and Security Agreement.

As discussed in Note 1, the Company has completed its IPO and believes it will be able to meet its payment obligations under the Loan and Security Agreement during the twelve months following the most recent balance sheet date. The Company has classified loan payments beyond twelve months to long term.

11


Aggregated annual payments due under the Loan and Security Agreement are as follows:

 

As of September 30, 2015 (in thousands)

 

 

 

 

2015

 

$

45

 

2016

 

 

1,775

 

2017

 

 

2,095

 

2018

 

 

1,391

 

Total payments

 

 

5,306

 

Less: Interest

 

 

(806

)

Present value of loans payable

 

 

4,500

 

Less: Debt discount

 

 

(91

)

Add: Final balloon payment

 

 

517

 

Less: Unamortized portion of final balloon payment

 

 

(360

)

Loans payable

 

 

4,566

 

Less: Current portion

 

 

(965

)

Loans payable, net of current portion

 

$

3,601

 

 

7.

Convertible Promissory Notes

On September 29, 2014 and February 19, 2015, the Company entered into convertible note purchase agreements and issued convertible promissory notes (the “Notes”) in an aggregate principal amount of $5.0 million and $4.0 million, respectively, to several related parties that own more than 10% of the Company’s capital stock. All principal and accrued interest on the Notes was converted to the Company’s common stock upon the completion of the Company’s initial public offering in April 2015.  Upon conversion, 2,287,120 shares of common stock were issued.

The Notes provided that upon completion of an initial public offering, the Notes would automatically convert into a number of shares of the Company’s common stock equal to the quotient obtained by dividing the entire principal amount and accrued interest on the Notes by 80% of the initial public offering price per share of the Company’s common stock.  The Notes bore interest at a rate of 5% per annum, compounded annually.

Due to the automatic conversion features contained in the Notes, the actual number of shares of common stock or preferred stock that would be required if a conversion of the Notes was made through the issuance of the Company’s common or preferred stock could not be predicted prior to the conversion taking place. In addition, the conversion that would occur upon a change in control of the Company met the definition of a put option and was not closely related to the debt. As a result, the automatic conversion features and put option, exclusive of the Series B conversion feature, required derivative accounting treatment and were bifurcated from the Notes and marked to market each reporting period through the statement of operations and comprehensive loss. The fair value of the automatic conversion features and put option of the Notes, exclusive of the Series B conversion feature, were recorded as a derivative liability instrument and measured at fair value at each reporting period.

As of December 31, 2014, the Company estimated the fair value of the derivative by estimating the fair value of the Notes with and without the conversion derivative. To calculate the fair value of the Notes without the conversion derivative, the Company estimated the present value of the expected cash payments at an assumed discount rate of 8.25%. To calculate the fair value of the Notes with the conversion feature, the Company calculated the present value of the Notes upon conversion at an initial public offering, and the present value of the Notes at an equity financing. The risk-free rate for the assumed discount period is estimated at 0.05% and 0.15% in the respective conversion scenarios. The risk-free rate for the assumed discount period is estimated at 0.05% and 0.12% in the respective conversion scenarios at the valuation date of December 31, 2014. The Company applied a probability of occurrence to all of the conversion scenarios associated with the derivative and estimated a weighted value of the Notes with the conversion feature. The difference between the fair value of the Notes with and without the conversion features is the derivative. The fair value of the derivative was $1,495,000 as of December 31, 2014.

Upon issuance of the February 2015 Notes, the Company calculated the derivative liability using the same methodology and assumptions as those used as of December 31, 2014 because there were not significant changes in the Company or in the operations of the Company that had occurred in that intervening time period. The additional derivative liability recorded upon issuance of the February 2015 Notes was $1,196,000.

At April 8, 2015, the Company remeasured the fair value of the derivative liability for the Notes using a methodology similar to the methodology used at December 31, 2014, with a minimal discount period. The fair value of the derivative was $2,287,000.

12


The Company determined that the Notes contain a beneficial conversion feature related to the conversion feature of the Notes into Series B convertible preferred stock. The beneficial conversion feature results from the difference between the fair value of the Company’s common stock at the date of issuance and the Series B Preferred Stock Conversion price of $4.8104 at the date of issuance. The beneficial conversion feature amounted to $2,275,000 for the September 2014 Notes and $158,000 for the February 2015 Notes as of the date of issuance of the respective Notes, and was recorded as a debt discount that would be amortized through the maturity date of the Notes.

At April 8, 2015, the beneficial conversion feature amounted to $202,000 for the September 2014 Notes and $158,000 for the February 2015 Notes.  The fair value of the shares issued upon conversion of the convertible promissory notes was first allocated to the beneficial conversion feature of $360,000.  

At April 8, 2015, the loss on extinguishment of the convertible promissory notes was calculated as follows:

 

 

 

 

 

 

Fair value of common stock issued upon conversion of convertible promissory notes and accrued interest

 

$

11,435

 

Less:

 

 

 

 

     Fair value of beneficial conversion feature on conversion date

 

 

(360

)

     Net book value of convertible promissory notes

 

 

(5,611

)

     Fair Value of derivative liability at conversion date

 

 

(2,287

)

Loss on extinguishment of convertible promissory notes

 

$

3,177

 

 

 

 

 

 

 

 

8.

Convertible Preferred Stock Warrants

The Company issued warrants to purchase shares of the Company’s convertible preferred stock at various times in connection with loans payable. Immediately prior to the closing of the IPO, all convertible preferred stock warrants were converted in to warrants exercisable for common stock.  The convertible preferred stock warrants outstanding as of December 31, 2014 were as follows (in thousands, except share and per share amounts):

 

 

 

Number of Shares

Underlying

Warrants

 

 

Exercise

Price per

Share

 

 

Fair Value, as

of December

31, 2014

 

Series A preferred stock

 

 

20,788

 

 

$

4.81

 

 

$

46

 

Series B preferred stock

 

 

103,941

 

 

$

4.81

 

 

$

417

 

 

 

 

124,729

 

 

 

 

 

 

$

463

 

 

The fair value of the convertible preferred stock warrant liability was remeasured as of each period end. As of December 31, 2014, the Company remeasured the fair value using a Black-Scholes option-pricing method with the following assumptions: a weighted average remaining life of 6.7 years, an expected volatility of 58.9%, a weighted average risk-free interest rate of 1.80% and no expected dividend. As of April 14, 2015, the Company remeasured the fair value of the convertible preferred stock warrant liability using a Black-Scholes option-pricing method with the following assumptions: the Company’s IPO price of $5.00 per share, a weighted average remaining life of 6.4 years, an expected volatility of 58.3%, a weighted average risk-free interest rate of 1.51% and no expected dividend. The Company evaluated the down-round protection provisions of the warrant agreements by using a Monte Carlo simulation model and determined that the impact of such provisions was immaterial to the fair value of the warrants at the reporting dates. The assumptions are further described as follows:

Expected Time to liquidity event — The Company estimated the time to liquidity event based on management’s analysis of the business, market conditions and clinical development.

Expected Volatility — The Company estimates the expected volatility based on the average volatility for comparable publicly traded biopharmaceutical companies over a period equal to the expected time to liquidity event. When selecting the publicly traded biopharmaceutical companies, the Company selected companies with comparable characteristics to it, including enterprise value and risk profiles, and with historical share price information sufficient to meet the time to liquidity event. The Company will continue to apply this process until a sufficient amount of historical information regarding the volatility of its own stock price becomes available.

Risk-Free Interest Rate — The risk-free interest rate is based on U.S. Treasury zero-coupon issues with remaining terms similar to the expected time to the liquidity event.

13


Expected Dividend Rate — The Company has never paid any dividends and does not plan to pay dividends in the foreseeable future, and, therefore, used an expected dividend rate of zero in the valuation model.

On April 8, 2015, the convertible preferred stock warrants automatically converted to common stock warrants. The convertible preferred stock warrant liability was reclassified to additional paid-in capital. During June 2015, the holder of the common stock warrants exercised those warrants for 56,545 shares of common stock in a cashless exercise.  

 

9.

Common Stock

As of September 30, 2015 the Company’s Amended and Restated Certificate of Incorporation, as amended, has authorized 100,000,000 shares of common stock at $0.001 par value.

Each share of common stock entitles the holder to one vote on all matters submitted to a vote of the Company’s stockholders. Common stockholders are entitled to receive dividends, as may be declared by the board of directors. As of September 30, 2015, no dividends have been declared.

10.

Stock Option Plan

Incentive stock options are granted with exercise prices not less than the estimated fair value of common stock, and non-statutory stock options may be granted with an exercise price of not less than 100% of the estimated fair value of the common stock on the date of grant. Options granted under the Plan expire no later than 10 years from the date of grant. Incentive stock options granted under the Plan vest over periods determined by the Board of Directors, generally over four years. Non-statutory stock options vest based on the terms of the individual agreement, generally from nine months to four years.

In April 2014, the Company terminated the 2004 Plan and the board of directors approved the 2014 Stock Option Plan (the 2014 Plan), authorizing 250,000 shares for issuance under the 2014 Plan. Shares underlying any outstanding stock awards or stock option grants previously awarded remain subject to the terms of the 2004 Plan. Any shares available for grant or any shares canceled or forfeited prior to vesting or exercise subsequent to the termination of the 2004 Plan became available for use under the 2014 Plan. Upon the effectiveness of the 2014 Plan, the Company ceased granting any equity awards under the 2004 Plan.

In January and February 2015, the board of directors and stockholders, respectively, approved the 2015 Equity Plan (the “2015 Equity Plan”). All future awards will be granted under the 2015 Plan.  In connection with the IPO, the Company terminated the 2014 Plan.  Shares underlying any outstanding stock option grants previously awarded under the 2014 Plan remain subject to the terms of such plan. Any shares available for grant or any shares canceled or forfeited prior to vesting or exercise subsequent to the termination of the 2014 Plan became available for use under the 2015 Plan.

As of September 30, 2015, options for 610,891 shares have been issued under the 2015 Equity Plan. The maximum number of shares of the Company’s common stock that may be delivered in satisfaction of awards under the 2015 Equity Plan is 1,532,534 shares, inclusive of 750,000 shares authorized upon creation of the 2015 Plan. The number of shares available for issuance under the Company’s 2015 Equity Plan will be increased on the first day of each fiscal year beginning in 2016, by an amount equal to the lessor of (1) 1,200,000 shares of stock and (2) four percent (4%) of the outstanding shares of stock on the last day of the immediately preceding year.

As of September 30, 2015, the Company had 1,722,262 shares issuable upon exercise of outstanding option awards.

In July 2015, the board of directors approved a non-qualified stock option grant of 165,903 shares of the Company’s common stock for an employee as an inducement grant in connection with his commencement of employment.  The grant was issued outside of the 2015 Equity Plan.  Stockholder approval was not required for this grant in reliance upon the employment inducement award exemption provided by NASDAQ Rule 5635(c)(4).    

Total stock-based compensation expense related to options and awards granted was allocated as follows (in thousands):

 

 

 

Three Months Ended September 30,

 

 

Nine Months Ended September 30,

 

 

 

2015

 

 

2014

 

 

2015

 

 

2014

 

Research and Development

 

$

86

 

 

$

60

 

 

$

96

 

 

$

78

 

General and administrative

 

 

203

 

 

 

40

 

 

 

348

 

 

 

130

 

Total

 

$

289

 

 

$

100

 

 

$

444

 

 

$

208

 

 

14


11.

Related Party Transactions

In September 2014 and February 2015, the Company issued the Notes to several related parties that own more than 10% of the Company’s capital stock (see Note 7).  Upon completion of the IPO, those Notes were converted in to shares of the Company’s common stock.

12.

Income Taxes

The Company’s effective tax rate is 0% for income tax for the three and nine months ended September 30, 2015 and the Company expects that its effective tax rate for the full year 2015 will be 0%. Based on the weight of available evidence, including cumulative losses since inception and expected future losses, the Company has determined that it is more likely than not that the deferred tax asset amount will not be realized and therefore a valuation allowance has been provided on net deferred tax assets.

The Company has substantial net operating loss carry forwards available to offset future taxable income for federal and state income tax purposes. The ability to utilize the net operating losses may be limited due to changes in our ownership as defined by Section 382 of the Internal Revenue Code (the “Code”). Under the provisions of Sections 382 and 383 of the Code, a change of control, as defined in the Code, may impose an annual limitation on the amount of the Company’s net operating loss and tax credit carryforwards, and other tax attributes that can be used to reduce future tax liabilities.

The Company files tax returns for U.S. Federal and State of California. The Company is not currently subject to any income tax examinations. Since the Company’s inception, the Company had incurred losses from operations, which generally allows all tax years to remain open.

The gross amount of unrecognized tax benefits as of September 30, 2015 is approximately $0.6 million related to the reserve on R&D credits, none of which will affect the effective tax rate if recognized due to the valuation allowance. The Company does not expect any material changes in the next 12 months in unrecognized tax benefits.

The Company recognizes interest and/or penalties related to uncertain tax positions. To the extent accrued interest and penalties do not ultimately become payable, amounts accrued will be reduced and reflected in the period that such determination is made. Any interest and penalties are recognized in income tax expense. The Company currently has no interest and penalties related to uncertain tax positions.

 

13.

Subsequent Events

In October 2015, the Company paid approximately $980,000 to the landlord of the Newark Lease for tenant improvement work to be performed.  The Company will account for this payment as an addition to leasehold improvements.

15


Item 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion in conjunction with our condensed financial statements (unaudited) and related notes included elsewhere in this report. This Quarterly Report on Form 10-Q contains forward-looking statements that involve risks and uncertainties. All statements other than statements of historical facts contained in this report are forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as “may,” “could,” “will,” “would,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “intend,” “predict,” “seek,” “contemplate,” “potential” or “continue” or the negative of these terms or other comparable terminology. These forward-looking statements, include, but are not limited to, the success, cost and timing of our product development activities and clinical trials and projections as to the timing of clinical studies and regulatory submissions; our ability to obtain and maintain regulatory approval of Hydros-TA, and any related restrictions, limitations, and/or warnings in the label of an approved product candidate; our ability to obtain funding for our operations, including funding necessary to complete clinical development and file an NDA for Hydros-TA; the performance of our third-party suppliers and manufacturers; the success of competing therapies that are or become available; and the accuracy of our estimates regarding expenses, future revenue, capital requirements and needs for additional financing. Any forward-looking statements in this Quarterly Report on Form 10-Q reflect our current views with respect to future events or our future financial performance, are based on assumptions, and involve known and unknown risks, uncertainties and other factors which 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. Given these uncertainties, you should not place undue reliance on these forward-looking statements. Factors that may cause actual results to differ materially from current expectations include, among other things, those listed under “Risk Factors” in the Prospectus or described elsewhere in this Quarterly Report on Form 10-Q. These forward-looking statements speak only as of the date hereof. Except as required by law, we assume no obligation to update or revise these forward-looking statements for any reason, even if new information becomes available in the future. Unless the context requires otherwise, in this Quarterly Report on Form 10-Q, the terms “Carbylan,” “Company,” “we,” “us” and “our” refer to Carbylan Therapeutics, Inc., a Delaware corporation.

Overview

We are a clinical-stage specialty pharmaceutical company focused on the development and commercialization of novel and proprietary combination therapies that address significant unmet medical needs. Our initial focus is on the development of Hydros-TA, our proprietary, potentially best-in-class intra-articular (“IA”), injectable product candidate to treat pain associated with osteoarthritis (“OA”), of the knee. Hydros-TA is a combination IA product designed to provide both rapid and sustained pain relief. We believe the low dose steroid component of Hydros-TA will provide rapid pain relief as well as sustained pain relief up to six months, from our proprietary hyaluronic acid component. Hydros-TA is currently being studied in a fully-enrolled Phase 3 trial, which we refer to as COR1.1. We expect to initiate our second Phase 3 trial, which we refer to as COR1.2, to open an investigational new drug application (“IND”), and begin enrolling U.S. patients in the first half of 2016. We anticipate reporting top-line results from COR1.1 in the first quarter of 2016 and COR1.2 by mid-2017, and submitting our NDA for Hydros-TA in mid-2017.

Since our inception, we have devoted substantially all our efforts and financial resources to identifying and developing product candidates utilizing our proprietary hyaluronic acid technology and to the clinical development of Hydros-TA. We have not generated any revenue from product sales and, as a result, we have incurred significant losses. Through September 30, 2015, we have funded substantially all of our operations through our initial public offering and prior to that, the sale and issuance of our convertible preferred stock and convertible promissory notes and through various credit facilities.

In November 2012, we entered into a technology license agreement with Shanghai Jingfeng Pharmaceutical Co., Ltd. (“Jingfeng”), pursuant to which we granted to Jingfeng an exclusive license to develop, manufacture and commercialize Hydros-TA in China, Taiwan, Hong Kong and Macau. In consideration for the exclusive license, we received a non-refundable up-front payment of $2.0 million ($1.7 million net of Chinese withholding tax). Additionally, we are eligible to receive future regulatory milestone payments of up to $1.5 million, which are considered non-substantive milestones for accounting purposes, and commercialization royalty payments of up to approximately $5.0 million (each excluding Chinese withholding tax).

Other than our arrangement with Jingfeng, we own global development and commercialization rights to Hydros-TA. Upon FDA approval, we expect to commercialize Hydros-TA for OA pain in the knee in the United States with an approximately 50 to 100 person specialty sales force targeting orthopedic surgeons, rheumatologists and pain specialists.

We do not have manufacturing facilities and all of our manufacturing activities are contracted out to third parties. Additionally, we currently utilize third-party clinical research organizations (“CROs”), to carry out our clinical trials and we do not yet have a sales organization. We expect to significantly increase our investment in costs relating to our clinical and commercial manufacturing process and inventory of Hydros-TA as we progress through our Phase 3 clinical trials and prepare for a possible commercial launch of Hydros-TA.

16


We have never been profitable and, as of September 30, 2015, we had an accumulated deficit of $67.0 million. We incurred net losses of approximately $19.2 million and $8.6 million in the nine months ended September 30, 2015 and 2014, respectively. We expect to continue to incur net operating losses as we advance Hydros-TA through clinical development, seek regulatory approval and prepare for and, if approved, proceed to commercialization.

Initial Public Offering

On April 8, 2015, our registration statement on Form S-1 (File No. 333-201278) relating to the IPO of our common stock was declared effective by the SEC. The IPO closed on April 14, 2015 at which time we sold 14,950,000 shares of our common stock, which included 1,950,000 shares of common stock purchased by the underwriters upon the full exercise of their option to purchase additional shares of common stock. We received cash proceeds of approximately $66.3 million from the IPO, net of underwriting discounts and commissions and estimated offering costs incurred by us.

Financial Overview

Revenue

We do not have any products approved for sale, and we have not generated any revenue from product sales since our inception and do not expect to generate any revenue from the sale of products in the near future. We may generate revenue from product sales, license fees, milestone payments and royalties from the sale of products developed using our intellectual property in the future. Our ability to generate revenue and become profitable depends on our ability to successfully commercialize Hydros-TA and any other product candidates that we may advance. If we fail to complete the development of, or obtain regulatory approval for, Hydros-TA or any future product candidates we may advance, our ability to generate future revenue and our results of operations and financial position will be adversely affected.

Our revenue to date has been generated from license revenue pursuant to our agreement with Jingfeng. Revenue under our license arrangement is recognized based on the performance requirements of the contract. Determinations of whether persuasive evidence of an arrangement exists and whether delivery has occurred or services have been rendered are based on management’s judgments regarding the fixed nature of the fees charged for deliverables and the collectability of those fees. Should changes in conditions cause management to determine that these criteria are not met for any new or modified transactions, revenue that we are able to recognize could be adversely affected. We have identified all of the deliverables at the inception of the Jingfeng agreement, including an exclusive royalty bearing license to certain of our patents relating to Hydros-TA, know-how and reasonable professional services, clinical or nonclinical data and information, collectively referred to as services, to be provided by us to assist Jingfeng in manufacturing, developing and commercializing the licensed product over the performance period, which is currently estimated to be January 2019. We have determined that the Jingfeng license and the services thereunder, represent two separate units of accounting, as the license has standalone value apart from the services because the development, manufacturing and commercialization rights conveyed would allow Jingfeng to perform all efforts necessary to bring the product to commercialization and begin selling the product upon regulatory approval. Non-substantive regulatory milestone and commercialization royalty payments are recognized in proportion to the two units of accounting identified at the inception of the agreement. Each portion will be recognized in accordance with the underlying unit of accounting.

We determined the BESP for the license unit of accounting using a discounted cash flow analysis. This measurement is based on the value indicated by current estimates of future payments to be received under the agreement and reflects management determined estimates and assumptions. These estimates and assumptions include but are not limited to estimated sales prices, estimated market opportunity, expected market share, the likelihood that clinical trials will be successful, the likelihood that regulatory approval will be received, the likelihood that the products will be commercialized, the determination of the markets served and the discount rate. We reduced the future payment to be received by the estimated amount of the professional services costs plus an estimated margin, which was based on industry benchmarking of similar companies. These estimates and assumptions formed the basis of an expected net future cash flow that was discounted based on an estimated weighted average cost of capital. The BESP for the services unit of accounting was determined using a similar methodology. This measurement is based on the estimated cost of the professional services plus an estimated margin based on industry benchmarking of similar companies.

The considerations of the Jingfeng agreement have been allocated to the units of accounting based on the relative selling price method. Of the $1.7 million up-front payment received (net of Chinese withholding tax), $1.5 million was allocated to the license and $0.1 million to the services. We recognized license revenue upon execution of the agreement as the associated unit of accounting had been delivered pursuant to the terms of the agreement. The $0.1 million allocated to services will be recognized as revenue on a straight-line basis over the performance period, which is currently estimated to be January 2019.

17


In November 2013, we received a $0.4 million regulatory milestone payment (net of Chinese withholding tax), and all but $35,000 was allocated to the license. We recognized license revenue upon execution of the agreement as the associated unit of accounting had been delivered pursuant to the terms of the agreement. The $35,000 allocated to services will be recognized as revenue on a straight-line basis over the performance period, which is currently estimated to be January 2019.

We expect that any revenue we generate will fluctuate from year to year as a result of the timing and amount of milestone payments from our license agreement with Jingfeng and any future collaboration partner.

Operating Expenses

Most of our operating expenses to date have been related to the research and development activities of Hydros-TA.

Research and Development Expenses. Since our inception, we have focused our resources on our research and development activities, including nonclinical and pre-clinical studies, clinical trials and chemistry manufacturing and controls. Our development expenses consist primarily of:

 

·

expenses incurred under agreements with consultants, CROs and investigative sites that conduct our pre-clinical studies and clinical trials;

 

·

costs of acquiring, developing and manufacturing clinical trial materials;

 

·

personnel costs, including salaries, benefits, stock-based compensation and travel expenses for employees engaged in scientific research and development functions;

 

·

costs related to compliance with regulatory requirements; and

 

·

allocated expenses for rent and maintenance of facilities, insurance and other general overhead.

Research and development costs are expensed as incurred. Costs for certain development activities, such as clinical trials, are recognized based on an evaluation of the progress to completion of specific tasks using data such as subject enrollment, clinical site activations or information provided to us by our third-party vendors.

We do not currently utilize a formal time allocation system to capture expenses on a project-by-project basis, as the majority of our past and planned expenses have been and will be in support of Hydros-TA. We expect to increase our research and development expenses for the foreseeable future as we initiate further clinical trials.

The following table summarizes our research and development expenses by functional area:

 

 

 

Three Months Ended September 30,

 

 

Nine Months Ended September 30,

 

 

 

2015

 

 

2014

 

 

2015

 

 

2014

 

 

 

(in thousands)

 

 

(in thousands)

 

Clinical development

 

$

859

 

 

$

689

 

 

$

3,443

 

 

$

1,904

 

Regulatory

 

 

381

 

 

 

66

 

 

 

1,226

 

 

 

239

 

Preclinical R&D

 

 

272

 

 

 

317

 

 

 

1,441

 

 

 

724

 

Personnel related

 

 

837

 

 

 

672

 

 

 

2,039

 

 

 

1,622

 

Manufacturing

 

 

1,184

 

 

 

344

 

 

 

3,790

 

 

 

774

 

Total research and development expenses

 

$

3,533

 

 

$

2,088

 

 

$

11,939

 

 

$

5,263

 

 

It is difficult to determine with any certainty the duration and completion costs of our currently planned or future clinical trials of Hydros-TA and any future product candidates we may advance, or if, when or to what extent we will generate revenue from the commercialization and sale of Hydros-TA or future product candidates that obtain regulatory approval. We may never succeed in achieving regulatory approval for any of our product candidates. The duration, costs and timing of clinical trials and development of our product candidates will depend on a variety of factors, including the uncertainties of future clinical trials and pre-clinical studies, uncertainties in clinical trial enrollment rate and significant and changing government regulation. In addition, the probability of success for each product candidate will depend on numerous factors, including competition, manufacturing capability and commercial viability.

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General and administrative expenses. General and administrative expenses consist of personnel costs, travel expenses and other expenses for outside professional services, including legal, human resources, audit and accounting services. Personnel costs consist of salaries, bonus, benefits and stock-based compensation. We expect to incur additional expenses as a result of operating as a public company, including expenses related to compliance with the rules and regulations of the Securities and Exchange Commission (“SEC”), Nasdaq listing standards, additional insurance expenses, investor relations activities and other administration and professional services. General and administrative expenses are expensed as incurred.

For the three months ended September 30, 2015 and 2014 our general and administrative expenses totaled approximately $1.4  million and $1.5 million, respectively. For the nine months ended September 30, 2015 and 2014 our general and administrative expenses totaled approximately $3.5 million and $2.6 million, respectively. We anticipate that our general and administrative expenses will increase in the future as we continue to build our corporate infrastructure to support the continued development of Hydros-TA.

Other Income (Expense), Net

Interest income. Interest income consists of interest earned on our cash and cash equivalents balances. The primary objective of our investment policy is capital preservation.

Interest expense. Interest expense consists of interest expense on amounts outstanding under our debt facility with Silicon Valley Bank (“SVB”), and the Notes, as well as non-cash interest expense related to the amortization of loan discounts and final loan interest payments. We expect to incur future interest expense related to the borrowing from SVB until June 2018.

Other income (expense), net. Other income (expense), net primarily consists of changes in the estimated fair value of the convertible preferred stock warrants and the derivative liability.

Income Taxes

The Company’s effective tax rate is 0% for income tax for the three and nine months ended September 30, 2015 and the Company expects that its effective tax rate for the full year 2015 will be 0%. Based on the weight of available evidence, including cumulative losses since inception and expected future losses, the Company has determined that it is more likely than not that the deferred tax asset amount will not be realized and therefore a valuation allowance has been provided on net deferred tax assets.

The Company files tax returns for U.S. Federal and State of California. The Company is not currently subject to any income tax examinations. Since the Company’s inception, the Company had incurred losses from operations, which generally allows all tax years to remain open.

The Company recognizes the financial statement effects of a tax position when it becomes more likely than not, based upon the technical merits, that the position will be sustained upon examination. The Company does not expect any material changes in the next 12 months in unrecognized tax benefits.

The Company recognizes interest and/or penalties related to uncertain tax positions. To the extent accrued interest and penalties do not ultimately become payable, amounts accrued will be reduced and reflected in the period that such determination is made. Any interest and penalties are recognized as a component of other expense and interest expense, respectively, as necessary. The Company currently has no interest and penalties related to uncertain tax positions.

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Results of Operations

Comparison of the Three Months Ended September 30, 2015 and 2014

The following table summarizes our results of operations for the three months ended September 30, 2015 and 2014:

 

 

 

Three Months Ended

 

 

 

September 30,

 

 

 

2015

 

 

2014

 

License Revenue

 

$

7

 

 

$

10

 

Operating Expenses:

 

 

 

 

 

 

 

 

Research and development

 

 

3,533

 

 

 

2,088

 

General and administrative

 

 

1,373

 

 

 

1,490

 

Total operating expenses

 

 

4,906

 

 

 

3,578

 

Loss from Operations

 

 

(4,899

)

 

 

(3,568

)

Other Income (expense):

 

 

 

 

 

 

 

 

Interest income

 

 

2

 

 

 

1

 

Interest expense

 

 

(95

)

 

 

(357

)

Other income (expense), net

 

 

1

 

 

 

(71

)

Total other income (expense)

 

 

(92

)

 

 

(427

)

Net Loss and Comprehensive Loss

 

$

(4,991

)

 

$

(3,995

)

Net loss per share to common stockholders, basic and diluted

 

$

(0.19

)

 

$

(5.89

)

Weighted average common shares outstanding, basic and diluted

 

 

26,322,494

 

 

 

678,189

 

 

License revenue

Revenues from the deferred upfront payments related to our license agreement for the three months ended September 30, 2015 and 2014 were $7,000 and $10,000 respectively, in each period.

Research and development expenses

Research and development expenses were $3.5 million and $2.1 million for the three months ended September 30, 2015 and 2014, respectively. The increase in research and development expenses period over period of $1.4 million, or 69%, was primarily due to the following:

 

·

an increase in clinical development expenses of $0.2 million related to our ongoing Phase 3 clinical trial, COR1.1;

 

·

an increase in regulatory expenses of $0.3 million primarily related to the increased use of outside services driven by an increase in IND enabling activities; and

 

·

an increase in manufacturing related expenses of $0.9 million, primarily related to an increased use of contract manufacturers preparing for the production of Hydros-TA for our COR1.2 clinical trial.

General and administrative expenses

General and administrative expenses were $1.4 million and $1.5 million for the three months ended September 30, 2015 and 2014, respectively. The decrease in general and administrative expenses period over period of $0.1 million, or -8%, was primarily due to reduced expenditures on marketing related activities.

Interest expense

Interest expense is attributable to our debt facility with SVB and non-cash amortization of debt discounts and final interest payments. Interest expense was $0.1 million and $0.4 million for the three months ended September 30, 2015 and 2014, respectively. The decrease in interest expense of $(0.3) million was primarily due to the payment of additional interest at the time of the amendment of the loan and security agreement in September 2014.

Other income (expense), net

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Other income (expense), net was $1,000 and $(71,000) for the three months ended September 30, 2015 and 2014, respectively. The expense for the three months ended September 30, 2014 primarily resulted from the mark to market of the Company’s convertible preferred stock warrant liability.  In April 2015, the convertible preferred stock warrants automatically converted to common stock warrants and the liability was therefore not present during the three months ended September 30, 2015.  

Comparison of the Nine Months Ended September 30, 2015 and 2014

The following table summarizes our results of operations for the nine months ended September 30, 2015 and 2014:

 

 

 

Nine Months Ended

 

 

 

September 30,

 

 

 

2015

 

 

2014

 

License Revenue

 

$

21

 

 

$

21

 

Operating Expenses:

 

 

 

 

 

 

 

 

Research and development

 

 

11,939