UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-K

 

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2019

OR

FOR THE TRANSITION PERIOD FROM ___ TO ___.

Commission file number 001-38356

 

MENLO THERAPEUTICS INC.

(Exact name of registrant as specified in its charter)

 

200 Cardinal Way, 2^nd Floor

Redwood City, California 94063

(Address of principal executive offices including zip code)

650-486-1416

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes  ☐    No  ☒

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

Yes  ☐    No  ☒

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 12b-2 of the Act).

Yes  ☐    No  ☒

The aggregate market value of the voting and non-voting common equity held by non-affiliates was $100.5 million, computed by reference to the last sales price of $5.99 as reported by the Nasdaq Market as of June 30, 2019. This calculation does not reflect a determination that certain persons are affiliates of the Registrant for any other purpose. The number of shares of common stock held by non-affiliates excluded 7,158,233 shares of common stock held by directors, officers and affiliates of directors. The number of shares owned by affiliates of directors was determined based upon information supplied by such persons and upon Schedules 13D and 13G, if any, filed with the SEC. Exclusion of shares held by any person should not be construed to indicate that such person possesses the power, direct or indirect, to direct or cause the direction of the management or policies of the Registrant, that such person is controlled by or under common control with the Registrant, or that such persons are affiliates for any other purpose.

As of February 14, 2020, there were 24,438,631 shares of the registrant’s Common Stock outstanding.

 

 

 

 

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TABLE OF CONTENTS

 

 

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Forward-Looking Statements

This Annual Report on Form 10-K contains “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). All statements other than statements of historical facts contained in this Annual Report on Form 10-K are statements that could be deemed forward-looking statements reflecting the current beliefs and expectations of management with respect to future events or to our future financial performance and 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 these forward-looking statements. These statements are often identified by the use of words such as “aim,” “anticipate,” “assume,” “believe,” “contemplate,” “continue,” “could,” “due,” “estimate,” “expect,” “goal,” “if,” “intend,” “may,” “objective,” “plan,” “predict,” “potential,” “positioned,” “project,” “seek,” “should,” “target,” “will,” “would,” “until,” and similar expressions or variations. Forward-looking statements contained in this Annual Report on Form 10-K include, but are not limited to, statements about:

In addition, the cautionary statement regarding forward looking statements set forth in Joint Proxy Statement/Prospectus filed with the SEC on January 6, 2020, and the documents incorporated by reference into the joint proxy statement/prospectus are incorporated herein, and this Annual Report may refer to forward-looking statements in the joint proxy statement/prospectus, which within the meaning of the federal securities law are subject to various risks and uncertainties that could cause our actual results to differ materially from those expressed or implied in such statements. Words such as “anticipate,” “expect,” “project,” “intend,” “forecast,” “believe,” and words and terms of similar substance used in connection with any discussion of future plans, actions or events identify forward-looking statements. Such factors include, but are not limited to: (i) conditions to the Closing of the Merger may not be satisfied; (ii) the Merger may involve unexpected costs, liabilities or delays; (iii) the effect of the announcement of the Merger on the ability of Menlo or Foamix to retain and hire key personnel and maintain relationships with customers, suppliers and others with whom Menlo or Foamix does business, or on Menlo’s or Foamix’s operating results and business generally; (iv) Menlo’s or Foamix’s respective businesses may suffer as a result of uncertainty surrounding the Merger and disruption of management’s attention due to the Merger; (v) the outcome of any legal proceedings related to the Merger; (vi) Menlo or Foamix may be adversely affected by other economic, business, and/or competitive factors; (vii) the risks and costs associated with clinical trials, including with respect to Menlo’s serlopitant for the treatment of pruritus associated with various conditions such as

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PN; (viii) the occurrence of any event, change or other circumstances that could give rise to the termination of the Merger Agreement; (ix) the risks and costs associated with the integration of, and the ability of Menlo and Foamix to integrate, the businesses successfully and to achieve anticipated synergies and other benefits from the Merger; (x) risks that the Merger disrupts current plans and operations; (xi) the risk that Menlo or Foamix may be unable to obtain governmental and regulatory approvals required for the transaction, or that required governmental and regulatory approvals may delay the transaction or result in the imposition of conditions that could reduce the anticipated benefits from the proposed transaction or cause the parties to abandon the proposed transaction; and (xii) other risks to consummation of the Merger, including the risk that the Merger will not be consummated within the expected time period or at all. In addition to the risk factors set forth herein, additional factors that may affect the future results of Menlo and Foamix are set forth in their respective filings with the SEC, including each of Menlo’s or Foamix’s most recently filed Annual Report on Form 10-K, subsequent Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and other filings with the SEC, which are available on the SEC’s website at www.sec.gov. See in particular Item 1A of Part II of Foamix’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2019 under the heading “Risk Factors”. The risks and uncertainties described above and in Foamix’s most recent Quarterly Report on Form 10-Q are not exclusive and further information concerning Foamix, including factors that potentially could materially affect its business, financial condition or operating results, may emerge from time to time. Readers are urged to consider these factors carefully in evaluating these forward-looking statements. Readers should also carefully review the risk factors described in other documents that Menlo and Foamix file from time to time with the SEC.

We caution you that the foregoing list may not contain all of the forward-looking statements made in this Annual Report on Form 10-K.

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. We discuss these risks in greater detail in “Risk Factors” and elsewhere in this Annual Report on Form 10-K. Given these uncertainties, you should not place undue reliance on these forward-looking statements. Also, forward-looking statements represent our management’s beliefs and assumptions only as of the date of this Annual Report on Form 10-K. Except as required by law, we assume no obligation to update these forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future.

This Annual Report on Form 10-K also contains estimates, projections and other information concerning our industry, our business and the markets for certain drugs, including data regarding the estimated size of those markets, their projected growth rates and the incidence of certain medical conditions. Information that is based on estimates, forecasts, projections or similar methodologies is inherently subject to uncertainties, and actual events or circumstances may differ materially from events and circumstances reflected in this information. Unless otherwise expressly stated, we obtained this industry, business, market and other data from reports, research surveys, studies and similar data prepared by third parties, industry, medical and general publications, government data and similar sources. In some cases, we do not expressly refer to the sources from which this data is derived. In that regard, when we refer to one or more sources of this type of data in any paragraph, you should assume that other data of this type appearing in the same paragraph is derived from the same sources, unless otherwise expressly stated or the context otherwise requires.

Trademarks

This Annual Report on Form 10-K includes trademarks, service marks and trade names owned by us or other companies. All trademarks, service marks and trade names included in this Annual Report on Form 10-K are the property of their respective owners.

 

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BUSINESS

Overview

We are a late-stage biopharmaceutical company focused on the development and commercialization of serlopitant for the treatment of pruritus, or itch, associated with various conditions such as prurigo nodularis and psoriasis. We believe that serlopitant, a highly selective small molecule inhibitor of the neurokinin 1 receptor, or NK₁-R, given as a once-daily, oral tablet, has the potential to significantly alleviate pruritus.

More than 80 million patients in the United States are affected by chronic pruritus associated with various conditions.  Chronic pruritus is defined as pruritus lasting longer than six weeks. Pruritus is the primary complaint among patients with prurigo nodularis and psoriasis, often significantly impacting their quality of life. Current therapies, however, do not adequately control pruritus in many of these patients. Accordingly, there is a significant opportunity for a once‑daily oral tablet therapy for pruritus associated with these disease conditions. We believe that serlopitant, if approved, may be adopted by physicians as an oral anti‑pruritic therapy either as an adjunct to topical or systemic treatments or as a monotherapy in patients for whom management of pruritus is the primary patient need. In January 2019, the FDA granted Breakthrough Therapy designation for serlopitant for the treatment of pruritus associated with prurigo nodularis. Breakthrough Therapy designation is granted to expedite the development and review process for drugs intended to treat a serious condition where preliminary clinical evidence indicates that the drug candidate may demonstrate substantial improvement over available therapies on a clinically significant endpoint.

Merger with Foamix and Change of Control

On November 10, 2019, we and Foamix Pharmaceuticals Ltd., or Foamix, and Giants Merger Subsidiary Ltd., a wholly-owned subsidiary of Menlo, or Merger Sub, entered into an Agreement and Plan of Merger (as amended by Amendment No. 1 to the Agreement and Plan of Merger, dated as of December 4, 2019, as may be further amended from time to time), or the Merger Agreement. Pursuant to the terms of the Merger Agreement, Merger Sub will merge with and into Foamix, with Foamix surviving as a wholly-owned subsidiary of Menlo, or the Merger.

The Merger is being undertaken to create a combined biopharmaceutical company, or the Combined Company, focused on the commercialization and development of therapeutics to serve patients in the dermatology space.  The transaction contemplated by the Merger Agreement will result in a change in control of our company as described below.  On February 6, 2020, the Merger was approved by both our stockholders and Foamix’ shareholders. The Merger is expected to close on March 9, 2020.

The Combined Company will have a diversified portfolio including an approved product and three late-stage product candidates focused on dermatologic indications:

The Combined Company has a compelling product portfolio and late-stage pipeline.  There are multiple recently completed or near-term upcoming milestones:

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The rationale for the Merger is to create value for the combined shareholders of Foamix and Menlo by creating a Combined Company capable of realizing several synergies, including:

The transaction is structured as a stock-for-stock exchange, enabling the Foamix and Menlo shareholders to share in the upside advantages of the Combined Company. Under the terms of the Merger Agreement at closing, each ordinary share of Foamix will be exchanged for 0.5924 of our shares of common stock and a non-transferrable contingent stock right, or CSR. The number of shares of our common stock to be received by Foamix shareholders will be subject to upwards adjustment via a CSR to 1.2739 or 1.8006 shares of our common stock for each ordinary share of Foamix if (a) on or prior to May 31, 2020, proof of statistically significant superiority of serlopitant treatment over placebo treatment on the primary endpoint, as set out in the Merger Agreement (“Serlopitant Significance”), was achieved in one Phase III PN trial but was not achieved (or has not been determined) in the other Phase III PN trial or (b) on or prior to May 31, 2020, Serlopitant Significant was not achieved in either Phase III PN trial or if the Efficacy Determination has not been delivered on or before May 31, 2020, respectively.

After the completion of the Merger, we will continue as a public company, with our common stock continuing to be listed and traded on Nasdaq, and will serve as the parent company of Foamix. Our headquarters will be moved to Bridgewater, New Jersey (the location of Foamix’s current U.S. headquarters). We will continue as a Delaware corporation and will continue to be governed by our existing Amended and Restated Certificate of Incorporation, Amended and Restated Bylaws and the Delaware General Corporation Law (DGCL). If the Merger is consummated successfully, the Combined Company would be led by David Domzalski, CEO of Foamix and the other members of the Foamix management team.  The board of the Combined Company would consist of five members designated by Foamix (including Mr. Domzalski) and two members designated by us (including Steve Basta, our current CEO).

Serlopitant Clinical Development Pipeline Summary

 

Our serlopitant development pipeline is summarized in the figure below:

 

 

 

 

We have a broad clinical development program for serlopitant, which is designated as a once‑daily oral tablet for treatment of pruritus. Our current development program includes the following:  

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Our current development program is focused on three double‑blind Phase 2 clinical trials in patients with pruritus in which we observed clinically relevant and statistically significant improvements in pruritus in patients treated with serlopitant compared to patients treated with placebo. 

Psoriasis: Our Phase 2 clinical trial conducted in 204 patients with pruritus associated with psoriasis, met its primary endpoint and a key secondary endpoint, demonstrating greater pruritus reduction in serlopitant-treated patients versus placebo.  In February 2020, we announced top-line results from a Phase 2 clinical trial in 233 patients with chronic pruritus of unknown origin, or CPUO, in which treatment with serlopitant failed to demonstrate benefit versus placebo on the primary endpoint. In addition, there were no meaningful differences observed between the serlopitant and placebo groups in the prospectively-defined secondary endpoints. Based upon the results of this trial, we do not anticipate further development of serlopitant for the treatment of CPUO.

 

The safety of serlopitant has been assessed in more than 2,000 individuals, including healthy volunteers and patients with pruritus and other indications, and has been shown to be well tolerated, including when administered to patients in a clinical trial for up to one year.

Management

Members of our current Menlo management team have extensive experience in product development, having held drug development, commercial and leadership roles at numerous biopharmaceutical and dermatology products companies.

 

If the Merger is consummated successfully, the Combined Company will be managed by the current Foamix management team and would be led by David Domzalski, CEO of Foamix and headquartered in New Jersey. The board of the Combined Company would consist of five members designated by Foamix (including Mr. Domzalski) and two members designated by us (including Steve Basta, our current CEO).

 

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Disease Overview

Chronic pruritus, defined as itching lasting longer than six weeks, affects approximately 80 million people in the U.S. and can be as burdensome as chronic pain in negatively impacting a patient’s quality of life. The urge to scratch can be unbearable, and the act of scratching can remove layers of skin and break the skin barrier leading to bleeding, scarring and greatly increasing the risk of infection. Similar to chronic pain, severe chronic pruritus causes a number of physical and psychological issues that substantially impact patients’ day-to-day well-being. Pruritus can lead to trouble sleeping, resulting in loss of work productivity and increased anxiety and depression as patients struggle to maintain self-control. Pruritus is the primary patient complaint in each of our current pruritus development programs:

Clinical Need in Pruritus

Despite its prevalence, chronic pruritus is not well addressed by current therapies. Skin diseases such as prurigo nodularis and psoriasis are commonly treated with a multi‑prong therapeutic approach. Skin barrier restoration and maintenance through application of topical moisturizers and treatment of skin lesions locally through the use of topical corticosteroids or other topical anti‑inflammatory agents are the predominant first‑line therapies for many pruritic skin diseases. Phototherapy and systemic immunomodulators including biologics are frequently used for more severe disease. These therapies may reduce pruritus to some degree in addition to their effects on skin health and inflammation. Yet many patients with prurigo nodularis and psoriasis still report high levels of pruritus despite active topical or systemic therapy. This significant medical need is reflected by the widespread use of therapies intended to address pruritus specifically, such as oral antihistamines, despite evidence demonstrating their relative lack of efficacy, as well as concerns regarding their safety and tolerability, such as sedative effects of antihistamines.

The itch‑scratch cycle can also undermine progress in treating skin lesions if pruritus is not addressed adequately. In any skin disease, repeated itching and scratching can lead to secondary cutaneous infections. In psoriasis patients, scratching can lead to the development of new psoriatic lesions. Similarly, prurigo nodularis is characterized by excoriations, crusting and sometimes ulceration of lesions due to the incessant scratching provoked by chronic pruritus. We believe that the pruritus associated with multiple distinct diseases, such as psoriasis and prurigo nodularis, involves activation of a common neuronal pathway for itch signaling, enabling a drug that is effective in reducing pruritus associated with one disease to have efficacy in reducing pruritus in others.

No treatment for prurigo nodularis has been approved in the United States or Europe. A high priority in any treatment for prurigo nodularis is to identify and address any underlying cause of itching. However, specific trigger factors for the development of prurigo nodularis in an individual patient may be difficult to identify. Treatment of prurigo nodularis typically involves a multifaceted approach to treat the lesions and reduce itch. Therapies may include corticosteroids and other immunosuppressive or anti‑inflammatory treatments, phototherapy and agents such as Neurontin or Horizant (gabapentin) and Lyrica (pregabalin). Prurigo nodularis is often treatment resistant with high recurrence rates.

Mild to moderate psoriasis is typically treated with topical therapies such as corticosteroids or vitamin D analogs. Moderate to severe psoriasis may be treated with topical therapies, systemic immunosuppressive or immunomodulatory drugs, or phototherapy. While all of these therapies can help reduce the skin irritation and plaques in patients with psoriasis, and may also reduce pruritus to some degree, they may not adequately resolve the pruritus associated with psoriasis.

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Our Solution: Serlopitant

We are developing serlopitant, a small molecule, highly selective NK₁‑R antagonist, as a once‑daily oral tablet therapy to reduce pruritus in patients with prurigo nodularis and psoriasis. We believe serlopitant has the potential to be a safe and efficacious treatment for pruritus based on the following:

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Background on Substance P and NK₁-R

Serlopitant is a small molecule, highly selective NK₁‑R antagonist. Two critical mediators of the urge to scratch are Substance P, or SP, and its receptor, the neurokinin‑1 receptor, or NK₁‑R. SP is a naturally occurring peptide in the tachykinin neuropeptide family. Tachykinins have a broad range of functions in the nervous and immune systems. SP binding of NK₁‑R has been shown to be a key mediator of sensory nerve signaling, including the itch‑scratch reflex and the vomiting reflex. The following figure illustrates the role of NK₁‑R in itch signaling:

 

 

SP administration and NK₁‑R inhibition have been validated in multiple animal models of human disease, which indicate potential therapeutic development paths in pruritus and vomiting. Based upon the animal models of vomiting, NK₁‑R antagonists have been successfully developed and commercialized as treatments for chemotherapy induced nausea and vomiting. In pruritus animal studies, SP injection can stimulate scratching and NK₁‑R inhibition can stop scratching.

Our work builds upon the successful demonstration of activity in animal models and human proof of concept studies in pruritus. Serlopitant has been designed to overcome many of the limitations of previous generation NK₁‑R antagonists, such as aprepitant. For instance, aprepitant is only approved for short term use associated with nausea and vomiting. Compared to aprepitant, serlopitant has a longer half‑life, fewer potential drug‑drug interactions, a more linear pharmacokinetic profile and was well tolerated when administered to patients in a clinical trial for up to one year.

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Serlopitant Clinical Trials in Pruritus

The primary efficacy results from the three Phase 2 pruritus clinical trials which showed statistically significant improvements in pruritus in patients treated with serlopitant compared to patients treated with placebo are illustrated in the figures below and more fully described in the clinical trials sections to follow.

Each of these clinical trials included endpoints requiring patients to report itch severity on the visual analog scale, or VAS, or on the Numeric Rating Scale, or NRS. The VAS requires patients place a mark on a 100 mm line corresponding to the degree of severity of their pruritus. The distance from the origin of the line is measured to indicate pruritus severity, where 0 mm represents no itch and 100 mm represents the worst itch imaginable.  To report itch severity on the NRS, patients select an integer ranging from 0 to 10 corresponding to the degree of severity of their pruritus, where 0 represents no itch and 10 represents the worst itch imaginable.

Prurigo Nodularis Clinical Trials

Prurigo Nodularis Completed Phase 2 Clinical Trial Design

In June 2016, we completed a Phase 2 clinical trial to evaluate the safety and efficacy of serlopitant in patients with pruritus associated with prurigo nodularis. The study was a multicenter, randomized, double‑blind, placebo‑controlled study in 127 adult patients (18 to 80 years of age) who had prurigo nodularis for more than six weeks, whose pruritus was nonresponsive or inadequately responsive to topical steroids or antihistamine and who had a baseline VAS pruritus score of at least 70 mm.

Patients underwent a screening period of up to four weeks. Eligible patients were randomized to either the serlopitant 5 mg group or the placebo group, and began an eight‑week treatment period, followed by a two‑week follow‑up period. At baseline, patients received a loading dose of three tablets. Thereafter, patients took one tablet every day at bedtime for eight weeks. A total of 127 randomized patients received study drug in one of the two arms (63 received placebo, 64 received 5 mg serlopitant). The mean age was 57.6 years, and 52.8% of the patients were female. Demographics were generally balanced across the two treatment arms.

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The primary efficacy analysis was the change in average itch VAS from baseline in patients in the serlopitant treatment group compared with placebo. The week four and eight tests were considered primary; hence, there were two primary comparisons, one for each visit. Secondary efficacy analyses included additional itch assessments such as the worst itch VAS and average and worst itch NRS, quality of life measures and assessments of prurigo nodularis lesion severity. Safety endpoints included TEAEs, laboratory values, vital signs and electrocardiogram findings.

Prurigo Nodularis Completed Phase 2 Clinical Trial Efficacy Results

The study met its primary and multiple secondary efficacy endpoints of pruritus reduction in patients in the serlopitant treatment group compared with placebo. For the primary efficacy analysis defined as change from baseline in average itch VAS at weeks four and eight, a serlopitant dose of 5 mg given once a day led to a superior change from baseline in average itch VAS than placebo. At week four, the serlopitant 5 mg group showed a 25 mm improvement from baseline in average itch VAS compared to a 15 mm improvement from baseline in the placebo group (p = 0.025), and at week eight, the serlopitant 5 mg group showed an improvement of 36 mm from baseline in average itch VAS compared with an improvement of 19 mm for the placebo group (p = 0.001). Patients receiving 5 mg serlopitant had a statistically significant reduction in the average itch VAS score for pruritus compared to the placebo group at every measured time point.

Serlopitant also demonstrated superior efficacy over placebo in multiple additional predefined measures of itch VAS and NRS change from baseline. The chart below summarizes the VAS and NRS in this study. After the study was completed, we conducted post‑hoc analyses of responder rates using a responder definition of 40 mm VAS improvement or a 4‑point or greater NRS improvement. These responder analyses were conducted for the purposes of planning our Phase 3 clinical trials and are consistent with the 4‑point or greater improvement responder definition we have set as the primary efficacy analysis for our ongoing Phase 3 clinical trials in pruritus associated with prurigo nodularis.

The following table summarizes VAS and NRS efficacy outcomes at week eight in the prurigo nodularis Phase 2 clinical trial:

 

 

Several additional measures of pruritus and prurigo nodularis severity recorded in the study as exploratory or secondary measures also indicated greater improvement in serlopitant-treated patients compared with the placebo-treated patients.

Prurigo Nodularis Completed Phase 2 Clinical Trial Safety Results

Serlopitant was well tolerated in this Phase 2 clinical trial. Two patients had severe adverse events, or SAEs, that were assessed as possibly related to serlopitant (depression and dizziness/vertigo). The most common treatment emergent adverse events, or TEAEs, in the serlopitant group were nasopharyngitis (17.2%), diarrhea (10.9%), fatigue (9.4%), dizziness (7.8%), headache (6.3%), peripheral edema (6.3%), pruritus (4.7%), hypertension (4.7%), vomiting (3.1%), bronchitis (3.1%) and cough (3.1%). The most common TEAEs in the placebo group were pruritus (11.1%), fatigue (6.3%), headache (6.3%), urinary tract infection (6.3%), diarrhea (4.8%), nasopharyngitis (3.2%), nausea (3.2%), upper abdominal pain (3.2%), asymptomatic bacteriuria (3.2%), bradycardia (3.2%), eczema (3.2%), insomnia (3.2%) and oral herpes (3.2%).

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Prurigo Nodularis Ongoing Phase 3 Clinical Trials

In 2018 we initiated two multicenter, placebo‑controlled, double‑blind Phase 3 clinical trials of serlopitant for the treatment of pruritus associated with prurigo nodularis. These trials are intended to evaluate if treatment with 5 mg serlopitant daily for ten weeks can reduce pruritus associated with prurigo nodularis compared with placebo. We are conducting one trial in the United States and one in Europe. Both trials are fully enrolled with 285 patients at 46 sites in the US trial and 295 patients at 39 sites in in the European trial. The trials enrolled patients with a worst‑itch NRS score, or WI‑NRS, of at least seven at screening. The primary efficacy analysis for both of these trials is a four‑point responder rate in the WI‑NRS at ten weeks. Secondary efficacy endpoints will include WI‑NRS at four weeks, change in WI‑NRS from baseline to day seven and day three, change in number of night time scratching events from baseline to week eight and changes in a measure of scratching behavior. Results from both trials are expected in March or April of 2020.

In January 2019, the FDA granted Breakthrough Therapy designation for serlopitant for this indication. Breakthrough Therapy designation is granted to expedite the development and review process for drugs intended to treat a serious condition where preliminary clinical evidence indicates that the drug candidate may demonstrate substantial improvement over available therapies on a clinically significant endpoint.

In parallel with the two Phase 3 clinical trials in prurigo nodularis, we have initiated an open label long‑term safety trial in which patients will receive treatment doses of 5 mg serlopitant for one year.

 

Psoriasis Clinical Trials

Psoriasis Completed Phase 2 Clinical Trial Design

We completed a Phase 2 clinical trial in pruritus associated with psoriasis in December 2018. The clinical trial was a randomized, double-blind, placebo-controlled Phase 2 clinical trial which evaluated the efficacy, safety, and tolerability of serlopitant for the treatment of pruritus associated with psoriasis.  The trial enrolled patients between 18 and 80 years of age with the diagnosis of plaque psoriasis for at least six months prior to randomization and with plaques covering less than 10% of the patients’ body surface area. In addition, patients had pruritus of at least four weeks duration prior to screening and a WI-NRS score consistent with severe pruritus at screening.  

Patients underwent a screening period of up to four weeks. Eligible patients were randomized 1:1 to receive either serlopitant 5 mg or placebo and began an eight‑week treatment period, followed by a two‑week follow‑up period. At baseline, patients received a loading dose of three tablets. Thereafter, patients took one tablet every day for eight weeks. Patients were not allowed to use any other psoriasis therapy, other than bland emollients, for the duration of the trial. A total of 204 patients were randomized, and 203 patients received study drug in one of the two arms (101 received placebo, 102 received 5 mg serlopitant). The mean age was 47.5 years, and 54.2% of the patients were female. Demographics were generally balanced across the two treatment arms.

This clinical trial was intended to evaluate if treatment with serlopitant 5 mg daily for eight weeks could improve pruritus compared with placebo. The primary efficacy endpoint was a responder analysis of the proportion of patients in each group achieving a 4-point or greater improvement in WI-NRS at week eight compared to baseline.  

 

Psoriasis Completed Phase 2 Clinical Trial Efficacy Results

 

The trial successfully met its primary endpoint, showing a statistically significant reduction in pruritus.  In the trial, 33% of patients treated with serlopitant 5 mg daily achieved a 4-point or greater improvement in the WI-NRS, at week eight compared to baseline (primary efficacy endpoint) vs. 21% of patients treated with placebo (p= 0.028).  

 

The trial also prospectively defined three key secondary endpoints at earlier timepoints for sequential step-down analyses. The trial successfully met the secondary endpoint of 4-point or greater WI-NRS responder rate at week four.  At week four, 21% of patients treated with serlopitant achieved a 4-point or greater WI-NRS improvement vs. 11% of patients treated with placebo (p=0.039).  Assessment of the secondary endpoints of the absolute change in WI-NRS from baseline to day seven and day three for serlopitant compared to placebo showed a greater numerical, but not statistically significant, improvement for the serlopitant group.  At every assessed time point in the trial (daily in week one and average weekly scores through week eight), the serlopitant treated group demonstrated greater numerical improvement than the placebo group in both the WI-NRS 4-point responder analysis and in the mean change in WI-NRS from baseline.

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Psoriasis Completed Phase 2 Clinical Trial Safety Results

Serlopitant was well-tolerated in this Phase 2 clinical trial. No SAEs were reported for serlopitant treated patients.  Treatment-emergent adverse events assessed as likely related to treatment were observed with similar frequency in both groups (4.0% for placebo and 4.9% for serlopitant). The most common TEAEs in the serlopitant group were diarrhea and headache (2.9% each), and nasopharyngitis, psoriasis, and urinary tract infection (2.0% each). The most common TEAEs in the placebo group were nasopharyngitis (6.0%), headache (5.0%), upper respiratory tract infection (4.0%), diarrhea (3.0%), and bronchitis, hypertension, hypertriglyceridemia, pain, and skin abrasion (2.0% each).

Psoriasis Phase 3 Clinical Program

We have chosen to defer the decision to start a Phase 3 clinical program in pruritus associated with psoriasis until 2020 in consideration of prudent resource prioritization and allocation management. We plan to consider any learnings from our ongoing PN trials once completed and our recently completed CPUO trial and evaluate the opportunity in psoriasis compared to potential alternative investments.

Chronic Pruritus and CPUO Clinical Trials

Chronic Pruritus Completed Phase 2 Clinical Trial Design

Our first Phase 2 clinical trial of serlopitant in pruritus was completed in December 2014 and evaluated the safety and efficacy of serlopitant in patients with chronic pruritus. The study was a multicenter, randomized, double‑blind, placebo‑controlled trial in 257 adult patients (18 to 65 years of age) with pruritus for more than six weeks that were non‑responsive or inadequately responsive to topical steroids or antihistamines, and who had a VAS of at least 70 mm.

Patients underwent a screening period of up to two weeks. Eligible patients were randomized to one of four treatment groups (placebo or serlopitant 0.25 mg, 1 mg or 5 mg tablets), and began a six‑week treatment period, followed by a four‑week follow‑up period. At baseline, patients received a loading dose of three tablets. Thereafter, patients took one tablet every day at bedtime for six weeks. A total of 257 patients were randomized into one of the four groups (64 received a placebo, 64 received 0.25 mg serlopitant, 65 received 1 mg serlopitant and 64 received 5 mg serlopitant). The mean age was 43.7 years, and 60.7% of the patients were female. Demographics were generally balanced across treatment groups.

The primary efficacy analysis compared the percent change from baseline in itch VAS score in each serlopitant treatment group with the placebo group. An important secondary efficacy endpoint was percent change from baseline in itch on the NRS. Other secondary efficacy endpoints included assessments of sleep and quality of life.

 

Chronic Pruritus Completed Phase 2 Clinical Trial Efficacy Results

The study met its primary and multiple secondary efficacy endpoints of pruritus reduction for patients treated at the two highest doses (serlopitant 5 mg and 1 mg daily). At week six, for the primary efficacy analysis, the serlopitant 5 mg group and serlopitant 1 mg group showed an improvement in pruritus of 42.5% and 41.4% from baseline, respectively, measured by the itch VAS. Each represents a statistically greater improvement compared with the placebo group improvement of 28.3% (5 mg, p = 0.013; 1 mg, p = 0.022).

 

Serlopitant at 5 mg and 1 mg also demonstrated superior efficacy over placebo for the secondary efficacy endpoint of percent change from baseline in itch NRS. At week six, the serlopitant 5 mg group and serlopitant 1 mg group showed an improvement in pruritus of 39.0% and 39.4% from baseline, respectively, measured by the itch NRS score. Each represents a statistically greater improvement compared with the placebo group improvement of 28.7% (5 mg, p = 0.038; 1 mg, p = 0.031).

After the completion of the trial, we conducted additional (post‑hoc) analyses to look at patients with at least 40 mm of improvement on the itch VAS or a minimum 4‑point improvement on itch NRS scores. These analyses were conducted to help us plan and power future clinical trials based upon our interactions with the FDA. In this analysis of itch VAS responders, 52.8% of patients receiving 5 mg serlopitant had at least a 40 mm improvement in itch VAS compared with 25.9% of patients in the placebo group showing similar improvement (p=0.004). 46.2% of patients receiving 5 mg serlopitant had at least a 4‑point improvement on the itch NRS as compared to 22.6% of patients in the placebo group (p = 0.011).

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The following table summarizes VAS and NRS efficacy outcomes at week six in the chronic pruritus Phase 2 clinical trial:

 

 

 

Chronic Pruritus Completed Phase 2 Clinical Trial Safety Results

Serlopitant was well tolerated in this study. No SAEs were assessed as definitely, probably, or possibly related to serlopitant. The most common TEAEs, in the serlopitant groups were diarrhea (6.2%, 1 mg group), upper respiratory tract infection (4.7%, 0.25 mg group), somnolence (4.7%, 5 mg group), nasopharyngitis (4.6%, 1 mg group), headache (4.6%, 1 mg group), urinary tract infection (3.1%, 5 mg group), dry mouth (3.1%, 1 mg group), nausea (3.1%, 1 mg group), arthralgia (3.1%, 0.25 mg group), musculoskeletal pain (3.1%, 1 mg group), and pruritus (3.1%, 0.25 and 1 mg groups). The most common TEAEs in the placebo group were headache (6.3%), nasopharyngitis (3.2%), upper respiratory tract infection (3.2%), urinary tract infection (3.2%) and asthma (3.2%).

CPUO Completed Phase 2 Clinical Trial

After the completion of our Phase 2 clinical trial in patients with pruritus associated with atopic dermatitis which did not meet its primary and secondary efficacy endpoints, we conducted retrospective analyses of our three Phase 2 pruritus clinical trials completed with serlopitant in an effort to understand further the atopic dermatitis clinical trial results and identify potential patient populations who may demonstrate greater response to serlopitant therapy. All of these post-hoc analyses were conducted solely for the purposes of informing future study design and indication selection, and do not constitute specific conclusions of efficacy. In these analyses, we observed several patterns that have informed our decision to initiate a clinical trial in patients with CPUO. Our analyses suggested that patients without inflammatory skin disease appeared to respond better to serlopitant therapy than patients with inflammatory skin disease. Older patients or patients who had been pruritic for longer appeared to respond better to serlopitant therapy than patients who were younger or had a shorter duration of pruritus. Based on these analyses, in 2018 we initiated a CPUO clinical program.

In the fourth quarter of 2018, we commenced a multicenter, placebo‑controlled double‑blind Phase 2 clinical trial of serlopitant for the treatment of CPUO and began enrolling patients in the first quarter of 2019. This trial enrolled 233 patients who have experienced CPUO for at least six months prior to enrollment across 36 sites in the U.S. This trial included a ten-week treatment period and a five-week follow-up period. This trial was intended to evaluate if treatment with 5 mg serlopitant daily for ten weeks can reduce CPUO compared to placebo. The primary efficacy analysis compared serlopitant versus placebo based on a WI-NRS 4-point or greater responder rate at week ten.  

 

CPUO Completed Phase 2 Clinical Trial Efficacy Results

 

In February 2020, we announced top-line results from this clinical trial in which treatment with serlopitant failed to demonstrate benefit versus placebo on the primary endpoint.  In the trial, 37.9% of patients treated with serlopitant 5 mg daily (N=116) achieved a 4-point or greater improvement in the WI-NRS, at week ten compared to baseline (primary efficacy endpoint) vs. 39.3% of patients treated with placebo (N=117).  In addition, there were no meaningful differences observed between the serlopitant and placebo groups in the prospectively-defined secondary endpoints.

 

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CPUO Completed Phase 2 Clinical Trial Safety Results

Serlopitant was well-tolerated in this Phase 2 clinical trial.  Two patients had a total of three SAEs that were assessed as unlikely related to serlopitant (intracranial mass, metastasis, pulmonary embolism). The most common TEAEs in the serlopitant group were diarrhea (6.9%), somnolence (5.2%), fatigue and headache (2.6% each). The most common TEAEs in the placebo group were gastroesophageal reflux disease and arthralgia (2.6% each).

Other Clinical Studies

In addition to the three successful clinical trials we have conducted with serlopitant for the treatment of pruritus, in 2018 we completed a Phase 2 pruritus clinical trial in 484 patients with pruritus associated with atopic dermatitis. Though numerical differences favoring the serlopitant treated groups were evident at all timepoints, the study did not meet its primary and secondary efficacy endpoints, with no statistically significant difference demonstrated. In February 2020, we announced top-line results from a Phase 2 clinical trial in 233 patients with CPUO in which treatment with serlopitant failed to demonstrate benefit versus placebo on the primary and key secondary endpoints. In 2018, we also completed a Phase 2 clinical trial in 185 patients with refractory chronic cough in which treatment with serlopitant failed to demonstrate benefit versus placebo on the primary and key secondary endpoints.

 

In addition to our efficacy and safety studies noted above, we have conducted additional studies required for regulatory review of serlopitant.  These include pharmacokinetics studies, safety studies, and other studies as needed to support our applications for regulatory approval in the United States and internationally.

Safety

Serlopitant has been evaluated in more than 2,000 individuals across multiple completed Phase 1 and Phase 2 clinical trials. Single doses up to 400 mg and doses up to 50 mg a day for four weeks have been administered. Doses of 4 mg (in a liquid filled capsule, which provides comparable exposure to our current 5 mg tablet) a day for up to one year have been administered. Serlopitant has been well tolerated to date. Across all completed Phase 2 studies, including the trials conducted by Merck, five patients have experienced SAEs which have been assessed by the reporting investigator or us as related to serlopitant; each of these SAEs has been reported only once. The most commonly reported treatment‑emergent adverse events across all completed Phase 2 studies excluding our recently completed Phase 2 clinical trial in CPUO patients, were urinary tract infection (4.8%, as compared to 2.5% for patients treated with placebo), nasopharyngitis (4.8%, as compared to 3.7% for patients treated with placebo), diarrhea (4.7%, as compared to 3.4% for patients treated with placebo) and headache (4.4%, as compared to 6.3% for patients treated with placebo). In our recently completed Phase 2 clinical trial in CPUO patients, the most common treatment‑emergent adverse events in the serlopitant group were diarrhea (6.9%), somnolence (5.2%), fatigue and headache (2.6% each), and the most common treatment‑emergent adverse events in the placebo group were gastroesophageal reflux disease and arthralgia (2.6% each).

The safety of serlopitant was evaluated in genetic toxicity, acute toxicity, repeated dose oral toxicity studies up to nine months in duration, two‑year oral carcinogenicity studies, developmental toxicity studies, fertility and reproduction studies and local tolerability (dermal and ocular) studies.  Serlopitant was neither mutagenic nor genotoxic in in vitro and in vivo assays. Additional non‑clinical studies are on-going to support NDA submission.

Regulatory Pathway

We expect to report top-line data from our PN Phase 3 trials in March or April of 2020 and, if these clinical trials are successful, we plan to submit an NDA for serlopitant for pruritus associated with PN in the second half of in 2020.

 

In January 2019, the FDA granted Breakthrough Therapy designation, or BTD, for serlopitant to treat pruritus associated with PN. Breakthrough Therapy designation is granted to expedite the development and review process for drugs intended to treat a serious condition where preliminary clinical evidence indicates that the drug candidate may demonstrate substantial improvement over available therapies on a clinically significant endpoint. We have had multiple interactions with the FDA regarding our development program and planned NDA submission for pruritus associated with prurigo nodularis, including an end-of-Phase 2 meeting, a CMC end of Phase 2 review, an initial multidisciplinary BTD meeting, among others. Guidance received from the FDA during these interactions provided overall concurrence with our NDA submission plan including our nonclinical, clinical and CMC development programs and the content and format of the planned NDA.

 

The serlopitant development program was designed with a global registration aim, however our initial regulatory submission will be made in the US with an NDA for serlopitant for treatment of pruritus associated with prurigo nodularis.

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Based on communications with the FDA, Menlo anticipates a Priority Review designation will be granted for this NDA under the provisions of BTD for use of serlopitant in the proposed indication.

 

In addition to treatment of pruritus associated with PN, we may pursue further development of serlopitant in other pruritic populations.  

Competition

Although there are currently no approved drugs in the United States or Europe specifically indicated for the treatment of pruritus associated with prurigo nodularis and psoriasis, we may face competition from companies that are developing drugs specifically to treat pruritus associated with a variety of underlying dermatologic or systemic conditions; from companies that are developing and marketing NK₁ receptor antagonists for other conditions, that, if approved, could be used off-label to treat pruritus; and from companies that currently market or are developing treatments intended to treat the underlying disease condition in psoriasis, or prurigo nodularis that have also been shown to have anti-pruritic effects.

License and Collaboration Agreements

Merck License

In December 2012, we entered into a license agreement with Merck for exclusive worldwide royalty‑free rights for the development and commercialization of serlopitant and two other NK₁‑R antagonists in all human diseases, disorders or conditions, except for the treatment or prevention of nausea or vomiting. We paid Merck an upfront licensing fee of $1.0 million and issued to Merck an aggregate of 1,243,168 shares of our common stock. In addition, we have agreed to make aggregate payments of up to $25.0 million upon the achievement of specified development and regulatory milestones for serlopitant. Furthermore, if we choose to pursue the development of any other products pursuant to this agreement, we may owe up to an aggregate of $50.0 million of additional payments upon the achievement of specified development and regulatory milestones. In 2018, upon dosing our first patient in our Phase 3 clinical trial for serlopitant for the treatment of pruritus associated with prurigo nodularis, we paid a milestone payment of $3.0 million to Merck. We are responsible for the prosecution and enforcement of patents licensed under the agreement. The agreement contains customary representations, warranties, and indemnities, and terminates on the date of achievement of all of milestones set forth in the agreement, after which our licenses become fully paid and perpetual. Each party may also terminate the agreement for material breach by the other party or for certain bankruptcy or insolvency related events, and we may terminate the agreement without cause at any time upon advance written notice to Merck.

Manufacturing

We currently contract with third parties for the manufacture of serlopitant drug substance and drug product for clinical trials and intend to continue doing so in the future. We require all of our contract manufacturing organizations, or CMOs, to conduct manufacturing activities in compliance with current good manufacturing practice, or cGMP, requirements. We have assembled a team of experienced employees and consultants to provide the necessary technical, quality and regulatory oversight over our CMOs. We rely solely on these third‑party manufacturers for scale‑up and process development work and to produce sufficient quantities of serlopitant for use in clinical and non-clinical studies. We currently have development contracts and quality agreements with two CMOs for the manufacturing of serlopitant drug substance and drug product. We anticipate that these CMOs will have capacity to support commercial scale production, but we do not have any formal agreements at this time with either of these CMOs to cover commercial production. We also may elect to pursue additional CMOs for manufacturing supplies of regulatory starting materials in the future. We currently have no plans to establish our own manufacturing capabilities and plan to continue to rely on third‑party manufacturers for any future trials and commercialization of serlopitant, if approved.

Commercial Operations

We currently have no marketing and sales organization. If approved by the FDA for pruritus associated with our target conditions, we intend to market and commercialize serlopitant by developing our own sales organization targeting a subset of the 10,000 to 12,000 dermatologists in the United States. Outside the United States, we intend to establish commercialization strategies for serlopitant as we approach possible commercial approval in each market, which may include collaborations with other companies. If the Merger is successful, we may be able to leverage commercial infrastructure from the Combined Company.

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Intellectual Property

Our commercial success depends in part on our ability to obtain and maintain proprietary protection for our drug candidates, manufacturing and process discoveries, and other know‑how, to operate without infringing the proprietary rights of others, and to prevent others from infringing our proprietary rights. Our policy is to seek to protect our proprietary position by, among other methods, filing U.S. and foreign patent applications related to our proprietary technology, inventions and improvements that are important to the development and implementation of our business. We also rely on trade secrets, know‑how, continuing technological innovation and potential in‑licensing opportunities to develop and maintain our proprietary position.

With regard to serlopitant, we intend to pursue composition‑of‑matter patents, where possible, and dosage and formulation patents, as well as method‑of‑use patents on novel indications for known compounds.

As of December 2019, we own or have an exclusive license to 15 issued U.S. patents and 53 issued foreign patents, which include granted European patent rights that have been validated in various EU member states, and 3 pending U.S. patent applications and greater than 35 pending foreign patent applications.

The patent portfolio for serlopitant is directed to cover compositions of matter and methods of treatment. This patent portfolio includes issued U.S. patents, pending U.S. patent applications and corresponding foreign national and regional counterpart patents and patent applications. The issued composition of matter patent (U.S. Patent No. 7,217,731), is exclusively licensed from Merck and if the appropriate maintenance fees are paid, is expected to expire in 2025. We own the patents and patent applications relating to the use of serlopitant. The issued methods of use patents (U.S. Patent Nos. 8,906,951; 9,198,898; 9,381,188; 9,474,741; 9,486,439, 9,737,507, 9,737,508, 9,974,769; 9,968,588, 10,278,952; and 10,278,953), if the appropriate maintenance fees are paid, are expected to expire in 2033. Additional patent term may be awarded for one of the serlopitant U.S. patents as a result of the patent term extension provision of the Hatch‑Waxman Amendments of 1984, or the Hatch‑Waxman Act.

The term of composition of matter patents and patent applications, if issued, relating to serlopitant in other jurisdictions (some of the major jurisdictions include Australia, Canada, China, Denmark, France, Germany, Ireland, Italy, Japan, Mexico, Netherlands, Norway, Spain, Sweden, Switzerland, Taiwan, United Kingdom and India) and methods of use patents and patent applications, if issued, relating to serlopitant (some of the major jurisdictions include Australia, Brazil, Canada, China, Europe, India, Indonesia, Israel, Japan, Korea and Mexico), if the appropriate maintenance, renewal, annuity and other government fees are paid, are expected to expire between 2025 and 2034. These patents and patent applications (if applicable), depending on the national laws, may benefit from extension of patent term in individual countries if regulatory approval of serlopitant is obtained in those countries. In the European Union member countries, for example, a supplementary protection certificate, if obtained, provides a maximum five years of market exclusivity. Likewise, in Japan, the term of a patent may be extended by a maximum of five years in certain circumstances.

Additional U.S. and foreign patent applications relating to serlopitant are pending. Patents resulting from these applications, if issued, and if the appropriate maintenance, renewal, annuity, and other government fees are paid, are expected to expire between 2037 and 2039.

We also protect our proprietary technology and processes, in part, by confidentiality and invention assignment agreements with our employees, consultants, scientific advisors and other contractors. These agreements may be breached, and we may not have adequate remedies for any breach. In addition, our trade secrets may otherwise become known or be independently discovered by competitors. To the extent that our employees, consultants, scientific advisors or other contractors use intellectual property owned by others in their work for us, disputes may arise as to the rights in related or resulting know‑how and inventions.

Our commercial success will also depend in part on not infringing the proprietary rights of third parties. It is uncertain whether the issuance of any third‑party patent would require us to alter our development or commercial strategies, alter our drugs or processes, obtain licenses or cease certain activities. Our breach of any license agreements or failure to obtain a license to proprietary rights that we may require to develop or commercialize our future drugs may have a material adverse impact on us. If third parties prepare and file patent applications in the United States that also claim technology to which we have rights, we may have to participate in interference proceedings in the United States Patent and Trademark Office, or USPTO, to determine priority of invention.

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Government Regulation

The FDA and comparable regulatory authorities in state and local jurisdictions and in other countries impose substantial and burdensome requirements upon companies involved in the clinical development, manufacture, marketing and distribution of drugs, such as serlopitant. These agencies and other federal, state and local entities regulate, among other things, the research and development, testing, manufacture, quality control, safety, effectiveness, labeling, storage, record keeping, approval, advertising and promotion, distribution, post‑approval monitoring and reporting, sampling and export and import of our product candidate.

U.S. Government Regulation of Drug Products

In the United States, the FDA regulates drugs under the Federal Food, Drug, and Cosmetic Act, or FDCA, and its implementing regulations. The process of obtaining regulatory approvals and the subsequent compliance with applicable federal, state, local and foreign statutes and regulations requires the expenditure of substantial time and financial resources. Failure to comply with the applicable U.S. requirements at any time during the product development process, approval process or after approval, may subject an applicant to a variety of administrative or judicial sanctions, such as the FDA’s refusal to approve pending NDAs, withdrawal of an approval, imposition of a clinical hold, issuance of warning letters, product recalls, product seizures, total or partial suspension of production or distribution, injunctions, fines, refusals of government contracts, restitution, disgorgement or civil or criminal penalties.

The process required by the FDA before a drug may be marketed in the United States generally involves the following:

Non-clinical Studies

Non-clinical studies include laboratory evaluation of product chemistry and formulation, as well as animal studies to assess safety, toxicity and efficacy. The conduct of the non-clinical tests must comply with federal regulations and requirements, including GLPs. An IND sponsor must submit the results of the non-clinical tests, together with manufacturing information, analytical data and any available clinical data or literature, among other things, to the FDA as part of an IND. Some non-clinical testing may continue even after the IND is submitted. An IND automatically becomes effective 30 days after receipt by the FDA, unless before that time the FDA raises concerns or questions related to one or more proposed clinical trials and places the clinical trial on a clinical hold. In such a case, the IND sponsor and the FDA must resolve any outstanding concerns before the clinical trial can begin. As a result, submission of an IND may not result in the FDA allowing clinical trials to commence.

Clinical Trials

Clinical trials involve the administration of the investigational new drug to human patients under the supervision of qualified investigators in accordance with GCP requirements, which include the requirement that all research patients

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provide their informed consent in writing for their participation in any clinical trial. Clinical trials are conducted under protocols detailing, among other things, the objectives of the trial, the parameters to be used in monitoring safety, and the effectiveness criteria to be evaluated. A protocol for each clinical trial and any subsequent protocol amendments must be submitted to the FDA as part of the IND. In addition, an IRB at each institution participating in the clinical trial must review and approve the protocol for any clinical trial including informed consent information before the study commences at that institution. Information about most clinical trials must be submitted within specific timeframes for publication on the www.clinicaltrials.gov website. Information related to the product, patient population, phase of investigation, study sites and investigators, and other aspects of the clinical trial is made public as part of the registration of the clinical trial. Sponsors are also obligated to discuss the results of their clinical trials after completion. Disclosure of the results of these trials can be delayed in some cases for up to two years after the date of completion of the trial. Competitors may use this publicly available information to gain knowledge regarding the progress of development programs.

Human clinical trials are typically conducted in three sequential phases, which may overlap or be combined:

Progress reports detailing the results of the clinical trials must be submitted at least annually to the FDA and more frequently if serious adverse events occur. The FDA or the sponsor may suspend or terminate a clinical trial at any time or the FDA may impose other sanctions on various grounds, including a finding that the research patients are being exposed to an unacceptable health risk. Similarly, an IRB can suspend or terminate approval of a clinical trial at its institution if the clinical trial is not being conducted in accordance with the IRB’s requirements or if the drug has been associated with unexpected serious harm to patients.

Marketing Approval

Assuming successful completion of the required clinical testing, the results of the non-clinical and clinical studies, together with detailed information relating to the product’s chemistry, manufacture, controls and proposed labeling, among other things, are submitted to the FDA as part of an NDA requesting approval to market the product for one or more indications. In most cases, the submission of an NDA is subject to a substantial application user fee. Under the Prescription Drug User Fee Act, or PDUFA, guidelines that are currently in effect, the FDA has 60 days from its receipt of an NDA to determine whether the application will be accepted for filing based on the agency’s threshold determination that the NDA is sufficiently complete to permit substantive review. The FDA may request additional information rather than accept an NDA for filing. In this event, the application must be resubmitted with the additional information. The resubmitted application is also subject to review before the FDA accepts it for filing. Once the submission is accepted for filing, the FDA begins an in‑depth substantive review. The FDA has agreed to certain performance goals in the review of NDAs. Most applications for standard review drug products are reviewed within ten to twelve months; most NDAs for priority review drugs are reviewed in six to eight months. The review process for both standard and priority review may be extended by FDA for three additional months to consider certain late‑submitted information, or information intended to clarify information already provided in the submission. The FDA reviews an NDA to determine, among other things, whether the drug is safe and effective and whether the facility in which it is manufactured, processed, packaged or held meets standards designed to assure the product’s continued safety, quality and purity.

In accordance with the Pediatric Research and Equity Act, certain NDAs or supplements to an NDA must contain data that are adequate to assess the safety and effectiveness of the drug for the claimed indications in all relevant pediatric subpopulations, and to support dosing and administration for each pediatric subpopulation for which the product is safe and effective. The FDA may, on its own initiative or at the request of the applicant, grant deferrals for submission of some or all pediatric data until after approval of the product for use in adults, or full or partial waivers from the pediatric data requirements.

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The FDA also may require submission of a REMS plan if it determines that a REMS is necessary to ensure that the benefits of the drug outweigh its risks. The REMS plan could include medication guides, physician communication plans, assessment plans and/or elements to assure safe use, such as restricted distribution methods, patient registries or other risk minimization tools.

The FDA may refer an application for a novel drug, or a drug that presents difficult questions of safety or efficacy, to an advisory committee. An advisory committee is a panel of independent experts, including clinicians and other scientific experts, that reviews, evaluates and provides a recommendation as to whether the application should be approved and under what conditions. The FDA is not bound by the recommendations of an advisory committee, but it considers such recommendations carefully when making decisions.

Before approving an NDA, the FDA typically will inspect the facility or facilities where the product is manufactured. The FDA will not approve an application unless it determines that the manufacturing processes and facilities are in compliance with cGMP requirements and adequate to assure consistent production of the product within required specifications. Additionally, before approving an NDA, the FDA may inspect one or more clinical trial sites and the sponsor to assure compliance with GCP requirements and the integrity of the clinical data submitted in an NDA.

After evaluating the NDA and all related information, including the advisory committee recommendation, if any, and inspection reports regarding the manufacturing facilities and clinical trial sites, the FDA will issue an approval letter or a complete response letter. A complete response letter generally outlines the deficiencies in the submission and contains a statement of specific conditions that must be met in order to secure final approval of the NDA and may require additional clinical or non-clinical testing in a resubmission to the NDA in order for the FDA to reconsider the application. FDA has committed to reviewing such submissions in two or six months depending on the type of information included in the resubmission. Even with submission of this additional information, the FDA ultimately may decide that the application does not satisfy the regulatory criteria for approval. If and when those conditions have been met to the FDA’s satisfaction, the FDA will typically issue an approval letter. An approval letter authorizes commercial marketing of the drug with specific prescribing information for specific indications.

Even if the FDA approves a product, it may limit the approved indications for use of the product, require that contraindications, warnings or precautions be included in the product labeling, require that post‑approval studies, including Phase 4 clinical trials, be conducted to further assess a drug’s safety after approval, require testing and surveillance programs to monitor the product after commercialization, or impose other conditions, including distribution and use restrictions or other risk management mechanisms under a REMS, which can materially affect the potential market and profitability of the product. The FDA may prevent or limit further marketing of a product based on the results of post‑marketing studies or surveillance programs. After approval, some types of changes to the approved product, such as adding new indications, manufacturing changes and additional labeling claims, are subject to further testing requirements and FDA review and approval.

Special FDA Expedited Review and Approval Programs

The FDA has various programs, including Fast Track designation, Breakthrough Therapy designation, Accelerated Approval, and Priority Review, which are intended to expedite or simplify the process for the development and FDA review of drugs that are intended for the treatment of serious or life-threatening diseases or conditions and demonstrate the potential to address unmet medical needs. The purpose of these programs is to provide important new drugs to patients earlier than under standard FDA review procedures.

Under the fast track program, the sponsor of a new drug candidate may request that FDA designate the drug candidate for a specific indication as a fast track drug concurrent with, or after, the filing of the IND for the drug candidate. Fast track designation provides opportunities for frequent interactions with the FDA review team to expedite development and review of the product. FDA may initiate review of sections of a fast track drug’s NDA before the application is complete. This rolling review is available if the applicant provides, and FDA approves, a schedule for the submission of the remaining information and the applicant pays applicable user fees. However, FDA’s time period goal for reviewing an application does not begin until the last section of the NDA is submitted.

In addition, a sponsor can request breakthrough therapy designation for a drug if it is intended, alone or in combination with one or more other drugs, to treat a serious or life-threatening disease or condition, and preliminary clinical evidence indicates that the drug may demonstrate substantial improvement over existing therapies on one or more clinically significant endpoints, such as substantial treatment effects observed early in clinical development. Drugs designated as breakthrough therapies are eligible for intensive guidance from FDA on an efficient drug development program, organizational commitment to the development and review of the product including involvement of senior managers, and, like fast track products, are also eligible for rolling review of the NDA. Both fast track and breakthrough therapy products are also eligible for accelerated approval and/or priority review, if relevant criteria are met.

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Under the FDA’s accelerated approval regulations, the FDA may approve a drug for a serious or life‑threatening illness that provides meaningful therapeutic benefit to patients over existing treatments based upon a surrogate endpoint that is reasonably likely to predict clinical benefit, or on a clinical endpoint that can be measured earlier than irreversible morbidity or mortality, that is reasonably likely to predict an effect on irreversible morbidity or mortality or other clinical benefit, taking into account the severity, rarity, or prevalence of the condition and the availability or lack of alternative treatments.

In clinical trials, a surrogate endpoint is a measurement of laboratory or clinical signs of a disease or condition that substitutes for a direct measurement of how a patient feels, functions, or survives. Surrogate endpoints can often be measured more easily or more rapidly than clinical endpoints. A drug candidate approved on this basis is subject to rigorous post‑marketing compliance requirements, including the completion of Phase 4 or post‑approval clinical trials to confirm the effect on the clinical endpoint. Failure to conduct required post‑approval studies, or confirm a clinical benefit during post‑marketing studies, will allow FDA to withdraw the drug from the market on an expedited basis. All promotional materials for drug candidates approved under accelerated approval regulations are subject to prior review by FDA.

Once an NDA is submitted for a product intended to treat a serious condition, the FDA may assign a priority review designation if FDA determines that the product, if approved, would provide a significant improvement in safety or effectiveness. A priority review means that the goal for the FDA to review an application is six months, rather than the standard review of ten months under current PDUFA guidelines. Under the current PDUFA agreement, these six- and ten- month review periods are measured from the 60-day filing date rather than the receipt date for NDAs for new molecular entities, which typically adds approximately two months to the timeline for review from the date of submission. Most products that are eligible for fast track breakthrough therapy designation are also likely to be considered appropriate to receive a priority review.

Even if a product qualifies for one or more of these programs, the FDA may later decide that the product no longer meets the conditions for qualification or decide that the time period for FDA review or approval will not be shortened. In addition, the manufacturer of an investigational drug for a serious or life‑threatening disease is required to make available, such as by posting on its website, its policy on responding to requests for expanded access. Furthermore, fast track designation, breakthrough therapy designation, accelerated approval and priority review do not change the standards for approval and may not ultimately expedite the development or approval process.

Post-Approval Requirements

Drugs manufactured or distributed pursuant to FDA approvals are subject to pervasive and continuing regulation by the FDA, including, among other things, requirements relating to recordkeeping, periodic reporting, product sampling and distribution, advertising and promotion and reporting of adverse experiences with the product. After approval, most changes to the approved product, such as adding new indications or other labeling claims are subject to prior FDA review and approval. There also are continuing, substantial annual user fee requirements for any marketed products. These fees are typically increased annually.

The FDA may impose a number of post‑approval requirements as a condition of approval of an NDA. For example, the FDA may require post‑marketing testing, including Phase 4 clinical trials, and surveillance to further assess and monitor the product’s safety and effectiveness after commercialization.

In addition, drug manufacturers and other entities involved in the manufacture and distribution of approved drugs are required to register their establishments with the FDA and state agencies, and are subject to periodic unannounced inspections by the FDA and state agencies for compliance with cGMP requirements. Changes to the manufacturing process are strictly regulated and often require prior FDA approval before being implemented. FDA regulations also require investigation and correction of any deviations from cGMP requirements and impose reporting and documentation requirements upon the sponsor and any third‑party manufacturers that the sponsor may decide to use. Accordingly, manufacturers must continue to expend time, money and effort in the area of production and quality control to maintain cGMP compliance.

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Once an approval of a drug is granted, the FDA may withdraw the approval if compliance with regulatory requirements and standards is not maintained or if problems occur after the product reaches the market. Later discovery of previously unknown problems with a product, including adverse events of unanticipated severity or frequency, or with manufacturing processes, or failure to comply with regulatory requirements, may result in mandatory revisions to the approved labeling to add new safety information; imposition of post‑market studies or clinical trials to assess new safety risks; or imposition of distribution or other restrictions under a REMS program. Other potential consequences include, among other things:

The FDA strictly regulates marketing, labeling, advertising and promotion of products that are placed on the market. Drugs may be promoted only for the approved indications and in accordance with the provisions of the approved label. The FDA and other agencies actively enforce the laws and regulations prohibiting the promotion of off‑label uses, and a company that is found to have improperly promoted off‑label uses may be subject to significant liability.

The Hatch-Waxman Act

Section 505 of the FDCA describes three types of applications that may be submitted to request marketing authorization for a new drug. A 505(b)(1) NDA is an application that contains full reports of investigations of safety and effectiveness. The Hatch‑Waxman Act created two additional marketing pathways under Sections 505(j) and 505(b)(2) of the FDCA. Section 505(j) establishes an abbreviated approval process for generic versions of approved drug products through the submission of an abbreviated new drug application, or ANDA. An ANDA provides for marketing of a drug product that has the same active ingredients in the same strengths and dosage form as the branded reference drug and has been shown to be bioequivalent to the branded reference drug. ANDA applicants are required to conduct bioequivalence testing to confirm chemical and therapeutic equivalence to the branded reference drug. Generic versions of drugs can often be substituted by pharmacists under prescriptions written for the branded reference drug.

A 505(b)(2) NDA is an application that contains full reports of investigations of safety and effectiveness but where at least some of the information required for approval comes from studies not conducted by or for the applicant. This alternate regulatory pathway enables the applicant to rely, in part, on the FDA’s findings of safety and efficacy for an existing product, or published literature, in support of its application. The FDA may then approve the new product candidate for all or some of the labeled indications for which the branded reference drug has been approved, as well as for any new indication sought by the 505(b)(2) applicant.

The Hatch‑Waxman Act establishes periods of regulatory exclusivity for certain approved drug products. The holder of an NDA may obtain five years of exclusivity upon approval of a new drug containing a new chemical entity, or NCE, that has not been previously approved by the FDA. During the five year exclusivity period, the FDA cannot accept for filing or approve any ANDA seeking approval of a generic version of that drug or any 505(b)(2) NDA for the same active moiety and that relies on the FDA’s findings regarding that drug, except that FDA may accept an application for filing (but still may not approve it) after four years if the follow‑on applicant makes a paragraph IV certification, as described below. The Hatch‑Waxman Act also provides three years of marketing exclusivity to the holder of an NDA for a particular condition of approval, or change to a marketed product, such as a new formulation or new indication for a previously approved product, if one or more new clinical studies (other than bioavailability or bioequivalence studies) was essential to the approval of the application and was conducted/sponsored by the applicant. This three‑year exclusivity period protects against FDA approval of ANDAs and 505(b)(2) NDA for drugs that include the innovation that required the new clinical data.

Upon submission of an ANDA or a 505(b)(2) NDA, an applicant must certify to the FDA, in the opinion of the applicant and to the best of its knowledge (1) that relevant patent information on the referenced drug product has not been submitted to the FDA; (2) that the relevant patent has expired; (3) the date on which the relevant patent expires; or (4) that such patent is invalid, unenforceable or will not be infringed upon by the manufacture, use or sale of the drug product for which the application is submitted. This last certification is known as a paragraph IV certification. If the NDA holder or patent owner(s) files a patent infringement action against the ANDA or 505(b)(2) applicant within 45 days of receipt of the

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paragraph IV certification, the FDA may not approve the ANDA or 505(b)(2) application until the earlier of (i) 30 months from the receipt of the notice of the paragraph IV certification (generally referred to as the 30 month stay), (ii) the expiration date of the patent(s) listed in the Orange Book for the reference drug product, (iii) the date the court enters a final order or judgment that the patent(s) are invalid, unenforceable and/or not infringed or (iv) such shorter or longer period as may be ordered by a court. Where the ANDA or 505(b)(2) applicant files an application with a paragraph IV certification within the fifth year of the five‑year NCE exclusivity period enjoyed by the NDA holder for the reference branded product, and where patent litigation is brought within 45 days of receipt of notice of the paragraph IV certification, the 30‑month stay will be extended by the amount of time such that 7.5 years will elapse from the date of approval of the NDA to the expiration of the stay. Thus, approval of an ANDA or 505(b)(2) NDA could be delayed for a significant period of time depending on the patent certification the applicant makes, whether the reference product enjoys NCE exclusivity, and the reference drug sponsor’s decision to initiate patent litigation. However, an ANDA applicant may be able to submit a section viii statement certifying that its proposed ANDA label does not contain (or carves out) any language regarding the patented method‑of‑use rather than certify to a listed method‑of‑use patent.

Regulation Outside the United States

In the European Economic Area, or EEA, which is composed of the 28 Member States of the European Union plus Norway, Iceland and Liechtenstein, medicinal products can only be commercialized after obtaining a Marketing Authorization, or MA.

There are two types of MAs:

Prior to obtaining an MA in the EEA, applicants have to demonstrate compliance with all measures included in a Paediatric Investigation Plan, or PIP, approved by the EEA regulatory agency, covering all subsets of the pediatric population, unless the EEA regulatory agency has granted (1) a product‑specific waiver, (2) a class waiver or (3) a deferral for one or more of the measures included in the PIP.

In the EEA, upon receiving an MA, new chemical entities generally receive eight years of data exclusivity and an additional two years of market exclusivity. If granted, data exclusivity prevents regulatory authorities in the EEA from referencing the innovator’s data to assess a generic application. During the additional two‑year period of market exclusivity, a generic marketing authorization can be submitted, and the innovator’s data may be referenced, but no generic product can be marketed until the expiration of the market exclusivity. However, there is no guarantee that a product will be considered by the EEA regulatory agencies to be a new chemical entity, and products may not qualify for data exclusivity.

Other Healthcare Laws

In addition to FDA restrictions on the marketing of pharmaceutical products, other foreign, federal and state healthcare regulatory laws restrict business practices in the pharmaceutical industry. These laws include, but are not limited to, federal and state anti‑kickback, false claims, data privacy and security, and physician payment and drug pricing transparency laws.

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The U.S. federal Anti‑Kickback Statute prohibits, among other things, any person or entity from knowingly and willfully offering, paying, soliciting, receiving or providing any remuneration, directly or indirectly, overtly or covertly, to induce or in return for purchasing, leasing, ordering, or arranging for or recommending the purchase, lease, or order of any good, facility, item or service reimbursable, in whole or in part, under Medicare, Medicaid or other federal healthcare programs. The term “remuneration” has been broadly interpreted to include anything of value. The Anti‑Kickback Statute has been interpreted to apply to arrangements between pharmaceutical and medical device manufacturers on the one hand and prescribers, purchasers, formulary managers and beneficiaries on the other hand. Although there are a number of statutory exceptions and regulatory safe harbors protecting some common activities from prosecution, the exceptions and safe harbors are drawn narrowly. Practices that involve remuneration that may be alleged to be intended to induce prescribing, purchases, or recommendations may be subject to scrutiny if they do not meet the requirements of a statutory or regulatory exception or safe harbor. Failure to meet all of the requirements of a particular applicable statutory exception or regulatory safe harbor does not make the conduct per se illegal under the U.S. federal Anti‑Kickback Statute. Instead, the legality of the arrangement will be evaluated on a case‑by‑case basis based on a cumulative review of all its facts and circumstances. Several courts have interpreted the statute’s intent requirement to mean that if any one purpose of an arrangement involving remuneration is to induce referrals of federal healthcare covered business, the statute has been violated. In addition, a person or entity does not need to have actual knowledge of the statute or specific intent to violate it in order to have committed a violation. Moreover, a claim including items or services resulting from a violation of the U.S. federal Anti‑Kickback Statute constitutes a false or fraudulent claim for purposes of the federal civil False Claims Act. The majority of states also have anti‑kickback laws, which establish similar prohibitions, and in some cases may apply to items or services reimbursed by any third‑party payor, including commercial insurers.

The federal false claims and civil monetary penalties laws, including the civil False Claims Act, prohibit, among other things, any person or entity from knowingly presenting, or causing to be presented, a false, fictitious or fraudulent claim for payment to, or approval by, the federal government, knowingly making, using, or causing to be made or used a false record or statement material to a false or fraudulent claim to the federal government, or knowingly making a false statement to avoid, decrease or conceal an obligation to pay money to the U.S. federal government. A claim includes “any request or demand” for money or property presented to the U.S. government. Actions under the civil False Claims Act may be brought by the Attorney General or as a qui tam action by a private individual in the name of the government. Violations of the civil False Claims Act can result in very significant monetary penalties and treble damages. Several pharmaceutical, medical device and other healthcare companies have been prosecuted under these laws for, among other things, allegedly providing free product to customers with the expectation that the customers would bill federal programs for the product. Other companies have been prosecuted for causing false claims to be submitted because of the companies’ marketing of products for unapproved (e.g., or off‑label) uses. In addition, the civil monetary penalties statute imposes penalties against any person who is determined to have presented or caused to be presented a claim to a federal health program that the person knows or should know is for an item or service that was not provided as claimed or is false or fraudulent. Many states also have similar fraud and abuse statutes or regulations that apply to items and services reimbursed under Medicaid and other state programs, or, in several states, apply regardless of the payor.

Violations of fraud and abuse laws, including federal and state anti‑kickback and false claims laws, may be punishable by criminal and civil sanctions, including fines and civil monetary penalties, the possibility of exclusion from federal healthcare programs (including Medicare and Medicaid), disgorgement and corporate integrity agreements, which impose, among other things, rigorous operational and monitoring requirements on companies. Similar sanctions and penalties, as well as imprisonment, also can be imposed upon executive officers and employees of such companies. Given the significant size of actual and potential settlements, it is expected that the government authorities will continue to devote substantial resources to investigating healthcare providers’ and manufacturers’ compliance with applicable fraud and abuse laws.

The federal Health Insurance Portability and Accountability Act of 1996, or HIPAA, created additional federal criminal statutes that prohibit, among other actions, knowingly and willfully executing, or attempting to execute, a scheme to defraud any healthcare benefit program, including private third‑party payors, knowingly and willfully embezzling or stealing from a healthcare benefit program, willfully obstructing a criminal investigation of a healthcare offense, and knowingly and willfully falsifying, concealing or covering up a material fact or making any materially false, fictitious or fraudulent statement in connection with the delivery of or payment for healthcare benefits, items or services. Similar to the U.S. federal Anti‑Kickback Statute, a person or entity does not need to have actual knowledge of the statute or specific intent to violate it in order to have committed a violation.

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In addition, there has been a recent trend of increased federal and state regulation of payments made to physicians and certain other healthcare providers. The Affordable Care Act imposed, among other things, new annual reporting requirements through the Physician Payments Sunshine Act for covered manufacturers for certain payments and “transfers of value” provided to physicians, certain other health care professionals beginning in 2022, and teaching hospitals, as well as ownership and investment interests held by physicians and their immediate family members. Failure to submit timely, accurately and completely the required information for all payments, transfers of value and ownership or investment interests may result in civil monetary penalties. Covered manufacturers must submit reports by the 90^th day of each subsequent calendar year and the reported information is publically made available on a searchable website. In addition, certain states require implementation of compliance programs and compliance with the pharmaceutical industry’s voluntary compliance guidelines and the relevant compliance guidance promulgated by the federal government, impose restrictions on marketing practices and/or require the tracking and reporting of marketing expenditures and pricing information as well as gifts, compensation and other remuneration or items of value provided to physicians and other healthcare professionals and entities.

We may also be subject to data privacy and security regulation by both the federal government and the states in which we conduct our business. HIPAA, as amended by the Health Information Technology for Economic and Clinical Health Act, or HITECH, and their respective implementing regulations, including the Final HIPAA Omnibus Rule published on January 25, 2013, impose specified requirements relating to the privacy, security and transmission of individually identifiable health information held by covered entities and their business associates. Among other things, HITECH made HIPAA’s security standards directly applicable to “business associates,” defined as independent contractors or agents of covered entities that create, receive, maintain or transmit protected health information in connection with providing a service for or on behalf of a covered entity. HITECH also increased the civil and criminal penalties that may be imposed against covered entities, business associates and possibly other persons, and gave state attorneys general new authority to file civil actions for damages or injunctions in federal courts to enforce the federal HIPAA laws and seek attorney’s fees and costs associated with pursuing federal civil actions. In addition, state laws govern the privacy and security of health information in certain circumstances, many of which differ from each other in significant ways and may not have the same requirements, thus complicating compliance efforts. By way of example, the California Consumer Privacy Act, or CCPA, effective January 1, 2020, creates individual privacy rights for California consumers and increases the privacy and security obligations of entities handling certain personal information. The CCPA provides for civil penalties for violations, as well as a private right of action for data breaches that is expected to increase data breach litigation. The CCPA may increase our compliance costs and potential liability, and similar laws have been proposed at the federal level and in other states.

Similar foreign laws and regulations, which may include, for instance, applicable post‑marketing requirements, anti‑fraud and abuse laws, and implementation of corporate compliance programs and reporting of payments or other transfers of value to healthcare professionals, may apply to us to the extent that any of our product candidates, once approved, are sold in a country other than the United States.

Coverage and Reimbursement

Significant uncertainty exists as to the coverage and reimbursement status of any pharmaceutical product for which we obtain regulatory approval. In the United States and markets in other countries, patients who are prescribed drugs generally rely on third‑party payors to reimburse all or part of the associated healthcare costs. Providers and patients are unlikely to use our products unless coverage is provided and reimbursement is adequate to cover a significant portion of the cost of our products. If approved, sales of serlopitant will depend, in part, on the availability of coverage and adequate reimbursement from third‑party payors. Third‑party payors include government authorities, managed care plans, private health insurers and other organizations.

In the United States, the process for determining whether a third‑party payor will provide coverage for a pharmaceutical product typically is separate from the process for setting the price of such product or for establishing the reimbursement rate that the payor will pay for the product once coverage is approved. With respect to drugs, third‑party payors may limit coverage to specific products on an approved list, also known as a formulary, which might not include all of the FDA‑approved products for a particular indication, or place products at certain formulary levels that result in lower reimbursement levels and higher cost‑sharing obligation imposed on patients. A decision by a third‑party payor not to cover a product could reduce physician utilization of a product. Moreover, a third‑party payor’s decision to provide coverage for a pharmaceutical product does not imply that an adequate reimbursement rate will be approved. Adequate third‑party reimbursement may not be available to enable a manufacturer to maintain price levels sufficient to realize an appropriate return on its investment in product development. Additionally, coverage and reimbursement for products can differ significantly from payor to payor. One third‑party payor’s decision to cover a particular medical product does not ensure that other payors will also provide coverage for the medical product, or will provide coverage at an adequate

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reimbursement rate. As a result, the coverage determination process usually requires manufacturers to provide scientific and clinical support for the use of their products to each payor separately and is a time‑consuming process.

In the European Union, governments influence the price of products through their pricing and reimbursement rules and control of national health care systems that fund a large part of the cost of those products to consumers. Some jurisdictions operate positive and negative list systems under which products may only be marketed once a reimbursement price has been agreed to by the government. To obtain reimbursement or pricing approval, some of these countries may require the completion of clinical trials that compare the cost effectiveness of a particular product to currently available therapies. Other member states allow companies to fix their own prices for medicines, but monitor and control company profits. The downward pressure on health care costs in general, particularly prescription products, has become very intense. As a result, increasingly high barriers are being erected to the entry of new products. In addition, in some countries, cross border imports from low‑priced markets exert a commercial pressure on pricing within a country.

The containment of healthcare costs has become a priority of federal, state and foreign governments, and the prices of pharmaceutical products have been a focus in this effort. Third‑party payors are increasingly challenging the prices charged for medical products and services, examining the medical necessity and reviewing the cost‑effectiveness of pharmaceutical products, in addition to questioning safety and efficacy. If third‑party payors do not consider a product to be cost‑effective compared to other available therapies, they may not cover that product after FDA approval or, if they do, the level of payment may not be sufficient to allow a manufacturer to sell its product at a profit.

Healthcare Reform and Other Potential Changes to Healthcare Laws

The FDA’s and other regulatory authorities’ policies may change and additional government regulations may be enacted that could prevent, limit or delay regulatory approval of our product candidates. For example, in December 2016, the 21st Century Cures Act, or Cures Act, was signed into law. The Cures Act, among other things, was intended to modernize the regulation of drugs and devices and to spur innovation. In addition, in August 2017, the FDA Reauthorization Act was signed into law, which reauthorized the FDA’s user fee programs and included additional drug and device provisions that build on the Cures Act. If we are slow or unable to adapt to changes in existing requirements or the adoption of new requirements or policies, or if we are not able to maintain regulatory compliance, we may lose any marketing approval that we may have obtained and we may not achieve or sustain profitability, which would adversely affect our business, prospects, financial condition and results of operations.

A primary trend in the U.S. healthcare industry and elsewhere is cost containment. Government authorities and other third‑party payors have attempted to control costs by limiting coverage and the amount of reimbursement for particular medical products and services, implementing reductions in Medicare and other healthcare funding, and applying new payment methodologies. For example, in March 2010, the Affordable Care Act was enacted, which, among other things, increased the minimum Medicaid rebates owed by most manufacturers under the Medicaid Drug Rebate Program; introduced a new methodology by which rebates owed by manufacturers under the Medicaid Drug Rebate Program are calculated for drugs that are inhaled, infused, instilled, implanted or injected; extended the Medicaid Drug Rebate Program to utilization of prescriptions of individuals enrolled in Medicaid managed care plans; imposed mandatory discounts for certain Medicare Part D beneficiaries as a condition for manufacturers’ outpatient drugs coverage under Medicare Part D; subjected drug manufacturers to new annual fees based on pharmaceutical companies’ share of sales to federal healthcare programs; imposed a new federal excise tax on the sale of certain medical devices; created a new Patient Centered Outcomes Research Institute to oversee, identify priorities in, and conduct comparative clinical effectiveness research, along with funding for such research; created the Independent Payment Advisory Board, which, once empaneled, will have authority to recommend certain changes to the Medicare program that could result in reduced payments for prescription drugs; and established a Center for Medicare Innovation at the CMS to test innovative payment and service delivery models to lower Medicare and Medicaid spending.

Since its enactment, there have been judicial and Congressional challenges to certain aspects of the Affordable Care Act, and we expect there will be additional challenges and amendments to the Affordable Care Act in the future. By way of example, the Tax Cuts and Jobs Acts was enacted, which, among other things, removes penalties for not complying with the individual mandate to carry health insurance. On December 14, 2018, a Texas U.S. District Court Judge ruled that the individual mandate is a critical and inseverable feature of the Affordable Care Act, and therefore, because it was repealed as part of the Tax Act, the remaining provisions of the Affordable Care Act are invalid as well. On December 18, 2019, the U.S. Court of Appeals for the 5th Circuit ruled that the individual mandate was unconstitutional and remanded the case back to the District Court to determine whether the remaining provisions of the Affordable Care Act are invalid as well. It is unclear how these decisions, subsequent appeals, and other efforts to challenge, repeal or replace the Affordable Care Act will impact the Affordable Care Act, our business or financial condition.

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In addition, other legislative changes have been proposed and adopted in the United States since the Affordable Care Act to reduce healthcare expenditures. These changes include the Budget Control Act of 2011, which led to aggregate reductions of Medicare payments to providers of 2% per fiscal year and that will remain in effect through 2029 unless additional action is taken by Congress; the American Taxpayer Relief Act of 2012, which, among other things, further reduced Medicare payments to several types of providers, including hospitals, imaging centers and cancer treatment centers, and increased the statute of limitations period for the government to recover overpayments to providers from three to five years; and the Medicare Access and CHIP Reauthorization Act of 2015, which ended the use of the statutory formula for Medicare payment adjustments to physicians, and provided for a 0.5% annual increase in payment rates under the Medicare Physician Fee Schedule through 2019, but no annual update from 2020 through 2025. More recently, there has been heightened governmental scrutiny over the manner in which manufacturers set prices for their marketed products, which has resulted in several Congressional inquiries and proposed bills designed to, among other things, bring more transparency to product pricing, review the relationship between pricing and manufacturer patient programs, and reform government program reimbursement methodologies for pharmaceutical products.

Individual states in the United States have also become increasingly aggressive in passing legislation and implementing regulations designed to control pharmaceutical product pricing, including price or patient reimbursement constraints, discounts, restrictions on certain product access and marketing cost disclosure and transparency measures, and, in some cases, designed to encourage importation from other countries and bulk purchasing.

Employees

As of December 31, 2019, we had 40 employees. Within our workforce, 23 employees are engaged in research and development and the remaining 17 in general management and administration, including finance and facilities. None of our employees are represented by labor unions or covered by collective bargaining agreements. We believe that we maintain good relations with our employees.

 

Financial Information About Segments

We view our operations and manage our business as one reportable segment. See Note 2 in the Notes to Financial Statements included in this Annual Report on Form 10 K. Additional information required by this item is incorporated herein by reference to Part II, Item 6, “Selected Financial Data.”

Available Information

We file reports, proxy statements and other information with the SEC. The SEC maintains a website that contains reports, proxy and information statements and other information about issuers, such as us, who file electronically with the SEC. The address of that website is http://www.sec.gov.

 

Our website address is www.menlotherapeutics.com. The information on or accessible through the SEC and our website, however, is not, and should not be deemed to be, a part of this filing. Further, our references to the URLs for these websites are intended to be inactive textual references only.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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1A. Risk Factors.

Our business is subject to various risks and uncertainties, including those described below, that we believe apply to our business and the industry in which we operate. You should carefully consider these risks, as well as the other information in this Annual Report on Form 10-K, including our financial statements and the related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The occurrence of any of the events or developments described below could have a material adverse effect on our business, results of operations, financial condition, prospects and stock price. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also impair our business.

 

Risks Related to the Proposed Merger

On November 10, 2019, we entered into the Merger Agreement with Foamix Pharmaceuticals Ltd. (“Foamix”) and Giants Merger Subsidiary Ltd., a wholly-owned subsidiary of Menlo (“Merger Sub”), pursuant to which, among other things, Merger Sub will merge with and into Foamix, with Foamix surviving as a wholly-owned subsidiary of Menlo (the “Merger”). In connection with the proposed Merger, we are subject to certain risks including, but not limited to, those set forth below. The description of each of the Merger Agreement and the Merger herein is qualified in its entirety by reference to the full text of the Merger Agreement which is filed as an exhibit to this Annual Report on Form 10-K.

We may fail to consummate the Merger, and uncertainties related to the consummation of the Merger may have a material adverse effect on our business, results of operations and financial condition and negatively impact the price of our common stock.

The Merger is subject to the satisfaction of a number of customary closing conditions, some of which are beyond our control. Failure to satisfy the conditions to the Merger could prevent or delay the completion of the Merger.

The efforts and costs to satisfy the closing conditions of the Merger, may place a significant burden on management and internal resources, and the Merger and related transactions, whether or not consummated, may result in a diversion of management’s attention from day-to-day operations. Any significant diversion of management’s attention away from ongoing business and difficulties encountered in the Merger process could have a material adverse effect on our business, results of operations and financial condition.

There also is no assurance that the Merger and the other transactions contemplated by the Merger Agreement will occur on the terms and timeline currently contemplated or at all.

The Merger Agreement also contains certain customary termination rights. It further provides that we may be required to pay Foamix a termination fee of $3.7 million upon termination of the Merger Agreement under specified circumstances, including (i) termination by Foamix after a change in the recommendation of the our Board; or (ii) termination by us, to accept and enter into a binding agreement to be acquired by a third party or (iii) (A) if a takeover proposal is made for us and is publicly known and is not withdrawn at the time of the our meeting, (B) the Merger Agreement is terminated due to the failure of our stockholders to approve the Merger or by Foamix due to a material breach of the Merger Agreement by us (including the “no solicitation” provisions) and (C) we enter into or consummate an alternative transaction within 12 months following such date of termination.

If the proposed Merger is not completed or the Merger Agreement is terminated, the price of our common stock may decline, including to the extent that the current market price of our common stock reflects an assumption that the Merger and the other transactions contemplated by the Merger Agreement will be consummated without further delays.

If the Merger Agreement is terminated and we determine to seek another business combination, we may not be able to negotiate a transaction with another party on terms comparable to, or better than, the terms of the Merger.

We are subject to various uncertainties and restrictions on the conduct of our business while the Merger is pending, which could have a material adverse effect on our business, results of operations and financial condition.

Uncertainty about the pendency of the Merger and the effect of the Merger on employees, customers, vendors, communities and other third parties who deal with us may have a material adverse effect on our business, results of operations and financial condition. These uncertainties may impair our ability to attract, retain and motivate key personnel pending the consummation of the Merger, as such personnel may experience uncertainty about their future roles following the consummation of the Merger. Additionally, these uncertainties could cause suppliers, manufacturers and other third parties who deal with us to seek to change existing business relationships with us or fail to extend an existing relationship

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with us, which could have a material adverse effect on our business, results of operations, financial condition and market price of our common stock. In addition, the Merger Agreement restricts us from taking certain actions without Foamix’s consent while the Merger is pending. These restrictions may, among other matters, prevent us from pursuing otherwise attractive business opportunities, buying or selling assets, making certain capital expenditures, refinancing or incurring additional indebtedness, entering into transactions, or making other changes to our business prior to consummation of the Merger or termination of the Merger Agreement. These restrictions and uncertainties could have a material adverse effect on our business, results of operations and financial condition.

Our stockholders are at risk of dilution as a result of adverse Phase 3 clinical trial results.

If one or both of our Phase 3 double-blinded, placebo-controlled trials of serlopitant for the treatment of pruritus associated with prurigo nodularis, referenced by Protocol Numbers MTI-105 (United States) and MTI-106 (Europe), fail to demonstrate proof of statistically significant superiority of serlopitant treatment over placebo treatment on the primary endpoint, the Foamix shareholders will receive additional shares of our common stock as consideration in the Merger and significantly dilute the ownership of our stockholders in the Combined Company.

Lawsuits that have been filed or that may be filed in connection with the Merger, the outcome of which are uncertain, could require us and Foamix to incur significant costs, suffer management distraction or delay or prevent the Merger.

Securities litigation or other shareholder litigation frequently follows the announcement of certain significant business transactions, such as the announcement of a business combination transaction. On December 11, 2019 and December 18, 2019, purported shareholders of Foamix filed putative class action lawsuits against the members of the Foamix Board, Foamix, Menlo Therapeutics and Merger Sub in the United States District Court for the District of Delaware and in the United State District Court for the District of New Jersey, respectively, and on December 12, 2019, December 17, 2019, December 20, 2019, January 7, 2020 and January 21, 2020, purported shareholders of Foamix filed individual lawsuits against the members of the Foamix Board and Foamix in the United States District Court for the District of New Jersey, the United States District Court for the Southern District of New York and the United States District Court for the Southern District of New York, respectively. The plaintiffs in each of the aforementioned lawsuits generally claim that the defendants disseminated a false or misleading registration statement regarding the proposed Merger in violation of Section 14(a) and Section 20(a) of the Exchange Act and/or Rule 14a‑9 promulgated under the Exchange Act. In addition, in the lawsuit filed on December 18, 2019, the plaintiff claims that the members of the Foamix Board breached their fiduciary duties in connection with the Merger.

Even if these lawsuits are without merit, as the defendants believe these lawsuits to be, defending against these claims could result in substantial costs and divert management time and resources. An adverse judgment could result in monetary damages, which could have a negative impact on our and Foamix’s respective liquidity and financial condition. The plaintiffs in the complaints seek, among other things, injunctive relief to prevent consummation of the Merger, rescission in the event the Merger is consummated, and an award of attorney’s fees. Any other lawsuit that may be filed in the future could also seek, among other things, injunctive relief or other equitable relief, including a request to rescind parts of the Merger Agreement already implemented and to otherwise enjoin the parties from consummating the Merger or money damages. If a plaintiff is successful in obtaining an injunction prohibiting completion of the Merger in the pending lawsuits or any other similar lawsuits, then that injunction may delay or prevent the Merger from being completed, which may adversely affect Menlo’s and Foamix’s respective business, financial position and results of operation.

One of the conditions to the closing of the Merger is that no injunction by any court or other governmental entity of competent jurisdiction has been entered and continues to be in effect that prohibits the closing. Consequently, if a lawsuit is filed and a plaintiff is successful in obtaining an injunction prohibiting completion of the Merger, then that injunction may delay or prevent the Merger from being completed within the expected time frame or at all, which may adversely affect our and Foamix’s respective business, financial position and results of operations.

See Note 6 of the Financial Statements – “Commitments and Contingencies” for more information about litigation related to the Merger that has been commenced prior to the date of this Annual Report on Form 10-K. There can be no assurance that additional complaints will not be filed with respect to the Merger.

We will continue to incur substantial transaction-related costs in connection with the Merger.

We have incurred significant legal, advisory and financial services fees in connection with Merger. We have incurred, and expect to continue to incur, additional costs in connection with the satisfaction of the various conditions to closing of the Merger, including seeking approval from our stockholders. If there is any delay in the consummation of the Merger, these costs could increase significantly.

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Risks Related to the Combined Company Following the Merger

If the Merger is completed, we may fail to realize the anticipated benefits, cost savings and synergies of the Merger, which could adversely affect the value of shares of our common stock.

The success of the Merger will depend, in part, on our ability to realize the anticipated benefits, cost savings and synergies from combining our business with Foamix’s business. Our ability to realize these anticipated benefits, cost savings and synergies is subject to certain risks, including, among others:

If we are not able to successfully combine our business with Foamix’s business within the anticipated time frame, or at all, the anticipated benefits, synergies, operational efficiencies and cost savings of the Merger may not be realized fully or may take longer to realize than expected, the combined businesses may not perform as expected and the share price, revenues, levels of expenses and results of our operations may be adversely affected.

We and Foamix have operated and, until completion of the Merger will continue to operate, independently, and there can be no assurances that their businesses can be integrated successfully. It is possible that the integration process could result in the loss of our or Foamix’s key employees, the disruption of either company’s or both companies’ ongoing businesses or in unexpected integration issues, higher than expected integration costs and an overall post-completion integration process that takes longer than originally anticipated. Specifically, issues that must be addressed in integrating our operations with Foamix in order to realize the anticipated benefits of the Merger so the combined business performs as expected include, among others:

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In addition, at times, the attention of certain members of each company’s management and each company’s resources may be focused on completion of the Merger and the integration of the businesses of the two companies and diverted from day-to-day business operations, which may disrupt each company’s ongoing business and the business of the combined company, or the Combined Company following the completion of the Merger.

The Combined Company will be subject to the risks that Foamix faces, in addition to the risks we face. In particular, the success of the Combined Company will depend on its ability to successfully commercialize AMZEEQ^TM and its other product candidates.

To date, Foamix has invested a majority of its efforts and financial resources in the research and development of AMZEEQ^TM for the treatment of moderate-to-severe acne, which received approval from the FDA on October 18, 2019 for the treatment of inflammatory lesions of non-nodular moderate-to-severe acne vulgaris in patients nine years of age and older, and FMX103 for the treatment of moderate-to-severe papulopustular rosacea in adults, for which the FDA has set a PDUFA action date of June 2, 2020. In addition, we have invested substantially all of our efforts and financial resources in the development of serlopitant, which is our sole product candidate in development as of the date of this Annual Report on Form 10-K. The success of the Combined Company will depend largely on its ability to (i) successfully commercialize AMZEEQ^TM, (ii) obtain regulatory approval for and successfully commercialize FMX103 and serlopitant for the treatment of pruritus associated with PN, (iii) advance the development of the Combined Company’s pipeline candidates and (iv) comply with the regulatory requirements that apply to these activities. If the Combined Company fails to successfully commercialize AMZEEQ^TM, obtain requisite regulatory approvals within the expected time frames, or at all, for FMX103 and serlopitant or does not successfully develop and commercialize its pipeline candidates, the Combined Company’s financial position and results of operations would be adversely affected.

The Combined Company will require substantial additional financing to achieve its goals, and a failure to obtain this necessary capital when needed on acceptable terms, or at all, could force the Combined Company to delay, limit, reduce or terminate product development, other operations or commercialization efforts.

It is expected that the Combined Company will expend substantial resources for the foreseeable future for the commercialization of AMZEEQ^TM and for pre-commercialization efforts related to FMX103, serlopitant for the treatment of pruritus associated with PN and other pipeline candidates. We also expect the Combined Company to continue the development of other indications and product candidates. However, the Combined Company may not have sufficient funds to carry out and complete all of these plans and may need to raise additional funds for such purposes, and/or alter or defer some activities.

These expenditures will include costs associated with research and development, conducting preclinical studies and clinical trials, and manufacturing and supply, as well as marketing and selling any products approved for sale. In addition, other unanticipated costs may arise. Because of the numerous risks and uncertainties associated with product development and commercialization, the actual amounts necessary to successfully complete the development and commercialization of any of the Combined Company’s product candidates cannot be precisely estimated.

The operating plan of the Combined Company may change as a result of many factors currently unknown. The Combined Company may therefore need to seek additional capital sooner than planned, through public or private equity or debt financings or other sources, such as strategic collaborations or additional license arrangements. Such financings may result in dilution to stockholders, imposition of debt covenants and repayment obligations or other restrictions that may affect the business of the Combined Company. In addition, due to favorable market conditions or strategic considerations, the Combined Company may seek additional capital even if it is believed that the Combined Company has sufficient funds for its current or future operating plans.

The Combined Company’s future capital requirements depend on many factors, including:

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Additional capital may not be available when needed, on terms that are acceptable or at all. If adequate funds are not available on a timely basis, the Combined Company may be required to:

If the Combined Company raises additional capital through marketing and distribution arrangements or other collaborations, strategic alliances or licensing arrangements with third parties, it may have to relinquish certain valuable rights to its product candidates, technologies, future revenue streams or research programs or grant licenses on terms that may not be favorable. If the Combined Company raises additional capital through public or private equity offerings, the ownership interest of its stockholders following the completion of the Merger will be diluted and the terms of any new equity securities may have a preference over the common stock of the Combined Company. If the Combined Company raises additional capital through debt financing, it may be subject to covenants limiting or restricting its ability to take

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specific actions, such as incurring additional debt or making capital expenditures or specified financial ratios, any of which could restrict its ability to commercialize its product candidates or operate as a business.

The Combined Company’s facilities and operations may be adversely affected by political, economic and military instability in Israel.

It is expected that the Combined Company will maintain Foamix’s offices located in Rehovot, Israel. In addition, some of Foamix’s key employees and officers are residents of Israel. Accordingly, political, economic and military conditions in Israel may directly affect Foamix’s or, following the Merger, the Combined Company’s business. Since the establishment of the State of Israel in 1948, a number of armed conflicts have taken place between Israel and its neighboring countries. Over the past decade, Israel has been engaged in several armed conflicts with Hamas, a terrorist group and political party that controls the Gaza Strip, and other terrorist groups from the Gaza Strip. During the summer of 2006, Israel was engaged in an armed conflict with Hezbollah, a Lebanese Islamist Shiite terrorist group and political party. These conflicts have involved missile strikes against civilian targets in various parts of Israel, including the area where Foamix’s facilities are located, and negatively affected business conditions in Israel. Any future hostilities involving Israel, or terrorist activities or political instability in the region, could interrupt or curtail trade between Israel and its trading partners, which could adversely affect Foamix’s or the Combined Company’s results of operations. Any such further armed conflicts could furthermore make it more difficult for Foamix or the Combined Company to raise capital. In addition, operations could be disrupted by the obligations of Foamix’s or the Combined Company’s Israeli personnel to perform military reserve service as a result of any such further conflicts.

Foamix’s commercial insurance does not cover losses that may occur as a result of an event associated with the security situation in the Middle East. Although the Israeli government is currently committed to covering the reinstatement value of direct damages that are caused by terrorist attacks or acts of war, we cannot assure you that this government coverage will be maintained, or if maintained, will be sufficient to compensate Foamix or the Combined Company fully for damages incurred. Any losses or damages incurred by our Israeli operations could have a material adverse effect on our business.

Further, certain countries, as well as certain companies and organizations, continue to participate in a boycott of Israeli businesses and businesses with large Israeli operations. Such boycott or other restrictive laws, policies or practices may have a material adverse effect on our business and financial condition in the future.

In connection with the Merger, we will become a guarantor and an obligor under Foamix’s Credit Agreement and will become subject to various financial and other restrictive covenants. These restrictions may limit our operational or financial flexibility and failure on the part of us or any other obligor (under Foamix’s Credit Agreement) to comply with these covenants could subject us to defaults under Foamix’s Credit Agreement.

In connection with entering into the Merger Agreement, Foamix also entered into to a Waiver and Consent Agreement to Credit Agreement and Guaranty (the “Waiver Agreement”), among Foamix, Foamix Pharmaceuticals Inc., a Delaware corporation, the lenders party thereto, and Perceptive Credit Holdings II, LP, as administrative agent for the lenders, relating to the Credit Agreement and Guaranty, dated as of July 29, 2019 (the “Credit Agreement”). Pursuant to the Waiver Agreement, the lenders under the Credit Agreement have, among other things, (i) granted consent to Foamix’s entering into the Merger Agreement and waived events of default under the Credit Agreement that would result therefrom and (ii) granted consent to the consummation of the transactions set forth under the Merger Agreement and waived certain events of default under the Credit Agreement as would result therefrom. This waiver is subject to the satisfaction of certain closing conditions as specified therein (including amendments to the Credit Agreement and other applicable loan documents so as to ensure that we become a guarantor and an obligor under the Credit Agreement and grants a first priority security interest in substantially all of our assets).

The Credit Agreement contains financial and other restrictive covenants that would (upon us becoming a party to it) limit our ability to incur new indebtedness; create liens on assets; make or enter into transactions that result in certain fundamental corporate changes, such as mergers or acquisitions; sell assets; change business activities; make certain investments or payments; pay dividends; change fiscal periods; enter into or become bound by certain inbound and outbound licenses; or enter into transactions with affiliates. The Credit Agreement also contains certain financial covenants, requiring that (1) the obligors maintain a minimum aggregate cash balance of $2.5 million; and (2) Foamix and its subsidiaries achieve certain revenue targets as of a specific date.

The restrictive covenants in the Credit Agreement may limit our ability to plan for or react to market conditions, meet capital needs or otherwise restrict our activities or business plans and adversely affect our ability to finance our operations,

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enter into acquisitions or to engage in other business activities that could be in our interest. Our ability to comply with the financial covenants can be affected by events beyond our control and it may not be able to do so. If we or any other obligor under the Credit Agreement is unable to remain in compliance with any of the covenants under the Credit Agreement, then it would cause a default under the Credit Agreement and amounts outstanding thereunder may be accelerated and become due immediately. Any such acceleration of debt could have a material adverse effect on our financial condition and results of operations.

Our obligation to guaranty debt under the Credit Agreement, in connection with the Merger, exposes us to risks that could adversely affect its business, operating results, overall financial condition and may result in further dilution to our stockholders.

Upon consummation of the Merger, we will become a guarantor and an obligor under the Credit Agreement. The Credit Agreement provides for a senior secured delayed draw term loan facility in an aggregate principal amount of $50.0 million, and upon consummation of the Merger it is expected that approximately $35.0 million of loans will be outstanding under the Credit Agreement. Our indebtedness under the Credit Agreement in connection with our guaranty obligations or in the event the Combined Company incurs additional indebtedness from another source could have an adverse impact on our business or operations. For example, it could:

Any future indebtedness that we incur will require us to make certain interest and principal payments. Our ability to make payments on any indebtedness (including indebtedness in connection with the guaranty obligations pursuant to the Credit Agreement) depends on our ability to generate cash in the future. It is expected that the Combined Company will experience negative cash flow for the foreseeable future as it funds its operations and capital expenditures. There can be no assurance we will be in a position to repay this indebtedness when due or obtain extensions to the maturity date. In order to repay these obligations when due, we may be required to sell assets, to refinance all or a portion of such indebtedness or to obtain additional financing, including on terms that are less favorable to us. If that additional financing involves the sale of equity securities or convertible securities, it would result in the issuance of additional shares of capital stock, which would result in dilution to our stockholders.

Changes in interest rates could adversely affect our earnings and/or cash flows.

Loans under the Credit Agreement are made at variable rates that use LIBOR as a benchmark for establishing the interest rate. LIBOR is the subject of recent proposals for reform. On July 27, 2017, the United Kingdom’s Financial Conduct Authority announced that it intends to stop persuading or compelling banks to submit LIBOR rates after 2021. These reforms may cause LIBOR to cease to exist, new methods of calculating LIBOR to be established or the establishment of an alternative reference rate(s). These consequences cannot be entirely predicted and could have an adverse impact on the market value for or value of LIBOR-linked loans that are due under the Credit Agreement that will be guaranteed by us. Changes in market interest rates may influence the financing costs and could reduce our earnings and cash flows.

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Risks Related to Our Financial Position and Capital Needs

 

We have a limited operating history, have incurred significant losses since our inception, and anticipate that we will continue to incur losses for the foreseeable future. Serlopitant is our only product candidate in clinical trials and we have had no commercial sales, which, together with our limited operating history, makes it difficult to assess our future viability.

We are a late-stage biopharmaceutical company with a limited operating history. Biopharmaceutical product development is a highly speculative undertaking and involves a substantial degree of risk. To date, we have focused principally on developing serlopitant, which is our only product in development. We are not profitable and have incurred losses in each year since our inception in 2011. We have only a limited operating history upon which stockholders can evaluate our business and prospects. In addition, we have limited experience and have not yet demonstrated an ability to successfully overcome many of the risks and uncertainties frequently encountered by companies in new and rapidly evolving fields, particularly in the biopharmaceutical industry. We have not generated any revenue from product sales to date. We continue to incur significant research and development and other expenses related to our ongoing operations. Our net loss for the years ended December 31, 2019, 2018 and 2017 was approximately $73.7 million, $51.4 million, and $29.1 million, respectively. As of December 31, 2019, we had an accumulated deficit of $184.3 million. Even if the Merger is successfully completed, we may continue to incur losses for some time, and these losses may increase as we continue our development, seek regulatory approval of, and, if approved, begin to commercialize serlopitant. Even if we achieve profitability in the future, we may not be able to sustain profitability in subsequent periods. Our prior losses, combined with expected future losses, have had and will continue to have an adverse effect on our stockholders’ equity and working capital.

 

We will require substantial additional financing, and a failure to obtain this necessary capital when needed on acceptable terms, or at all, could force us to delay, limit, reduce or terminate our product development, other operations or commercialization efforts.

We have devoted substantially all of our financial resources and efforts to the development of serlopitant. As of December 31, 2019, we had capital resources consisting of cash, cash equivalents and investments of $76.9 million. We expect to incur substantial expenditures in the foreseeable future as we advance serlopitant through clinical development, the regulatory approval process and, if approved, commercial launch activities. In the near term, we expect to incur substantial expenses relating to our ongoing clinical trials and the development and validation of our commercial manufacturing process for serlopitant drug substance and drug product. Furthermore, we expect to continue to incur additional costs associated with operating as a public company, including significant legal, accounting, investor relations and other expenses that we did not incur as a private company. We also expect to incur expenses related to the recruitment and retention of personnel, working capital and other general corporate purposes. We may incur additional expenses in connection with expanding our pipeline, including by pursuing additional indications for serlopitant or the in-license or acquisition of additional drug candidates or commercial products. In November 2018 and January 2019, putative securities class action complaints were filed against us, certain of our current executive officers and directors, and certain underwriters in our initial public offering. The complaints allege violations of Sections 11, 12(a)(2) and 15 of the Securities Act of 1933 due to allegedly false and misleading statements in connection with the initial public offering. The parties have mediated the consolidated lawsuit and reached a settlement. The settlement is subject to final documentation and Court approval. We maintain director and officer insurance with liability coverage limits that we believe are adequate and customary for the nature of our business, and we have submitted these claims to our insurance carrier. However, we may not have sufficient insurance coverage for these or future claims, and we may not be able to obtain additional or expanded insurance in amounts or scope sufficient to provide us with adequate coverage against all potential liabilities. Claims brought against us, with or without merit, could increase our insurance rates. Claims paid in excess of our insurance coverage would be paid out of cash reserves, harming our financial condition and reducing our operating results.

If the Merger is successfully completed, we believe that our existing cash, cash equivalents and investments, together with the cash, cash equivalents and investments of Foamix, will be sufficient to fund our planned operations for at least the next 12 months from the issuance of our financial statements as of and for the year ended December 31, 2019. If the Merger is not successfully completed, we believe that our existing cash, cash equivalents and investments will be sufficient to fund our planned operations for at least the next 12 months from the issuance of our financial statements as of and for year ended December 31, 2019. However, because the outcome of any clinical trial, regulatory approval or commercialization process is highly uncertain, we cannot reasonably estimate the actual amounts necessary to successfully complete the development, regulatory approval process and ultimate commercialization of serlopitant, if approved, nor the timing of such expenditures. Nor can we reasonably estimate the actual amounts necessary to operate following a successful completion of the Merger. Our operating plan may change as a result of many factors currently unknown to us, and we may need to seek additional funds sooner than planned, through public or private equity , through debt financings or from other sources, such as strategic collaborations. Such financing may result in dilution to stockholders, imposition of debt covenants and repayment obligations, or other restrictions that may affect our business. In addition, we may seek

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additional capital due to favorable market conditions or strategic considerations, even if we believe we have sufficient funds for our current or planned operations.

The size and timing of our future funding requirements will depend on many factors, including, but not limited to:

•      the cost of ongoing securities litigation or any future litigation to which we may become a party;

 

If the Merger is successfully completed, the size and timing of the Combined Company’s future funding requirements would depend on many similar factors as applicable to the combined company’s and the status of its collective products and product candidates.

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We may opportunistically seek financing before capital is required, including with our at-the-market offering program, based upon factors such as the market value of our securities, investor interest in acquiring ownership in our company, prevailing capital market conditions and results of our operations. Additional funds may not be available when we need them, on terms that are acceptable to us, or at all. If adequate funds are not available to us on a timely basis, we may be required to delay, limit, reduce or terminate clinical trials or other development and commercialization activities for serlopitant.

 

Risks Related to Our Business

If the Merger is not successfully completed, we will be substantially dependent on the success of our sole product candidate, serlopitant.

To date, we have invested substantially all of our efforts and financial resources in the development of serlopitant, which is our sole product candidate in development. If the Merger is not successfully completed, our prospects, including our ability to finance our operations and generate revenue from product sales, will depend entirely on the successful development and commercialization of serlopitant. The clinical and commercial success of serlopitant will depend on a number of factors, including the following:

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Many of these factors are beyond our control. Accordingly, we cannot be certain that we will ever be able to generate revenue through the sale of serlopitant. If we are not successful in commercializing serlopitant, or are significantly delayed in doing so, our business will be materially harmed. Further, if the Merger is successfully completed, the prospects of the Combined Company, including its ability to finance its operations and generate revenue from product sales, would depend on the successful commercialization of AMZEEQ and on the development and commercialization of FMX103, and their commercial and clinical success will depend on a number of similar factors. If the Combined Company is not successful in commercializing its products and product candidates, or are significantly delayed in doing so, its business will be materially harmed.

 

Clinical drug development involves a lengthy and expensive process, with an uncertain outcome. We may incur additional costs or experience delays in completing, or ultimately be unable to complete, the development and commercialization of serlopitant.

To gain approval to market a drug product such as serlopitant, we must provide the FDA and foreign regulatory authorities with non-clinical, clinical, and chemistry, manufacturing, and controls, or CMC, data that adequately demonstrates the safety and efficacy of the product for the intended indication applied for in the New Drug Application, or NDA, or other respective regulatory filing. Drug development is a long, expensive and uncertain process, and delay or failure can occur at any stage of any of our clinical trials. Further, although members of our management team have conducted clinical trials and obtained marketing approvals for product candidates in the past while employed at other companies, we as a company have not done so. As a result, such activities may require more time and cost than we anticipate.

Our business currently depends entirely on the successful development, regulatory approval and commercialization of serlopitant following completion of all required non-clinical and clinical trials, and generation of adequate CMC data. We initiated two multi-center placebo-controlled double-blind Phase 3 clinical trials of serlopitant for the treatment of pruritus associated with prurigo nodularis in 2018. However, there can be no assurances that such clinical trials, or any future clinical trials, will be successful. For example, our completed Phase 2 clinical trials of serlopitant for the treatment of refractory chronic cough, for the treatment of pruritus associated with atopic dermatitis, and for the treatment of CPUO did not meet their primary or key secondary endpoints.

Development of serlopitant for use in pediatric patients may be a required element of our development program for some of our target indications. We have received a pediatric waiver from the FDA for pruritus associated with prurigo nodularis.

We may experience numerous unforeseeable events during or as a result of our non-clinical studies and clinical trials that could delay or prevent our ability to receive marketing approval or commercialize serlopitant, including:

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In addition, disruptions at the FDA and other regulatory agencies that are unrelated to our company or our products could also cause delays to the regulatory approval process for our products. For example, over the last several years, including in December 2018 and January 2019, the U.S. government has shut down several times and certain regulatory agencies, including the FDA, have had to furlough critical employees and stop critical activities. If a prolonged government shutdown occurs, it could significantly impact the ability of the FDA to timely review and process our regulatory submissions.

 

Any delay or prevention of our ability to receive marketing approval or commercialize serlopitant would materially and adversely affect our business.

If the Merger is successfully completed, the Combined Company will face similar risks related to the development and regulatory review of FMX103 and the commercialization of FMX103 and AMZEEQ.

Our business could be harmed if a clinical trial is delayed, suspended or terminated by us, by oversight authorities for such trial, or by the FDA or other regulatory authorities.

If we experience delays in the completion of, or termination of, any clinical trial of serlopitant, the commercial prospects of serlopitant will be harmed, and our ability to generate product revenues from serlopitant will be delayed. Authorities may impose a clinical delay, suspension or termination due to a number of factors, including

In addition, any delays in successfully completing our clinical trials will increase our costs, slow down our development of serlopitant and its approval process and jeopardize our ability to commence product sales and generate revenues, which may materially harm our business, financial condition and prospects. In addition, many of the factors that cause, or lead to, a delay in the commencement or completion of clinical trials may also ultimately lead to the denial of regulatory approval of serlopitant. Any delay or prevention of our ability to receive marketing approval or commercialize serlopitant would materially and adversely affect our business, results of operations and financial condition.

 

If the Merger is successfully completed, the Combined Company will face similar risks related to clinical trials of Foamix products.

We may be required to conduct additional clinical trials or other testing of serlopitant beyond those that we currently contemplate.

If we are unable to successfully complete clinical trials of serlopitant candidates or other testing, if the results of these trials or tests are not favorable or if there are safety concerns, we may be required to conduct additional clinical trials or other testing of serlopitant beyond those that we currently contemplate.  In such an event, we may:

If any of these events were to occur, it could cause delays, require us to incur additional costs and materially and adversely affect our business, results of operations and financial condition. Further, if the Merger is successfully completed, the Combined Company will face similar risks related to clinical trials and testing of Foamix products.

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Results obtained in non-clinical studies and completed clinical trials may not predict success in later clinical trials.

Success in non-clinical testing and early clinical trials does not ensure that later clinical trials will be successful, and we cannot be certain that any of our current Phase 3 clinical trials or any other clinical trials that we may conduct will demonstrate consistent or adequate efficacy and safety to obtain regulatory approval to market serlopitant in any indication.

 

The primary efficacy analysis in our completed Phase 2 clinical trials of chronic pruritus and pruritus associated with prurigo nodularis was a statistically significant change in itch visual analogue scale, or VAS, from baseline compared to placebo measured at week six or eight. Based upon our interactions with the FDA, we will use a different efficacy analysis for our Phase 3 clinical trials, a 4-point responder rate on the worst-itch numeric rating scale, or WI-NRS. We analyzed 4-point responders in our chronic pruritus and prurigo nodularis Phase 2 clinical trials after the completion of the studies. The analyses of the percentage of patients with at least a 40 mm response in VAS, or a 4-point response on WI-NRS, were not pre-specified in our initial completed Phase 2 clinical trials’ statistical analysis plans and are thus considered post-hoc analyses. For these and other reasons, our Phase 2 clinical trials may not predict serlopitant’s ability to demonstrate a statistically significant reduction in pruritus using this measure in Phase 3 clinical trials. It is also possible that the FDA or other regulatory agencies may require additional endpoints that are not currently included in our serlopitant clinical trials.

 

In our completed Phase 2 clinical trial of serlopitant for pruritus associated with prurigo nodularis, concomitant medications for treatment of pruritus other than loratadine or cetirizine were excluded. In our Phase 3 clinical trials for pruritus associated with prurigo nodularis, patients are being permitted to take certain additional medications that were not permitted in the Phase 2 clinical trial. The efficacy or safety of serlopitant when used with other agents in the Phase 3 clinical trials may differ from the Phase 2 clinical trial as a result of these additional medications. Phase 3 clinical trials with larger numbers of patients or longer durations of therapy may also reveal safety concerns that were not identified in earlier smaller or shorter trials.

 

We and other companies in the biopharmaceutical industry have frequently suffered significant setbacks in later clinical trials, even after achieving promising results in earlier non-clinical studies or clinical trials. For example, our completed Phase 2 clinical trials of serlopitant for the treatment of refractory chronic cough, for the treatment of pruritus associated with atopic dermatitis and for the treatment of CPUO did not meet their primary or key secondary endpoints.

 

If the Merger is successfully completed, the Combined Company will face similar risks related to development of Foamix products.

 

We have utilized retrospective data analyses to inform our decision to modify our Phase 3 prurigo nodularis trial eligibility criteria.

 

After the completion of our Phase 2 study in atopic dermatitis, which failed to meet its primary and secondary endpoints, we conducted retrospective analyses of our three Phase 2 pruritus studies completed with serlopitant in an effort to further understand the atopic dermatitis trial results and determine potential patient populations who may best respond to serlopitant therapy. In these analyses, we observed patterns that informed our decision to modify eligibility criteria to exclude subjects from participation in our Phase 3 prurigo nodularis trials should they have active inflammatory skin disease other than prurigo nodularis. Our post hoc analyses were conducted solely for the limited purposes of informing future study design and indication selection, and do not constitute specific conclusions of efficacy, nor do these analyses indicate that our clinical trials will be successful in meeting their primary or secondary endpoints. Retrospective analysis of data is susceptible to bias in data selection, analysis, and interpretation.

 

Use of patient-reported outcome assessments, or PROs, in our clinical trials may delay or impair the development of serlopitant and/or adversely impact our clinical trials.

 

Due to the difficulty of objectively measuring pruritus, the assessment of pruritus in clinical trials typically involves the use of patient-reported outcome assessments, or PROs. PROs have an important role in the development and regulatory approval of treatments for pruritus. PROs involve patients’ subjective assessments of efficacy, and this subjectivity can increase the uncertainty of clinical trial outcomes assessing pruritus. Such assessments can be influenced by a number of factors and can vary widely from day to day for a particular patient, and from patient to patient and site to site within a clinical trial, leading to high variability in PRO measurements.

 

The variability of PRO measures for itch and the high placebo response rates could adversely impact our serlopitant development program. PROs for itch assessment have historically been observed to have high placebo group response rates, including in some of our trials. For example, in our Phase 2 clinical trial in patients with chronic pruritus, patients receiving placebo reported a greater than 25% decrease from baseline in itch VAS scores. Variability in the placebo group response has adversely impacted clinical results of other therapies being tested for itch reduction and could adversely

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impact our clinical trial results. The variability of a PRO measure may be greater than some measures used for clinical trial assessments, and that variability can complicate clinical trial design, adversely impact the ability of a study to show a statistically significant improvement, and generally adversely impact a clinical development program by introducing additional uncertainties.

 

It is also possible that the FDA may require changes in the PRO we are currently using or may indicate that the PRO we are using is not acceptable for demonstrating efficacy in pruritus reduction, potentially delaying clinical development of serlopitant, increasing our costs and making additional clinical trials necessary.

 

If we experience delays or difficulties in the enrollment of subjects in clinical trials, our receipt of necessary regulatory approvals could be delayed or prevented.

Successful and timely completion of clinical trials will require that we enroll a sufficient number of subjects on schedule. Patient enrollment, a significant factor in the timing of clinical trials, is affected by many factors including the size and nature of the patient population and the ability of clinical sites to successfully recruit and retain subjects in clinical trials. Trials may be subject to delays as a result of patient enrollment taking longer than anticipated or patient withdrawal. In particular, among our target indications, prurigo nodularis is not a well-recognized condition, and although we have been able to enroll enough patients into clinical trials for these indications to date, this does not mean that future trials in these indications, if required, would be able to be enrolled in a timely manner at a reasonable cost. We may not be able to initiate, continue, or complete clinical trials for certain indications, if we are unable to locate and enroll a sufficient number of eligible subjects to participate in these trials in a timely manner. If patient enrollment in a trial becomes too difficult, we may determine to cancel or significantly modify that trial. For example, we previously initiated a clinical trial of serlopitant to treat pruritus following burn injury but discontinued the trial due to lack of timely enrollment. Enrollment can also be affected by seasonality and other factors.

We cannot predict how successful we will be at enrolling subjects in future clinical trials. Subject enrollment is affected by other factors including:

Our inability to enroll a sufficient number of subjects for clinical trials would result in significant delays and could require us to abandon one or more clinical trials altogether. Enrollment delays in these clinical trials may result in increased development costs for serlopitant or delays in regulatory filings and progression, which would cause the value of our company to decline and limit our ability to obtain additional financing. Furthermore, we rely on and expect to continue to rely on CROs and clinical trial sites to ensure the proper and timely conduct of our clinical trials, and we will have limited influence over their performance.

 

If the Merger is successfully completed, the Combined Company will face similar risks related to enrollment of subjects in clinical trials for Foamix products.

We rely on third parties to conduct our non-clinical studies and our clinical trials. If these third parties do not successfully carry out their contractual duties or meet expected deadlines, we may be unable to obtain regulatory approval for or commercialize serlopitant.

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We do not have the ability to independently conduct non-clinical studies and clinical trials. We rely on medical institutions, clinical investigators, contract laboratories, collaborative partners and other third parties, such as CROs, to conduct non-clinical studies and clinical trials on serlopitant. The third parties with whom we contract for execution of our non-clinical studies and clinical trials play a significant role in the conduct of these studies and trials and the subsequent collection and analysis of data. However, these third parties are not our employees, and except for contractual duties and obligations, we have limited ability to control the amount or timing of resources that they devote to our programs. These third parties may also have relationships with other commercial entities, some of which may compete with us. In some cases, these third parties could terminate their agreements with us without cause.

Although we rely on third parties to conduct our non-clinical studies and clinical trials, we remain responsible for ensuring that each of our non-clinical studies and clinical trials is conducted in accordance with its investigational plan and protocol. Moreover, the FDA and foreign regulatory authorities require us to comply with regulations and standards, including some regulations commonly referred to as good clinical practices, or GCPs, for conducting, monitoring, recording and reporting the results of clinical trials to ensure that the data and results are scientifically credible and accurate, and that the trial subjects are adequately informed of the potential risks of participating in clinical trials. In the past, we have experienced an issue of non-compliance with dosing among several patients at one of the clinical sites in one of our trials. We determined through analysis of the results of the trial and a comprehensive third-party audit that this single-site issue did not affect the results of that clinical trial.

In addition, the execution of non-clinical studies and clinical trials, and the subsequent compilation and analysis of the data produced, requires coordination among various parties. In order for these functions to be carried out effectively and efficiently, it is imperative that these parties communicate and coordinate with one another. If the third parties conducting our clinical trials do not perform their contractual duties or obligations, experience work stoppages, do not meet expected deadlines, terminate their agreements with us or need to be replaced, or if the quality or accuracy of the clinical data they obtain is compromised due to the failure to adhere to our clinical trial protocols or GCPs, or for any other reason, we may need to enter into new arrangements with alternative third parties, which could be difficult, costly or impossible, and our clinical trials may be extended, delayed or terminated or may need to be repeated, which would have a material adverse effect on our business.

 

If the Merger is successfully completed, the Combined Company will face similar risks related to development of Foamix products.

We rely completely on third-party suppliers to manufacture serlopitant, and we intend to continue to rely on third parties to produce non-clinical, clinical and commercial supplies of serlopitant.

We currently contract with one third party for the manufacture of serlopitant drug substance and another third party for serlopitant drug products for clinical trials, and we do not plan to acquire the infrastructure or internal capability to produce our non-clinical, clinical or commercial supplies of serlopitant. We anticipate that these third parties will have capacity to support commercial operations, but we do not have any formal agreements at this time to cover commercial production of serlopitant.

In order for us to obtain approval of serlopitant, our contract manufacturers must, pursuant to inspections that would be conducted after we submit our NDA or relevant foreign regulatory submission, maintain a compliance status acceptable to the FDA and other comparable foreign regulatory agencies. We do not directly control the manufacturing of serlopitant, and we are completely dependent on our contract manufacturers for compliance with the cGMP requirements for manufacture of both active drug substances and finished drug products. If our contract manufacturers cannot successfully manufacture material that conforms to our specifications and the strict regulatory requirements of the FDA or foreign regulatory agencies, we will not be able to secure and/or maintain regulatory approval for their manufacturing facilities. In addition, we have no direct control over the ability of our contract manufacturers to maintain adequate quality control, quality assurance and qualified personnel. Furthermore, all of our contract manufacturers are engaged with other companies to supply or manufacture materials or products for such companies, which exposes our manufacturers to regulatory risks for the production of such materials and products. As a result, failure to meet the regulatory requirements for the production of those materials and products may generally affect the regulatory clearance of our contract manufacturers’ facilities. If the FDA or a comparable foreign regulatory agency does not approve these facilities for the manufacture of serlopitant, or if it withdraws its approval in the future, we may need to find alternative manufacturing facilities, which would negatively impact our ability to develop, obtain regulatory approval for or market serlopitant, if approved.

We and our third-party manufacturers continue to refine and improve the manufacturing process, certain aspects of which are complex and unique, and we may encounter difficulties with new or existing processes, particularly as we seek to significantly increase our capacity to commercialize serlopitant. Our reliance on contract manufacturers also exposes us to

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the possibility that they, or third parties with access to their facilities, will have access to and may appropriate our trade secrets or other proprietary information.

As drug candidates are developed through non-clinical studies to late-stage clinical trials towards approval and commercialization, it is common that various aspects of the development program, such as manufacturing methods, methods of making drug formulations, and drug formulations, are altered along the way in an effort to optimize processes and results. Such changes carry the risk that they will not achieve these intended objectives. Any of these changes could cause our drug candidates to perform differently and affect the results of clinical trials or other future clinical trials conducted with the altered materials. Such changes may also require additional testing, FDA notification or FDA approval. This could delay completion of clinical trials, require the conduct of bridging clinical trials or the repetition of one or more clinical trials, increase clinical trial costs, delay approval of our drug candidates and jeopardize our ability to commence sales and generate revenue.

If the merger is successfully completed, the Combined Company will face similar risks related to Foamix products.

Key manufacturing steps and materials used in our drug substance and in our drug product are provided by limited numbers of suppliers, and supply shortages or loss of these suppliers could result in interruptions in supply or increased costs.

Certain manufacturing steps and materials used in our serlopitant drug substance and in our serlopitant drug product are currently performed by or purchased from single outside sources. We may engage additional contract manufacturers for production of supplies of materials used in the manufacture of serlopitant and to participate in the manufacture of the drug substance or drug product.

The reliance on a limited number of suppliers could result in:

We have supply agreements in place for certain materials of our drug substance and drug products, but do not have in place long term supply agreements. Therefore, the supply of a particular material could be terminated at any time without penalty to the supplier. In addition, we may not be able to procure required materials from third-party suppliers at a quantity, quality and cost acceptable to us. Any interruption in the supply of single source material could cause us to seek alternative sources of supply or manufacture these materials internally. Furthermore, in some cases, we are relying on our third-party collaborators to procure supply of necessary materials. If the supply of any materials for serlopitant is interrupted, materials from alternative suppliers may not be available in sufficient volumes or at acceptable quality levels, or at acceptable cost within required timeframes, if at all, to meet our needs or those of our third-party collaborators. This could delay our ability to complete clinical trials and obtain approval for commercialization and marketing of serlopitant, causing us to incur additional costs, delay new product introductions, or lose sales, and could harm our reputation.

Investigator sponsored trials of serlopitant may produce results and safety signals that are beyond our control and impact our development and commercialization of serlopitant.

Serlopitant has been evaluated in a 14-patient exploratory investigator sponsored study at Stanford University as a potential treatment to reduce pruritus associated with epidermolysis bullosa, a rare and primarily pediatric skin condition. the Stanford University investigator is also evaluating serlopitant in an additional investigator sponsored study in patients with pruritus associated with epidermolysis bullosa. In the future, we may permit other investigators to evaluate serlopitant in other investigator sponsored studies. These studies have the potential to result in unexpected or adverse clinical trial results, serious adverse events or the identification of other undesirable side effects, or unexpected characteristics of serlopitant or other product candidates, which could adversely impact our development programs.

We currently have no sales organization. If we are unable to establish sales capabilities on our own or through third parties, we may not be able to market and sell serlopitant, if approved, or generate product revenue.

We currently do not have a sales organization. If the Merger is not successfully completed, we would need to build our marketing, sales, distribution, managerial and other non-technical capabilities or make arrangements with third parties to perform these services in order to commercialize serlopitant, if approved, and we may not be successful in doing so. If the Merger is not successfully completed and serlopitant receives regulatory approval, we expect to establish a specialty sales

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organization with technical expertise and supporting distribution capabilities to commercialize it primarily to dermatologists, which will be expensive and time consuming. We have no prior experience in the marketing, sale and distribution of pharmaceutical products and there are significant risks involved in building and managing a sales organization, including our ability to hire, retain and incentivize qualified individuals, provide adequate training to sales and marketing personnel, gain access to physicians or persuade adequate numbers of physicians to prescribe serlopitant, if approved, or any future drugs, and effectively manage a geographically dispersed sales and marketing team. Our efforts to commercialize serlopitant on our own may also be impacted by the lack of complementary drugs to be offered by sales personnel, which may put us at a competitive disadvantage relative to companies with more extensive product lines, and any unforeseen costs and expenses associated with creating an independent sales and marketing organization. Any failure or delay in the development of our internal sales, marketing and distribution capabilities would adversely impact the commercialization of these products.

We may choose to collaborate with third parties that have direct sales forces and established distribution systems, either to augment our own sales organization and distribution systems or in lieu of our own sales organization and distribution systems. If we are unable to enter into such arrangements on acceptable terms or at all, we may not be able to successfully commercialize serlopitant. If we are not successful in commercializing serlopitant, either on our own or through collaborations with one or more third parties, our future product revenue will suffer, and we would incur significant additional losses.

If we breach our license agreement for serlopitant, we could lose the ability to continue the development and commercialization of our product. Merck also retains rights to serlopitant in specific fields.

In December 2012, we entered into a license agreement with Merck to obtain exclusive worldwide rights to research, develop, manufacture, market and sell serlopitant, other than for the treatment or prevention of nausea and vomiting. This agreement requires us to use commercially reasonable efforts to develop and commercialize serlopitant, make timely milestone payments, provide certain information regarding our activities with respect to such products, maintain the confidentiality of information we receive from Merck and indemnify Merck with respect to our development and commercialization activities under the terms of the agreement.

If we fail to meet these obligations, Merck has the right to terminate our exclusive license and upon the effective date of such termination, has the right to re-obtain the licensed technology as well as aspects of any intellectual property controlled by us and developed during the period the agreement was in force that relate to the licensed technology. This means that Merck could effectively take control of the development and commercialization of serlopitant after an uncured, material breach of our license agreement by us. This would also be the case if we voluntarily terminate the agreement. While we would expect to exercise all rights and remedies available to us, including seeking to cure any breach by us, and otherwise seek to preserve our rights under the patents licensed to us, we may not be able to do so in a timely manner, at an acceptable cost or at all. Any uncured, material breach under the license could result in our loss of exclusive rights and may lead to a complete termination of our product development and any commercialization efforts for serlopitant.

Merck could also develop serlopitant for treatment of nausea or vomiting or license these rights to a third party. Development of serlopitant in other fields could increase the possibility of identification of adverse safety results that impact our development of serlopitant for pruritus associated with various conditions. In addition, if approved, commercialization of serlopitant in other fields could result in an increased threat of off-label use to compete with the sale of serlopitant to treat these indications.

Collaboration arrangements that we may enter into in the future may not be successful, which could adversely affect our ability to develop and commercialize serlopitant.

We may seek collaboration arrangements with pharmaceutical or biotechnology companies for the development or commercialization of serlopitant in the future. We may enter into these arrangements on a selective basis, depending on the merits of retaining commercialization rights ourselves compared to entering into selective collaboration arrangements with pharmaceutical or biotechnology companies for serlopitant internationally and possibly also in the United States. There can be no assurance that any such collaboration arrangements will be successful.

In addition, the success of future collaboration arrangements that we may enter into will depend heavily on the efforts and activities of our collaborators. Collaborators generally have significant discretion in determining the efforts and resources that they will apply to these collaborations.

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When entering collaboration arrangements, we are subject to a number of risks, including:

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We face substantial competition, which may result in others discovering, developing or commercializing drugs before or more successfully than we do.

The biopharmaceutical industry is intensely competitive and is subject to rapid and significant change. We face competition from other pharmaceutical and biotechnology companies, research institutions, and other organizations, particularly companies that develop and market pharmaceutical products for dermatologic and respiratory conditions. Our commercial potential may be limited by other companies that develop and sell other novel products that are effective for our target indications, or that may be more effective, safer or cost less than serlopitant. If the Merger is successfully completed, the Combined Company will face similar competition related to FMX103 and AMZEEQ.

Although there are currently no approved drugs specifically indicated for pruritus associated with psoriasis or prurigo nodularis, either in the United States or in Europe, we may face competition from those companies that are developing drugs specifically to treat pruritus associated with a variety of underlying dermatologic or systemic conditions, companies that are developing and marketing NK₁ -receptor antagonists for other conditions, that, when approved, could be used off-label to treat pruritus and companies that currently market or are developing treatments intended directly to treat the underlying disease condition in psoriasis, prurigo nodularis, or other diseases that have also been shown to have anti-pruritic effects.

Even if serlopitant receives marketing approval, it may fail to achieve the degree of market acceptance by physicians, patients, third-party payors and others in the medical community necessary for commercial success.

If serlopitant receives marketing approval, it may nonetheless fail to gain sufficient market acceptance by physicians, patients, third-party payors and others in the medical community. If serlopitant does not achieve an adequate level of acceptance, we may not generate significant revenue and we may not become profitable. The degree of market acceptance of serlopitant, if approved for commercial sale, will depend on a number of factors, including:

 

If the Merger is successfully completed, the Combined Company will face similar risks with FMX103 and AMZEEQ.

If coverage and adequate reimbursement from third-party payors are not available, it may make it difficult for us to sell serlopitant profitably.

Our ability to commercialize serlopitant successfully will depend in part on the extent to which governmental authorities, private health insurers and other third-party payors establish coverage and adequate reimbursement for it. Patients who are prescribed treatments for their conditions and providers furnishing such services generally rely on third-party payors to

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reimburse all or part of the associated healthcare costs. Patients are unlikely to use our products unless coverage is provided, and reimbursement is adequate to cover a significant portion of the cost of serlopitant, once approved.

Significant uncertainty exists as to the coverage and reimbursement status of newly approved products. A trend in the U.S. healthcare industry and elsewhere is cost containment. Government authorities and other third-party payors have attempted to control costs by limiting coverage and the amount of reimbursement for particular medical products. Third-party payors also are increasingly challenging the effectiveness of and prices charged for medical products and services, including requiring companies to demonstrate the comparative effectiveness of a new therapy against other types of therapies that are available. The clinical trials we have conducted and plan to conduct on serlopitant test serlopitant’s performance against a placebo. Third-party payors may request additional trials to demonstrate comparative effectiveness. Such trials would be expensive and time consuming, and the results are uncertain. As a result of these cost containment measures, coverage and reimbursement may not be available for serlopitant when it is approved for commercialization, and, even if available, the level of reimbursement may not be sufficient enough for successful commercialization of serlopitant or may significantly limit our revenue or profits, if any.

In the United States, private third-party payors often rely upon Medicare coverage policy and payment limitations in setting their own reimbursement policies. However, no uniform policy for determining coverage and reimbursement for products exists among third-party payors and coverage and reimbursement can differ significantly from payor to payor. Each plan determines whether or not it will provide coverage, what amount it will pay, and with respect to pharmaceutical products, on what tier of its formulary such product will be placed. The position of a prescription drug on a formulary generally determines the co-payment that a patient will need to make to obtain the product and can strongly influence the adoption of a product by patients and physicians. Each plan may separately require us to provide scientific and clinical support for the use of our products and, as a result, the coverage determination process is often a time-consuming and costly process with no assurance that coverage and adequate reimbursement will be applied consistently or obtained at all. Our inability to obtain coverage and adequate reimbursement promptly from both government-funded and private payors for any approved products that we develop could significantly harm our operating results, our ability to raise capital needed to commercialize serlopitant and our overall financial condition.

 

If the Merger is successfully completed, the Combined Company will face similar risks with FMX103 and AMZEEQ.

Serlopitant may cause undesirable side effects or have other properties that could delay or prevent its regulatory approval or result in significant negative consequences following marketing approval, if any. The number of patients exposed to serlopitant treatment and the average exposure time in the clinical development program may be inadequate to detect rare adverse events that may only be detected once serlopitant is administered to more patients and for greater periods of time.

Undesirable side effects caused by serlopitant could cause us or regulatory authorities to interrupt, delay or halt clinical trials and could result in a more restrictive label or the delay or denial of regulatory approval by the FDA or other comparable foreign authorities. Serlopitant has been dosed in approximately 2,000 individuals across multiple completed Phase 1 and Phase 2 clinical trials and has been shown to be well-tolerated, including when administered to patients in a clinical trial for up to one year, and in shorter trials at much higher doses than our current planned therapeutic dose. However, patients may experience adverse reactions when using serlopitant. The most commonly reported treatment-emergent adverse events across all completed Phase 2 clinical trials excluding our recently completed Phase 2 clinical trial in CPUO patients, were urinary tract infection (4.8%, as compared to 2.5% for patients treated with placebo), nasopharyngitis (4.8%, as compared to 3.7% for patients treated with placebo), diarrhea (4.7%, as compared to 3.4% for patients treated with placebo) and headache (4.4% as compared to 6.3% for patients treated with placebo). In our recently completed Phase 2 clinical trial in CPUO patients, the most common treatment emergent adverse events in the serlopitant group were diarrhea (6.9%), somnolence (5.2%), fatigue and headache (2.6% each), and the most common treatment emergent adverse events in the placebo group were gastroesophageal reflux disease and arthralgia (2.6% each). Although we have not observed evidence of these adverse reactions causing a safety concern in our clinical programs, it is possible that the FDA may ask for additional data regarding any adverse events seen in our trials. Results of our ongoing or future trials could reveal a high and unacceptable severity and prevalence of these or other side effects. In such an event, our trials could be suspended or terminated, and the FDA or comparable foreign regulatory authorities could order us to cease further development of or deny approval for serlopitant for any or all targeted indications. The drug-related side effects could affect patient recruitment or the ability of enrolled patients to complete the trial or result in potential product liability claims. In addition, our patient population includes a substantial proportion of elderly participants, which may increase the risk of adverse events, related or unrelated to serlopitant during our clinical trials. Any of these occurrences may harm our business, financial condition and prospects significantly.

Although we have monitored the subjects in our trials for certain safety concerns and we have not seen evidence of significant safety concerns in our clinical trials to date, patients treated with serlopitant may experience adverse reactions and it is possible that the FDA may ask for additional data regarding such matters. As part of our preparations for the filing of a New Drug Application, we have conducted clinical trials to assess the pharmacokinetics of serlopitant in multiple patient populations, such as drug-drug interactions, and we have evaluated standard safety assessments in these patient

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populations. In this regard, we have evaluated the exposure to serlopitant in the presence of drugs that impact CYP3A4 activity, the primary pathway for serlopitant metabolism, and as expected, we have observed that coadministration of serlopitant with a CYP3A4 inhibitor may increase serlopitant concentrations and exposure, and coadministration with a CYP3A4 inducer may reduce serlopitant concentrations and exposure. We plan to include the findings from our safety studies and drug-drug interaction studies in our NDA submission to FDA, and reference to findings from such studies could be included in final approved labeling for serlopitant, if approved.

Additionally, clinical trials by their nature utilize a sample of the potential patient population. However, with a limited number of subjects and limited duration of exposure, we cannot be fully assured that rare and severe side effects of serlopitant may only be uncovered with a significantly larger number of patients exposed to the drug. If serlopitant receives marketing approval, and we or others later identify undesirable side effects caused by it, a number of potentially significant negative consequences could result, including:

 

If the Merger is successfully completed, the Combined Company will face similar adverse-event risks with FMX103 and AMZEEQ.

We must successfully manage multiple complex clinical trials simultaneously while growing our business.

We currently have multiple ongoing Phase 2 and Phase 3 clinical trials of serlopitant, an ongoing long-term safety study of serlopitant and an ongoing Phase 1 clinical study of serlopitant to support an NDA. If the results of our ongoing Phase 3 clinical trials are promising, we plan to rapidly submit an NDA for one or more of those indications. As of December 31, 2019, we had 40 employees. In order to manage our operations, clinical trials, regulatory filings, manufacturing and supply activities, marketing and commercialization activities for serlopitant, we will need to continue to expand our managerial, operational, finance, systems, facilities and other resources. To effectively execute our strategy, we must:

Inability to effectively expand or manage our personnel and other resources, and complexities or unforeseen expenses or setbacks associated with managing our clinical trials and other activities, could delay or prevent completion of our clinical trials, the commercialization of serlopitant or any future product candidates, or the successful expansion of our product pipeline.

 

If the Merger is successfully completed, the Combined Company will face similar challenges and will face additional challenges related to the Merger.

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We are highly dependent on the services of our senior management and our ability to attract and retain qualified personnel.

Our success depends in part on our continued ability to attract, retain and motivate highly qualified personnel. If the Merger is not successfully completed, we will continue to be highly dependent upon our experienced senior management, including Steven Basta, Chief Executive Officer, Paul Kwon, M.D., Chief Scientific Officer, Kristine Ball, Senior Vice President, Corporate Strategy and Chief Financial Officer. The loss of the services of any of the members of our senior management team could materially adversely impact our ability to sustain or grow our operations.

Although we have not historically experienced unique difficulties attracting and retaining qualified employees, we could experience such problems in the future. Competition for qualified personnel in the biotechnology and pharmaceuticals field is intense due to the limited number of individuals who possess the skills and experience required by our industry. The San Francisco Bay Area has a high cost of living, which may make it harder to recruit personnel. We will need to hire additional personnel as we expand our clinical development and commercial activities, and we may be required to expend significant financial resources in our employee recruitment and retention efforts. We may not be able to attract and retain quality personnel on acceptable terms, or at all. In addition, to the extent we hire personnel from competitors, we may be subject to allegations that they have been improperly solicited or that they have divulged proprietary or other confidential information, or that their former employers own their research output or other proprietary knowledge.

 

If the Merger is successfully completed, the Combined Company will be similarly dependent upon its senior management and qualified personnel.

We may not be successful in our efforts to develop and obtain regulatory approval for serlopitant in multiple indications or at all.

We are currently and intend to continue to develop serlopitant for multiple indications and we may seek approval for serlopitant for pruritus associated with one or more conditions. Because we have limited financial and management resources, our resource allocation decisions may impact the timing of our current programs. For example, we recently chose to defer the decision to start a Phase 3 clinical program in pruritus associated with psoriasis.

It is possible that our strategy of pursuing multiple indications may distribute our activities in a manner that is less advantageous than a strategy that may focus on fewer indications or a single indication. It is possible that the data from trials in multiple indications could adversely affect the regulatory review of serlopitant as compared with data from trials for a single indication.

 

If the Merger is successfully completed, the Combined Company will face similar risks with FMX103 and AMZEEQ.

We may have chosen indications for serlopitant development that are more difficult or have less commercial potential than other possible indications.

Because we have limited financial and management resources, we are focusing on development programs for specific indications. We are currently primarily focused on the development of serlopitant for the treatment of pruritus associated with certain conditions. As a result, we may forego or delay pursuit of opportunities in other indications, or with other drug candidates that we may identify or that may be available, that later prove to have greater commercial potential. Our resource allocation decisions may cause us to fail to capitalize on profitable market opportunities. Our spending on current and future development programs and drug candidates for specific indications may not yield any commercially viable indication. If we do not accurately evaluate the commercial potential or target market for a particular indication for serlopitant, or for any other drug candidate, we may relinquish valuable rights to that drug candidate or indication through collaboration, licensing or other royalty arrangements in cases in which it would have been more advantageous for us to retain sole development and commercialization rights.

 

If the Merger is successfully completed, the Combined Company will face similar risks regarding the indications chosen for the development of Foamix products.

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If we seek and obtain approval to commercialize serlopitant outside of the United States, a variety of risks associated with international operations could materially adversely affect our business.

If serlopitant is approved for commercialization outside the United States, we may choose to commercialize it ourselves or enter into agreement with third parties to do so. If we chose to directly commercialize internationally, we expect that we will be subject to additional risks, including:

 

If the Merger is successfully completed, the Combined Company will face similar risks related to the commercialization of FMX103 and AMZEEQ outside of the United States.

Product liability lawsuits against us could cause us to incur substantial liabilities and to limit commercialization of serlopitant.

We face an inherent risk of product liability exposure related to the testing of serlopitant in human clinical trials and will face an even greater risk if we sell serlopitant commercially. If we cannot successfully defend ourselves against claims that serlopitant causes injuries, we will incur substantial liabilities. Regardless of merit or eventual outcome, liability claims may result in:

We currently hold product liability insurance coverage in amounts that we believe are reasonable and customary for our industry and stage of development. This coverage may not be adequate to cover all liabilities that we may incur. We may need to increase our insurance coverage as we expand our clinical trials or if we commence commercialization of

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serlopitant. Insurance coverage is increasingly expensive. We may not be able to maintain insurance coverage at a reasonable cost or in an amount adequate to satisfy any liability that may arise.

 

If the Merger is successfully completed, the Combined Company will face similar risks related to product liability lawsuits related to FMX103 and AMZEEQ.

Our business involves the use of hazardous materials and we and our third-party manufacturers and suppliers must comply with environmental laws and regulations, which can be expensive and restrict how we do business.

Our research and development activities and our third-party manufacturers’ and suppliers’ activities involve the controlled storage, use and disposal of hazardous materials, including the components of serlopitant and other hazardous compounds. We and our manufacturers and suppliers are subject to laws and regulations governing the use, manufacture, storage, handling and disposal of these hazardous materials. In some cases, these hazardous materials and various wastes resulting from their use are stored at our and our manufacturers’ facilities pending their use and disposal. We cannot eliminate the risk of contamination, which could cause an interruption of our commercialization efforts, research and development efforts and business operations, environmental damage resulting in costly clean-up and liabilities under applicable laws and regulations governing the use, storage, handling and disposal of these materials and specified waste products. Although we believe that the safety procedures utilized by our third-party manufacturers for handling and disposing of these materials generally comply with the standards prescribed by these laws and regulations, we cannot guarantee that this is the case or eliminate the risk of accidental contamination or injury from these materials. In such an event, we may be held liable for any resulting damages and such liability could exceed our resources and state or federal or other applicable authorities may curtail our use of certain materials and/or interrupt our business operations. Furthermore, environmental laws and regulations are complex, change frequently and have tended to become more stringent. We cannot predict the impact of such changes and cannot be certain of our future compliance. We do not currently carry biological or hazardous waste insurance coverage.

 

Significant disruptions of information technology systems or breaches of data security could materially adversely affect our business, results of operations and financial condition.

We collect and maintain information in digital form that is necessary to conduct our business, and we are increasingly dependent on information technology systems and infrastructure to operate our business. In the ordinary course of our business, we collect, store and transmit large amounts of confidential information, including intellectual property, proprietary business information and personal information. It is critical that we do so in a secure manner to maintain the confidentiality and integrity of such confidential information. We have established physical, electronic and organizational measures to safeguard and secure our systems to prevent a data compromise, and rely on commercially available systems, software, tools and monitoring to provide security for our information technology systems and the processing, transmission and storage of digital information. We have also outsourced elements of our information technology infrastructure, and as a result a number of third-party vendors may or could have access to our confidential information. Our internal information technology systems and infrastructure, and those of our current and any future collaborators, contractors and consultants and other third parties on which we rely, are vulnerable to damage from computer viruses, malware, natural disasters, terrorism, war, telecommunication and electrical failures, cyber-attacks or cyber-intrusions over the Internet, attachments to emails, persons inside our organization, or persons with access to systems inside our organization.

The risk of a security breach or disruption, particularly through cyber-attacks or cyber intrusion, including by computer hackers, foreign governments and cyber terrorists, has generally increased as the number, intensity and sophistication of attempted attacks and intrusions from around the world have increased. In addition, the prevalent use of mobile devices that access confidential information increases the risk of data security breaches, which could lead to the loss of confidential information or other intellectual property. The costs to us to mitigate network security problems, bugs, viruses, worms, malicious software programs and security vulnerabilities could be significant, and while we have implemented security measures to protect our data security and information technology systems, our efforts to address these problems may not be successful, and these problems could result in unexpected interruptions, delays, cessation of service and other harm to our business and our competitive position. If such an event were to occur and cause interruptions in our operations, it could result in a material disruption of our product development programs. For example, the loss of clinical trial data from completed or ongoing clinical trials could result in delays in our regulatory approval efforts and significantly increase our costs to recover or reproduce the data. Moreover, if a computer security breach affects our systems or results in the unauthorized release of personally identifiable information, our reputation could be materially damaged. In addition, such a breach may require notification to governmental agencies, the media or individuals pursuant to various federal, state and foreign privacy and security laws, if applicable, including the Health Insurance Portability and

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Accountability Act of 1996, as amended by the Health Information Technology for Clinical Health Act of 2009, and its implementing rules and regulations, as well as regulations promulgated by the Federal Trade Commission and state breach notification laws and the EU General Data Protection Regulation. We would also be exposed to a risk of loss or litigation and potential liability, which could materially adversely affect our business, results of operations and financial condition.

We or the third parties upon whom we depend may be adversely affected by earthquakes or other natural disasters and our business continuity and disaster recovery plans may not adequately protect us from a serious disaster.

Our corporate headquarters and other facilities are located in the San Francisco Bay Area, which in the past has experienced severe earthquakes. We do not carry earthquake insurance. Earthquakes or other natural disasters could severely disrupt our operations, and have a material adverse effect on our business, results of operations, financial condition and prospects.

If a natural disaster, power outage or other event occurred that prevented us from using all or a significant portion of our headquarters, that damaged critical infrastructure, such as our enterprise financial systems or manufacturing resource planning and enterprise quality systems, or that otherwise disrupted operations, it may be difficult or, in certain cases, impossible for us to continue our business for a substantial period of time. We may incur substantial expenses as a result of the limited nature of our disaster recovery and business continuity plans, which, particularly when taken together with our lack of earthquake insurance, could have a material adverse effect on our business.

Furthermore, integral parties in our supply chain are operating from single sites, increasing their vulnerability to natural disasters or other sudden, unforeseen and severe adverse events. If such an event were to affect our supply chain, it could have a material adverse effect on our business.

Risks Related to Our Intellectual Property

We may become subject to claims alleging infringement of third parties’ patents or proprietary rights and/or claims seeking to invalidate our patents, which would be costly, time consuming and, if successfully asserted against us, delay or prevent the development and commercialization of serlopitant.

There have been many lawsuits and other proceedings asserting patents and other intellectual property rights in the pharmaceutical and biotechnology industries. We cannot assure you that serlopitant will not infringe existing or future third-party patents. Because patent applications can take many years to issue and may be confidential for 18 months or more after filing, there may be applications now pending of which we are unaware and which may later result in issued patents that we may infringe by commercializing serlopitant. Moreover, we may face claims from non-practicing entities that have no relevant product revenue and against whom our own patent portfolio may thus have no deterrent effect. We may be unaware of one or more issued patents that would be infringed by the manufacture, sale or use of serlopitant.

We may be subject to third-party claims in the future against us or our collaborators that would cause us to incur substantial expenses and, if successful against us, could cause us to pay substantial damages, including treble damages and attorney’s fees if we are found to be willfully infringing a third-party’s patents. We may be required to indemnify future collaborators against such claims. If a patent infringement suit were brought against us or our collaborators, we or they could be forced to stop or delay research, development, manufacturing or sales of the product or product candidate that is the subject of the suit. As a result of patent infringement claims, or in order to avoid potential claims, we or our collaborators may choose to seek, or be required to seek, a license from the third-party and would most likely be required to pay license fees or royalties or both. These licenses may not be available on acceptable terms, or at all. Even if we or our collaborators were able to obtain a license, the rights may be nonexclusive, which would give our competitors access to the same intellectual property. Ultimately, we could be prevented from commercializing a product, or forced to redesign it, or to cease some aspect of our business operations if, as a result of actual or threatened patent infringement claims, we or our collaborators are unable to enter into licenses on acceptable terms. Even if we are successful in defending against such claims, such litigation can be expensive and time consuming to litigate and would divert management’s attention from our core business. Any of these events could harm our business significantly.

In addition to infringement claims against us, if third parties prepare and file patent applications in the United States that also claim technology similar or identical to ours, we may have to participate in interference or derivation proceedings in the United States Patent and Trademark Office, or the USPTO, to determine which party is entitled to a patent on the disputed invention. We may also become involved in similar opposition proceedings in the European Patent Office or similar offices in other jurisdictions regarding our intellectual property rights with respect to our products and technology. Since patent applications are confidential for a period of time after filing, we cannot be certain that we were the first to file any patent application related to our product candidates.

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If our intellectual property related to serlopitant or any future product candidates is not adequate, we may not be able to compete effectively in our market.

We rely upon a combination of patents, trade secret protection and confidentiality agreements to protect the intellectual property related to serlopitant and our development programs. Patents covering the composition of matter for serlopitant will expire in 2025, subject to potential extensions, where available, including, potential extension of up to five years in the United States. Patents and patent applications, if issued, covering methods-of-use for serlopitant to treat pruritus will expire in 2033 in the United States and 2034 in foreign countries. The expiration of our patents will limit our ability to profit from the commercialization of serlopitant. Furthermore, any disclosure to or misappropriation by third parties of our confidential or proprietary information could enable competitors to quickly duplicate or surpass our technological achievements, thus eroding our competitive position in our market.

The strength of patents in the biotechnology and pharmaceutical field involves complex legal and scientific questions and can be uncertain. The patent applications that we own or license may fail to result in issued patents in the United States or in foreign countries. Even if patents do successfully issue, third parties may challenge the validity, enforceability or scope thereof, which may result in such patents being narrowed, invalidated or held unenforceable. For example, patents granted by the USPTO may be subject to third-party challenges such as (without limitation) re-examination proceedings, post-grant review, or inter partes review, and patents granted by the European Patent Office may be opposed by any person within nine months from the publication of the grant. Similar proceedings are available in other jurisdictions, and in some jurisdictions third parties can raise questions of validity with a patent office even before a patent has granted. Furthermore, even if they are unchallenged, our patents and patent applications may not adequately protect our intellectual property or prevent others from designing around our claims. For example, a third-party may develop a competitive product that provides therapeutic benefits similar to serlopitant but has a sufficiently different composition to fall outside the scope of our patent protection. If the breadth or strength of protection provided by the patents and patent applications we hold or pursue with respect to serlopitant or any future product candidates is successfully challenged, then our ability to commercialize serlopitant or any future product candidates could be negatively affected, and we may face unexpected competition that could have a material adverse impact on our business. Further, if we encounter delays in our clinical trials, the period of time during which we could market serlopitant or any future product candidates under patent protection would be reduced.

Even where laws provide protection, costly and time-consuming litigation could be necessary to enforce and determine the scope of our proprietary rights, and the outcome of such litigation would be uncertain. If we or one of our future collaborators were to initiate legal proceedings against a third party to enforce a patent covering serlopitant or one of our future products, the defendant could counterclaim that our patent is invalid and/or unenforceable. In patent litigation in the United States, defendant counterclaims alleging invalidity and/or unenforceability are commonplace. Grounds for a validity challenge could be an alleged failure to meet any of several statutory requirements, including lack of novelty, obviousness or non-enablement. Grounds for an unenforceability assertion could be an allegation that someone connected with prosecution of the patent withheld relevant information from the USPTO, or made a misleading statement, during prosecution. The outcome following legal assertions of invalidity and unenforceability is unpredictable. With respect to validity, for example, we cannot be certain that there is no invalidating prior art, of which we and the patent examiner were unaware during prosecution. If a defendant were to prevail on a legal assertion of invalidity and/or unenforceability against our intellectual property related to serlopitant, we would lose at least part, and perhaps all, of the patent protection on serlopitant. Such a loss of patent protection would have a material adverse impact on our business. Moreover, our competitors could counterclaim that we infringe their intellectual property, and some of our competitors have substantially greater intellectual property portfolios than we do.

We also rely on trade secret protection and confidentiality agreements to protect proprietary know-how that may not be patentable, processes for which patents may be difficult to obtain and/or enforce and any other elements of our product development processes that involve proprietary know-how, information or technology that is not covered by patents. Although we require all of our employees to assign their inventions to us, and endeavor to execute confidentiality agreements with all of our employees, consultants, advisors and any third parties who have access to our proprietary know-how, information or technology, we cannot be certain that we have executed such agreements with all parties who may have helped to develop our intellectual property or who had access to our proprietary information, nor can we be certain that our agreements will not be breached. We cannot guarantee that our trade secrets and other confidential proprietary information will not be disclosed or that competitors will not otherwise gain access to our trade secrets or independently develop substantially equivalent information and techniques. Further, the laws of some foreign countries do not protect proprietary rights to the same extent or in the same manner as the laws of the United States. As a result, we may encounter significant problems in protecting and defending our intellectual property both in the United States and abroad. If we are unable to prevent material disclosure of the intellectual property related to our technologies to third parties, we will not be able to establish or maintain a competitive advantage in our market, which could materially adversely affect our business, results of operations and financial condition.

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Changes in U.S. patent law could diminish the value of patents in general, thereby impairing our ability to protect our products.

As is the case with other biopharmaceutical companies, our success is heavily dependent on intellectual property, particularly patents. Obtaining and enforcing patents in the biopharmaceutical industry involve both technological and legal complexity. Therefore, obtaining and enforcing biopharmaceutical patents is costly, time consuming and inherently uncertain. In addition, the United States has recently enacted and is currently implementing wide-ranging patent reform legislation. The U.S. Supreme Court has ruled on several patent cases in recent years, either narrowing the scope of patent protection available in certain circumstances or weakening the rights of patent owners in certain situations. In addition to increasing uncertainty with regard to our ability to obtain patents in the future, this combination of events has created uncertainty with respect to the value of patents once obtained. Depending on future actions by the U.S. Congress, the federal courts and the USPTO, the laws and regulations governing patents could change in unpredictable ways that would weaken our ability to obtain new patents or to enforce our existing patents and patents that we might obtain in the future.

Obtaining and maintaining our patent protection depends on compliance with various procedural, document submission, fee payment and other requirements imposed by governmental patent agencies, and our patent protection could be reduced or eliminated for non-compliance with these requirements.

The USPTO and various foreign patent agencies require compliance with a number of procedural, documentary, fee payment and other provisions to maintain patent applications and issued patents. Noncompliance with these requirements can result in abandonment or lapse of a patent or patent application, resulting in partial or complete loss of patent rights in the relevant jurisdiction. In such an event, competitors might be able to enter the market earlier than would otherwise have been the case.

We have not yet registered trademarks for a commercial trade name for serlopitant in the United States or elsewhere and failure to secure such registrations could adversely affect our business.

We have not yet registered trademarks for a commercial trade name for serlopitant in the United States or elsewhere. During trademark registration proceedings, our trademark application may be rejected. Although we are given an opportunity to respond to those rejections, we may be unable to overcome such rejections. In addition, in the USPTO and in comparable agencies in many foreign jurisdictions, third parties can oppose pending trademark applications and seek to cancel registered trademarks. Opposition or cancellation proceedings may be filed against our trademarks, and our trademarks may not survive such proceedings. Moreover, any name we propose to use with our product candidates in the United States must be approved by the FDA, regardless of whether we have registered it, or applied to register it, as a trademark. The FDA typically conducts a review of proposed product names, including an evaluation of potential for confusion with other product names. If the FDA objects to any of our proposed proprietary product names, we may be required to expend significant additional resources in an effort to identify a suitable substitute name that would qualify under applicable trademark laws, not infringe the existing rights of third parties and be acceptable to the FDA.

We may not be able to enforce our intellectual property rights throughout the world.

The laws of some foreign countries do not protect intellectual property rights to the same extent as the laws of the United States. Many companies have encountered significant problems in protecting and defending intellectual property rights in certain foreign jurisdictions. The legal systems of some countries, particularly developing countries, do not favor the enforcement of patents and other intellectual property protection, especially those relating to life sciences. This could make it difficult for us to stop the infringement of our patents or the misappropriation of our other intellectual property rights. For example, many foreign countries have compulsory licensing laws under which a patent owner must grant licenses to third parties. In addition, many countries limit the enforceability of patents against third parties, including government agencies or government contractors. In these countries, patents may provide limited or no benefit.

Proceedings to enforce our patent rights in foreign jurisdictions, whether or not successful, could result in substantial costs and divert our efforts and attention from other aspects of our business. Furthermore, while we intend to protect our intellectual property rights in our expected significant markets, we cannot ensure that we will be able to initiate or maintain similar efforts in all jurisdictions in which we may wish to market serlopitant or any future products. Accordingly, our efforts to protect our intellectual property rights in such countries may be inadequate. In addition, changes in the law and legal decisions by courts in the United States and foreign countries may affect our ability to obtain and enforce adequate intellectual property protection for our technology.

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If we are unable to protect the confidentiality of our proprietary information and know-how, the value of our technology and products could be adversely affected.

We may not be able to protect our proprietary information and technology adequately. Although we use reasonable efforts to protect our proprietary information, technology, and know-how, our employees, consultants, contractors and outside scientific advisors may unintentionally or willfully disclose our information to competitors. Enforcing a claim that a third party illegally obtained and is using any of our proprietary information, technology or know-how is expensive and time consuming, and the outcome is unpredictable. In addition, courts outside the United States are sometimes less willing to protect proprietary information, technology and know-how. We rely, in part, on non-disclosure and confidentiality agreements with our employees, consultants and other parties to protect our proprietary information, technology and know-how. These agreements may be breached, and we may not have adequate remedies for any breach. Moreover, others may independently develop similar or equivalent proprietary information, and third parties may otherwise gain access to our proprietary knowledge.

Our intellectual property agreements with third parties may be subject to disagreements over contract interpretation, which could narrow the scope of our rights to the relevant intellectual property or technology or increase our financial or other obligations to our licensors.

Certain provisions in our intellectual property agreements may be susceptible to multiple interpretations. The resolution of any contract interpretation disagreement that may arise could affect the scope of our rights to the relevant intellectual property or technology or affect financial or other obligations under the relevant agreement, either of which could have a material adverse effect on our business, financial condition, results of operations and prospects.

In addition, while it is our policy to require our employees and contractors who may be involved in the conception or development of intellectual property to execute agreements assigning such intellectual property to us, we may be unsuccessful in executing such an agreement with each party who in fact conceives or develops intellectual property that we regard as our own. Our assignment agreements may not be self-executing or may be breached, and we may be forced to bring claims against third parties, or defend claims they may bring against us, to determine the ownership of what we regard as our intellectual property.

Risks Related to Government Regulation

The regulatory approval process is lengthy, time-consuming, and highly uncertain, and we may experience significant delays and may not obtain regulatory approval for the commercialization of serlopitant.

The research, testing, manufacturing, labeling, approval, selling, import, export, marketing and distribution of drug products are subject to extensive regulation by the FDA and other regulatory authorities in the United States and other countries, which regulations differ from country to country. We currently have no products approved for sale, and we may never obtain regulatory approval to commercialize serlopitant. Neither we nor any future collaborator is permitted to market serlopitant or any future product candidate in the United States or in any foreign countries until we or they receive approval of an NDA from the FDA or marketing authorization from the applicable regulatory authorities of such jurisdictions. We have not submitted an application or obtained marketing approval for serlopitant anywhere in the world. Obtaining regulatory approval of an NDA can be a lengthy, expensive and uncertain process. In addition, failure to comply with FDA and other applicable United States and foreign regulatory requirements may subject us to administrative or judicially imposed sanctions or other actions, including:

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Prior to obtaining approval to commercialize a drug candidate in the United States or abroad, we or any future collaborators must demonstrate with substantial evidence from well-controlled clinical trials, and to the satisfaction of the FDA or other foreign regulatory agencies, that such drug candidate is safe and effective for its intended uses. The number of non-clinical studies and clinical trials that will be required for FDA approval varies depending on many factors, including the drug candidate, the disease or condition that the drug candidate is designed to address, and results of non-clinical studies and clinical trials of the drug candidate. Even if we believe the non-clinical or clinical data serlopitant is promising, such data may not be sufficient to support approval by the FDA and other regulatory authorities. Administering drug candidates to humans may produce undesirable side effects, which could interrupt, delay or halt clinical trials and result in the FDA or other regulatory authorities denying approval of a drug candidate for any or all targeted indications.

Regulatory approval of an NDA is not guaranteed, and the approval process is expensive and may take several years. The FDA also has substantial discretion in the approval process and we may encounter matters with the FDA that requires us to expend additional time and resources and delay or prevent the approval of serlopitant. For example, the FDA may require us to conduct additional studies or trials for serlopitant either prior to or post-approval, such as additional drug-drug interaction studies or safety or efficacy studies or trials, or it may object to elements of our clinical development program such as the number of subjects in our current clinical trials from the United States. The FDA can delay, limit or deny approval of a drug candidate for many reasons, including, but not limited to, the following:

If serlopitant fails to demonstrate safety and efficacy in clinical trials or does not gain regulatory approval, our business and results of operations will be materially and adversely harmed. Additionally, if the FDA requires that we conduct additional clinical studies, places limitations on serlopitant in our label, delays approval to market serlopitant or limits the use of serlopitant, our business and results of operations may be harmed.

Even if we receive regulatory approval of serlopitant, the approval may be limited and we will be subject to ongoing regulatory obligations and continued regulatory review, which may result in significant additional expense, and we may be subject to penalties if we fail to comply with regulatory requirements or experience unanticipated problems with serlopitant.

Any regulatory approvals or other marketing authorizations we obtain for serlopitant may be subject to limitations on the indicated uses for which the product may be marketed or the conditions of approval or marketing authorization, or contain requirements for potentially costly post-market testing and surveillance to monitor the safety and efficacy of serlopitant. In addition, if the FDA or a comparable foreign regulatory authority authorizes serlopitant for marketing, the manufacturing processes, labeling, packaging, distribution, adverse event reporting, storage, advertising, promotion, import, export and record keeping for our product candidates will be subject to extensive and ongoing regulatory requirements. These requirements include submissions of safety and other post-marketing information and reports, registration, as well as continued compliance with cGMPs, and GCP requirements for any clinical trials that we conduct post-approval. Later discovery of previously unknown problems with serlopitant, including adverse events of unanticipated severity or frequency, or with our third-party manufacturers or manufacturing processes, or failure to comply with regulatory requirements, may result in, among other things:

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The FDA’s and other regulatory authorities’ policies may change, and additional government regulations may be enacted that could prevent, limit or delay regulatory approval of serlopitant. If we are slow or unable to adapt to changes in existing requirements or the adoption of new requirements or policies, or if we are not able to maintain regulatory compliance, we may not obtain marketing approval, or we may lose any marketing approval that we may have obtained, and we may not achieve or sustain profitability, which would adversely affect our business, prospects, financial condition and results of operations.

On May 30, 2018, the Trickett Wendler, Frank Mongiello, Jordan McLinn, and Matthew Bellina Right to Try Act of 2017, or the Right to Try Act, was signed into law. The law, among other things, provides a federal framework for certain patients to access certain investigational new drug products that have completed a Phase I clinical trial and that are undergoing investigation for FDA approval. Under certain circumstances, eligible patients can seek treatment without enrolling in clinical trials and without obtaining FDA permission under the FDA expanded access program. There is no obligation for a drug manufacturer to make its drug products available to eligible patients as a result of the Right to Try Act.

We cannot predict the likelihood, nature or extent of government regulation that may arise from future legislation or administrative or executive action, either in the United States or abroad. For example, certain policies of the Trump administration may impact our business and industry. Namely, the Trump administration has taken several executive actions, including the issuance of a number of Executive Orders, that could impose significant burdens on, or otherwise materially delay, the FDA’s ability to engage in routine regulatory and oversight activities such as implementing statutes through rulemaking, issuance of guidance, and review and approval of marketing applications. It is difficult to predict how these or future executive actions It is difficult to predict how these or future executive actions will be implemented, and the extent to which they will impact the FDA’s ability to exercise its regulatory authority. If these executive actions impose constraints on the FDA’s ability to engage in oversight and implementation activities in the normal course, our business may be negatively impacted.

If we obtain regulatory approval to market serlopitant in the United States, any such approval will be limited to the specific indication authorized by the FDA. If we are found to be in violation of FDA and other regulations restricting the promotion of serlopitant for unapproved uses, we could be subject to criminal penalties, substantial fines or other sanctions and damage awards.

If our clinical trials are successful, we intend to seek approval to market serlopitant for the treatment of pruritus associated with various specified conditions. If we obtain regulatory approval to market serlopitant with an indication statement for the treatment of one or more of these indications, we will likely be prohibited from marketing serlopitant using any promotional claims relating to treatment of pruritus generally. Marketing of serlopitant may also be limited by regulatory authorities based on use as a monotherapy or adjuvant, concomitant medications, severity of pruritus and other conditions of use.

The regulations relating to the promotion of products for unapproved uses are complex and subject to substantial interpretation by the FDA and other government agencies. serlopitant may not be promoted for uses that are not approved in the labeling by the FDA or EMA. Physicians may, following FDA approval, nevertheless prescribe serlopitant off-label to their patients in a manner that is inconsistent with the approved label. We intend to implement compliance and training programs designed to ensure that our sales and marketing practices comply with applicable regulations. Notwithstanding these programs, the FDA or other government agencies may allege or find that our practices constitute prohibited promotion of serlopitant for unapproved uses. We also cannot be sure that our employees will comply with company policies and applicable regulations regarding the promotion of products for unapproved uses, but we may nevertheless be deemed responsible for their marketing activities.

In recent years, a significant number of pharmaceutical and biotechnology companies have been the target of inquiries and investigations by various federal and state regulatory, investigative, prosecutorial and administrative entities in connection with the promotion of products for unapproved uses and other sales practices, including the Department of Justice and various U.S. Attorneys’ Offices, the Office of Inspector General of the Department of Health and Human Services, the FDA, the Federal Trade Commission and various state Attorneys General offices. These investigations have alleged violations of various federal and state laws and regulations, including claims asserting antitrust violations, violations of the Federal Food, Drug and Cosmetic Act, the False Claims Act, the Prescription Drug Marketing Act, anti-kickback laws and other alleged violations in connection with the promotion of products for unapproved uses, pricing and Medicare and/or Medicaid reimbursement. Many of these investigations originate as “qui tam” actions under the False Claims Act. Under the False Claims Act, any individual can bring a claim on behalf of the government alleging that a person or entity has presented a false claim, or caused a false claim to be submitted, to the government for payment. The person bringing a qui tam suit is entitled to a share of any recovery or settlement. Qui tam suits, also commonly referred to as “whistleblower suits,” are often brought by current or former employees. In a qui tam suit, the government must decide whether to intervene and prosecute the case. If it declines, the individual may pursue the case alone.

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If the FDA or any other governmental agency initiates an enforcement action against us or if we are the subject of a qui tam suit and it is determined that we violated prohibitions relating to the promotion of products for unapproved uses, we could be subject to warning letters, untitled letters, substantial civil or criminal fines or damage awards and other sanctions such as consent decrees and corporate integrity agreements pursuant to which our activities would be subject to ongoing scrutiny and monitoring to ensure compliance with applicable laws and regulations. Any such fines, awards or other sanctions would have an adverse effect on our revenue, business, financial prospects and reputation.

If approved, serlopitant or any future products may cause or contribute to adverse medical events that we are required to report to regulatory agencies and if we fail to do so we could be subject to sanctions that would materially harm our business.

If we are successful in completing the development, obtaining approval for and commercializing serlopitant or any other products, FDA and foreign regulatory agency regulations require that we report certain information about adverse medical events if those products may have caused or contributed to those adverse events. The timing of our obligation to report would be triggered by the date we become aware of the adverse event as well as the nature of the event. We may fail to report adverse events we become aware of within the prescribed time frame. We may also fail to appreciate that we have become aware of a reportable adverse event, especially if it is not reported to us as an adverse event or if it is an adverse event that is unexpected or removed in time from the use of our products. If we fail to comply with our reporting obligations, the FDA or a foreign regulatory agency could take action, including criminal prosecution, the imposition of civil monetary penalties, seizure of our products or delay in approval or clearance of future products.

If third-party manufacturers fail to comply with manufacturing regulations, our financial results and financial condition will be adversely affected.

Before our contract manufacturers can begin commercial manufacture of serlopitant, the process and systems used in the manufacture of serlopitant must be approved and each facility must have a compliance status that is acceptable to the FDA and other regulatory authorities. In addition, pharmaceutical manufacturing facilities are continuously subject to inspection by the FDA and foreign regulatory authorities, before and after product approval. Due to the complexity of the processes used to manufacture pharmaceutical products and product candidates, any potential third-party manufacturer may be unable to continue to pass or initially pass federal, state or international regulatory inspections in a cost-effective manner. Furthermore, although we do not have day-to-day control over the operations of our contract manufacturers, we are responsible for ensuring compliance with applicable laws and regulations, including cGMPs.

If a third-party manufacturer with whom we contract is unable to comply with applicable laws and regulations, including cGMPs, serlopitant may not be approved, or we may be subject to fines, unanticipated compliance expenses, recall or seizure of our products, total or partial suspension of production and/or enforcement actions, including injunctions, and criminal or civil prosecution. These possible sanctions would adversely affect our financial results and financial condition.

Our failure to obtain regulatory approvals for serlopitant in foreign jurisdictions would prevent us from marketing our products in such jurisdictions.

In order to market any product in the European Economic Area, or EEA (which is composed of the 28 Member States of the European Union plus Norway, Iceland and Liechtenstein), and many other foreign jurisdictions, separate regulatory approvals are required. In the EEA, medicinal products can only be commercialized after obtaining a Marketing Authorization, or MA. Before granting the MA, the European Medicines Agency, or EMA, or the competent authorities of the Member States of the EEA make an assessment of the risk-benefit balance of the product on the basis of scientific criteria concerning its quality, safety and efficacy.

The approval procedures vary among countries and can involve additional clinical testing, and the time required to obtain approval may differ from that required to obtain FDA approval. Clinical trials conducted in one country may not be accepted by regulatory authorities in other countries. Approval by the FDA does not ensure approval by regulatory authorities in other countries, and approval by one or more foreign regulatory authorities does not ensure approval by regulatory authorities in other foreign countries or by the FDA. However, a failure or delay in obtaining regulatory approval in one country may have a negative effect on the regulatory process in others. The foreign regulatory approval process may include all of the risks associated with obtaining FDA approval. We may not be able to file for regulatory approvals or to do so on a timely basis, and even if we do file we may not receive necessary approvals to commercialize our products in any market.

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We may be subject to healthcare laws and regulations relating to our business, and could face substantial penalties if we are determined not to have fully complied with such laws, which would have an adverse impact on our business.

Our business operations and current and future arrangements with investigators, healthcare professionals, consultants, third-party payors, customers and patients, may expose us to broadly applicable fraud and abuse and other healthcare laws and regulations. These laws may constrain the business or financial arrangements and relationships through which we conduct our operations, including how we research, market, sell and distribute our products for which we obtain marketing approval. Such laws include:

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Efforts to ensure that our current and future business arrangements with third parties will comply with applicable healthcare laws and regulations will involve substantial costs. It is possible that governmental authorities may conclude that our business practices, including our consulting and advisory board arrangements with physicians and other healthcare providers, some of whom receive stock options as compensation for services provided, do not comply with current or future statutes, regulations, agency guidance or case law involving applicable healthcare laws. If our operations are found to be in violation of any of these or any other health regulatory laws that may apply to us, we may be subject to significant penalties, including the imposition of significant civil, criminal and administrative penalties, damages, monetary fines, disgorgement, individual imprisonment, possible exclusion from participation in Medicare, Medicaid and other U.S. healthcare programs, integrity oversight and reporting obligations, contractual damages, reputational harm, diminished profits and future earnings, and curtailment or restructuring of our operations, any of which could adversely affect our ability to operate our business and our results of operations. Defending against any such actions can be costly, time-consuming and may require significant financial and personnel resources. Therefore, even if we are successful in defending against any such actions that may be brought against us, our business may be impaired. If any of the above occur, it could adversely affect our ability to operate our business and our results of operations.

Recently enacted and future legislation may increase the difficulty and cost for us to obtain marketing approval of and commercialize our serlopitant and affect the prices we may obtain.

In the United States and some non-U.S. jurisdictions, there have been, and we expect there will continue to be, a number of legislative and regulatory changes and proposed changes regarding the healthcare system that could, among other things, prevent or delay marketing approval of serlopitant, restrict or regulate post-approval activities and affect our ability to profitably sell serlopitant for which we obtain marketing approval.

For example, in March 2010, the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act, collectively the Affordable Care Act was enacted in the United States to broaden access to health insurance, reduce or constrain the growth of healthcare spending, enhance remedies against fraud and abuse, add new transparency requirements for healthcare and health insurance industries, impose new taxes and fees on the health industry and impose additional health policy reforms. The law has continued the downward pressure on the pricing of medical items and services, especially under the Medicare program, and increased the industry’s regulatory burdens and operating costs. Among the provisions of the Affordable Care Act of importance to serlopitant are the following:

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Since its enactment, there have been judicial and Congressional challenges to certain aspects of the Affordable Care Act, as well as efforts by the Trump administration to repeal and replace certain provisions of the Affordable Care Act. By way of example, the Tax Cuts and Jobs Act of 2017 includes a provision repealing, the tax-based shared responsibility payment imposed by the Affordable Care Act on certain individuals who fail to maintain qualifying health coverage for all or part of a year that is commonly referred to as the “individual mandate.” On December 14, 2018, a U.S. District Court Judge in the Northern District of Texas, or Texas District Court Judge, ruled that the individual mandate is a critical and inseverable feature of the ACA, and therefore, because it was repealed as part of the U.S. Tax Act, the remaining provisions of the ACA are invalid as well. On December 18, 2019, the U.S. Court of Appeals for the 5th Circuit upheld the District Court's decision that the individual mandate was unconstitutional but remanded the case back to the District Court to determine whether the remaining provisions of the Affordable Care Act are invalid as well.

In addition, other legislative changes have been proposed and adopted in the United States since the Affordable Care Act was enacted. These changes include the Budget Control Act of 2011, which, among other things, resulted in reductions to Medicare payments to providers of 2% per fiscal year, due to the subsequent legislative amendments, including under the BBA, and will remain in effect through 2029; the American Taxpayer Relief Act of 2012, which, among other things, further reduced Medicare payments to several types of providers and increased the statute of limitations period for the government to recover overpayments to providers from three to five years; and the Medicare Access and CHIP Reauthorization Act of 2015, which, among other things, ended the use of the sustainable growth rate formula and provides for a 0.5% update to physician payment rates for each calendar year through 2019, after which there will be a 0% annual update each year through 2025. In addition, there has been heightened governmental scrutiny over the manner in which manufacturers set prices for their marketed products, which has resulted in several Congressional inquiries and enacting federal and state legislation designed to, among other things, bring more transparency to product pricing, review the relationship between pricing and manufacturer patient programs, and reform government program reimbursement methodologies for pharmaceutical products.

At the federal level, the Trump administration’s budget proposal for fiscal year 2020 contains further drug price control measures that could be enacted during the 2020 budget process or in other future legislation. The Department of Health and Human Services, or HHS, has already started the process of soliciting feedback on some of these measures and, at the same, is immediately implementing others under its existing authority. While some proposed measures will require authorization through additional legislation to become effective, Congress and the Trump administration have each indicated that it will continue to seek new legislative and/or administrative measures to control drug costs.

At the state level, individual states in the United States have also become increasingly active in passing legislation and implementing regulations designed to control pharmaceutical product and medical device pricing, including price or patient reimbursement constraints, discounts, restrictions on certain product access and marketing cost disclosure and transparency measures, and, in some cases, designed to encourage importation from other countries and bulk purchasing. For example, California passed a new law which requires transparency from biopharmaceutical companies regarding price increases for prescription drugs. In addition, regional healthcare authorities and individual hospitals are increasingly using bidding procedures to determine what pharmaceutical products and medical devices to purchase and which suppliers will be included in their prescription drug and other healthcare programs.

We expect that the Affordable Care Act, as well as other healthcare reform measures that may be adopted in the future, may result in more rigorous coverage criteria, new payment methodologies and in additional downward pressure on the price that we receive for any approved or cleared product. Any reduction in reimbursement from Medicare or other government programs may result in a similar reduction in payments from private payors. We cannot predict the likelihood, nature or extent of government regulation that may arise from future legislation or administrative action, either in the United States or abroad. If we are slow or unable to adapt to new requirements or policies, or if we are not able to maintain regulatory compliance, our product candidates may lose any regulatory approval that may have been obtained and we may not achieve or sustain profitability, which would adversely affect our business.

We face regulation and potential liability related to privacy, data protection and information security which may require significant resources and may adversely affect our business, operations and financial performance.

The regulatory environment surrounding privacy, data protection and information security is increasingly demanding. We are subject to numerous U.S. federal and state laws and non-U.S. regulations governing the protection of personal and confidential information of our clinical subjects, clinical investigators, employees and vendors/business contacts, including in relation to medical records, credit card data and financial information. Failure to comply with these data protection laws and regulations could result in government enforcement actions and create liability for us (which could include civil and/or criminal penalties), private litigation and/or adverse publicity that could negatively affect our operating results and business.

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For example, HIPAA, as amended by HITECH, and their respective implementing regulations, impose specific requirements relating to the privacy, security and transmission of individually identifiable health information held by HIPAA “covered entities” and their “business associates”. Among other things, HITECH made HIPAA’s security standards directly applicable to HIPAA “business associates,” defined as independent contractors or agents of covered entities that create, receive, maintain or transmit protected health information in connection with providing a service for or on behalf of a covered entity. HITECH also increased the civil and criminal penalties that may be imposed against covered entities, business associates and possibly other persons, and gave state attorneys general new authority to file civil actions for damages or injunctions in federal courts to enforce the federal HIPAA laws and seek attorney’s fees and costs associated with pursuing federal civil actions. In addition, state laws govern the privacy and security of health information in certain circumstances, many of which differ from each other in significant ways and may not have the same requirements, thus complicating compliance efforts.

Also, the European Parliament has adopted the General Data Protection Regulation, or the GDPR which became effective on May 25, 2018. This regulation replaced the EU’s 1995 data protection directive and is the single EU standard across all member states. The GDPR takes a broad view of the types of information that are deemed covered as personal identification information and contains provisions that require businesses to protect such personal data and the privacy of EU citizens for transactions that occur within EU member states. The GDPR also regulates the exportation of personal data outside of the EU. Non-compliance with the GDPR could result in significant penalties. We are working with our contract research organizations and clinical trial sites in Europe to ensure compliance with this regulation.

 

In the United States, California enacted the California Consumer Privacy Act (“CCPA”) on June 28, 2018, which went into effect on January 1, 2020. The CCPA gives California residents expanded rights to access and delete their personal information, opt out of certain personal information sharing, and receive detailed information about how their personal information is used. The CCPA provides for civil penalties for violations, as well as a private right of action for data breaches that is expected to increase data breach litigation. The CCPA may increase our compliance costs and potential liability. Some observers have noted that the CCPA could mark the beginning of a trend toward more stringent privacy legislation in the United States, which could increase our potential liability and adversely affect our business. If any person, including any of our employees, clinical vendors or collaborators or those with whom we share such information, negligently disregards or intentionally breaches our established controls with respect to our clinical subject, clinical investigator or employee data, or otherwise mismanages or misappropriates that data, we could be subject to significant monetary damages, regulatory enforcement actions, fines and/or criminal prosecution in one or more jurisdictions. As above, under the GDPR there are significant new punishments for non-compliance which could result in a penalty of up to 4% of a firm’s global annual revenue. In addition, a data breach could result in negative publicity which could damage our reputation and have an adverse effect on our business, financial condition or results of operations.

We strive to comply with all applicable laws, but they may conflict with each other, and by complying with the laws or regulations of one jurisdiction, we may find that we are violating the laws or regulations of another jurisdiction. Despite our efforts, we may not have fully complied in the past and may not in the future. If we become liable under laws or regulations applicable to us, we could be required to pay significant fines and penalties, our reputation may be harmed and we may be forced to change the way we operate. That could require us to incur significant expenses or to discontinue certain services, which could negatively affect our business.

Risks Related to Our Common Stock and Our Status as a Public Company

An active public market for our common stock may not be sustained.

We completed our initial public offering, or IPO in January 2018. Prior to that offering, there had been no public market for our common stock, and an active trading market for our shares may not be sustained. Further, certain of our existing institutional investors, including investors affiliated with certain of our directors, purchased an aggregate of 1,684,118 shares of common stock in our IPO. Accordingly, fewer shares may be actively traded in the public market because these stockholders will be restricted from selling the shares by restrictions under applicable securities laws, which would reduce the liquidity of the market for our common stock.

The lack of an active market may contribute to volatility of our stock price, impair our ability to raise capital and may impair our ability to acquire other businesses, applications or technologies using our shares as consideration.

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The trading price of the shares of our common stock is volatile, and stockholders could incur substantial losses.

Our stock price is volatile. The stock market in general, and the market for biopharmaceutical companies in particular, have experienced extreme volatility that has often been unrelated to the operating performance of particular companies. As a result of this volatility, stockholders may not be able to sell their common stock at or above the price paid for the shares. The market price for our common stock may be influenced by many factors, including:

 

In addition, in the past, stockholders have initiated class action lawsuits against pharmaceutical and biotechnology companies following periods of volatility in the market prices of these companies’ stock. In November 2018 and January 2019, putative securities class action complaints were filed against us, certain of our current executive officers and directors, and certain underwriters in our initial public offering. The complaints allege violations of Sections 11 and 15 of

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the Securities Act of 1933 due to allegedly false and misleading statements in connection with the initial public offering. This litigation could divert management’s attention, as well as resources, from our business. The parties have mediated the consolidated lawsuit and reached a settlement. The settlement is subject to final documentation and Court approval. We maintain director and officer insurance with liability coverage limits that we believe are adequate and customary for the nature of our business, and we have submitted these claims to our insurance carrier. However, we may not have sufficient insurance coverage for these or future claims, and we may not be able to obtain additional or expanded insurance in amounts or scope sufficient to provide us with adequate coverage against all potential liabilities. Claims brought against us, with or without merit, could increase our insurance rates. Claims paid in excess of our insurance coverage would be paid out of cash reserves, harming our financial condition and reducing our operating results.

If equity research analysts do not publish research or reports, or publish unfavorable research or reports, about us, our business or our market, our stock price and trading volume could decline.

The trading market for our common stock may be influenced by the research and reports that equity research analysts publish about us and our business. We do not have any control over the analysts, or the content and opinions included in their reports. The price of our stock could decline if one or more equity research analysts downgrade our stock or issue other unfavorable commentary or research. If one or more equity research analysts cease coverage of our company or fail to publish reports on us regularly, demand for our stock could decrease, which in turn could cause our stock price or trading volume to decline. If our operating results fail to meet the forecast of analysts, our stock price will likely decline.

Raising additional funds by issuing securities may cause dilution to our existing stockholders.

To the extent that we raise additional capital by issuing equity securities, the share ownership of existing stockholders will be diluted. For example, on February 1, 2019, we filed a Registration Statement on Form S-3, covering the offering of up to $150.0 million of shares of common stock, preferred stock, debt securities, warrants, purchase contracts and units. In addition, on February 1, 2019, we filed a prospectus supplement and entered into the Sales Agreement with Cantor Fitzgerald & Co., or Cantor Fitzgerald, to sell shares of our common stock, from time to time, with aggregate gross sales proceeds of up to $50.0 million, through an at-the-market equity offering program under which Cantor Fitzgerald will act as our sales agent.

Sales of a substantial number of shares of our common stock by our existing stockholders in the public market could cause our stock price to fall.

Sales of a substantial number of shares of our common stock in the public market could occur at any time. These sales, or the perception in the market that the holders of a large number of shares intend to sell shares, could reduce the market price of our common stock. Moreover, certain holders of shares of our common stock have rights, subject to certain conditions, to require us to file registration statements covering their shares or to include their shares in registration statements that we may file for ourselves or other stockholders. We have registered and intend to continue to register all shares of common stock that we may issue under our equity compensation plans. Once we register these shares, they can be freely sold in the public market upon issuance, subject to volume limitations applicable to affiliates.

Provisions in our corporate charter documents and under Delaware law may prevent or frustrate attempts by our stockholders to change our management and hinder efforts to acquire a controlling interest in us, and the market price of our common stock may be lower as a result.

Our amended and restated certificate of incorporation and amended and restated bylaws contain provisions that could delay or prevent changes in control or changes in our management without the consent of our board of directors. These provisions include the following:

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In addition, these provisions would apply even if we were to receive an offer that some stockholders may consider beneficial.

We are also subject to the anti-takeover provisions contained in Section 203 of the Delaware General Corporation Law. Under Section 203, a corporation may not, in general, engage in a business combination with any holder of 15% or more of its capital stock unless the holder has held the stock for three years or, among other exceptions, the board of directors has approved the transaction.

Claims for indemnification by our directors and officers may reduce our available funds to satisfy successful third-party claims against us and may reduce the amount of money available to us.

Our amended and restated certificate of incorporation and amended and restated bylaws provide that we will indemnify our directors and officers, in each case to the fullest extent permitted by Delaware law.

In addition, as permitted by Section 145 of the Delaware General Corporation Law, our amended and restated bylaws and our indemnification agreements that we have entered into with our directors and officers provide that:

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Our certificate of incorporation provides that the Court of Chancery of the State of Delaware will be the exclusive forum for substantially all disputes between us and our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers or employees.

Our certificate of incorporation provides that the Court of Chancery of the State of Delaware is the exclusive forum for any derivative action or proceeding brought on our behalf, any action asserting a breach of fiduciary duty, any action asserting a claim against us arising pursuant to the Delaware General Corporation Law, our certificate of incorporation or our bylaws, any action to interpret, apply, enforce, or determine the validity of our certificate of incorporation or bylaws, or any action asserting a claim against us that is governed by the internal affairs doctrine. The choice of forum provision may limit a stockholder’s ability to bring a claim in a judicial forum that it finds favorable for disputes with us or our directors, officers or other employees, which may discourage such lawsuits against us and our directors, officers and other employees.

Alternatively, if a court were to find the choice of forum provision contained in our certificate of incorporation to be inapplicable or unenforceable in an action, we may incur additional costs associated with resolving such action in other jurisdictions, which could adversely affect our business and financial condition.

We do not currently intend to pay dividends on our common stock, and, consequently, our stockholders’ ability to achieve a return on their investment will depend on appreciation in the price of our common stock.

We do not currently intend to pay any cash dividends on our common stock for the foreseeable future. We currently intend to invest our future earnings, if any, to fund our growth. Therefore, stockholders are not likely to receive any dividends on their common stock for the foreseeable future. Since we do not intend to pay dividends, stockholders’ ability to receive a return on their investment will depend on any future appreciation in the market value of our common stock. There is no guarantee that our common stock will appreciate or even maintain the price at which our holders have purchased it.

Concentration of ownership of our common stock among our existing executive officers, directors and principal stockholders may prevent new investors from influencing significant corporate decisions.

As of December 31, 2019, our executive officers, directors and current beneficial owners of 5% or more of our common stock and their respective affiliates will, in the aggregate, beneficially own 62.7% of our outstanding common stock.

As a result, these persons, acting together, would be able to significantly influence all matters requiring stockholder approval, including the election and removal of directors, any merger, consolidation, sale of all or substantially all of our assets, or other significant corporate transactions. This may prevent or discourage unsolicited acquisition proposals or offers for our common stock that certain stockholders may believe are in their best interest.

We are an “emerging growth company” and, as a result of the reduced disclosure and governance requirements applicable to emerging growth companies, our common stock may be less attractive to investors.

We are an “emerging growth company” as defined in the Jumpstart Our Business Startups Act of 2012, or the JOBS Act, and we intend to take advantage of some of the exemptions from reporting requirements that are applicable to other public companies that are not emerging growth companies, including:

We may take advantage of these reporting exemptions until we are no longer an emerging growth company. We will remain an emerging growth company until the earlier of (1) December 31, 2023, (2) the last day of the fiscal year (a) in which we have total annual gross revenue of at least $1.07 billion, or (b) in which we are deemed to be a large accelerated filer, which means the market value of our common stock that is held by non-affiliates exceeds $700 million as of the prior

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June 30th, and (2) the date on which we have issued more than $1.0 billion in non-convertible debt during the prior three-year period.

Under Section 107(b) of the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards until such time as those standards apply to private companies. We have irrevocably elected not to avail ourselves of this exemption from new or revised accounting standards and, therefore, we will be subject to the same new or revised accounting standards as other public companies that are not emerging growth companies.

If we fail to maintain proper and effective internal controls, our ability to produce accurate financial statements on a timely basis could be impaired.

We are subject to the reporting requirements of the Securities Exchange Act of 1934, the Sarbanes-Oxley Act and the rules and regulations of Nasdaq. The Sarbanes-Oxley Act requires, among other things, that we maintain effective disclosure controls and procedures and internal control over financial reporting. We must perform system and process evaluation and testing of our internal control over financial reporting to allow management to report on the effectiveness of our internal control over financial reporting in our Form 10-K filing each year, as required by Section 404 of the Sarbanes-Oxley Act. This requires that we incur substantial additional professional fees and internal costs within our accounting and finance functions and that we expend significant management efforts.

We may identify weaknesses in our system of internal financial and accounting controls and procedures that could result in a material misstatement of our financial statements. Our internal control over financial reporting will not prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud will be detected.

If we are not able to comply with the requirements of Section 404 of the Sarbanes-Oxley Act in a timely manner, or if we are unable to maintain proper and effective internal controls, we may not be able to produce timely and accurate financial statements. If that were to happen, the market price of our stock could decline, and we could be subject to sanctions or investigations by the stock exchange on which our common stock is listed, the Securities and Exchange Commission, or SEC, or other regulatory authorities.

We might not be able to utilize a significant portion of our net operating loss carryforwards and research and development tax credit carryforwards.

As of December 31, 2019, we had federal and state net operating loss carryforwards of $165.8 million and $17.6 million, respectively. These carryforwards will begin to expire in 2031 for federal and state purposes. As of December 31, 2019, we had federal and state research and development tax credit carryforwards of $7.1 million and $2.1 million, respectively. The federal credits begin to expire in 2031 and the California research credits have no expiration dates. These net operating loss and tax credit carryforwards could expire unused and be unavailable if we do not generate sufficient taxable income prior to their expiration. In addition, under Sections 382 and 383 of the Internal Revenue Code of 1986, as amended, and corresponding provisions of state law, if a corporation undergoes an “ownership change” (generally defined as a greater than 50 percentage point change, by value, in its equity ownership by significant stockholders over a three-year period) the corporation’s ability to use its pre-change net operating loss carryforwards and other pre-change tax attributes to offset its post-change income or tax liability may be limited. We have not determined if we have experienced Section 382 ownership changes in the past and if a portion of our net operating loss and tax credit carryforwards are subject to an annual limitation under Sections 382 or 383. We may have experienced ownership changes in the past, including in connection to our IPO, and we may experience ownership changes in the future as a result of the proposed Merger and/or subsequent shifts in our stock ownership, some of which may be outside of our control. As a result, even if we earn net taxable income, the ability of the Combined Company to use the net operating loss and tax credit carryforwards may be materially limited, which could harm our future operating results by effectively increasing our future tax obligations.

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We incur significant costs and demands upon management as a result of being a public company.

As a public company listed in the United States, we incur significant additional legal, accounting and other costs, as compared to the costs we incurred as a private company. These additional costs could negatively affect our financial results. In addition, changing laws, regulations and standards relating to corporate governance and public disclosure, including regulations implemented by the SEC and the Nasdaq Stock Market, LLC, may increase legal and financial compliance costs and make some activities more time-consuming. These laws, regulations and standards are subject to varying interpretations and, as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies. We may experience significantly increased general and administrative expenses and a diversion of management’s time and attention from our primary business operations if we are required to invest significant resources to comply with new and evolving laws, regulations and standards. If notwithstanding our efforts to comply with new laws, regulations and standards, we fail to comply, regulatory authorities may initiate legal proceedings against us and our business may be harmed.

Failure to comply with these rules might also make it more difficult for us to obtain some types of insurance, including director and officer liability insurance, and we might be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. The impact of these events could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors, on committees of our board of directors or as members of senior management.

Item 1B. Unresolved Staff Comments.

None.

Item 2. Properties.

We lease our principal facilities, which consist of approximately 14,000 square feet of office space located in Redwood City, California under a lease that expires in December 2020. We believe that our existing facilities are adequate for our current needs; however, we may require additional space and facilities as our business expands.

Item 3. Legal Proceedings.

 

On November 8, 2018 and January 28, 2019, two purported class actions were filed in the Superior Court of California, San Mateo County, against the Company and certain of our officers and directors. The actions are entitled Savelstrov v. Menlo Therapeutics Inc., et al., and McKay v. Menlo Therapeutics Inc., et al. The underwriters for our initial public offering were also named as defendants in these lawsuits. The complaints contain identical allegations against the same defendants. Both complaints alleged that the Registration Statement and prospectus for our initial public offering contained false and misleading statements in violation of Sections 11, 12(a)(2) and 15 of the Securities Act of 1933 due to allegedly false and misleading statements in connection with our initial public offering. The complaints seek, among other things, an award of damages in an amount to be proven at trial, along with reimbursement of reasonable costs and expenses, including attorneys’ fees and expert fees. The McKay action has been consolidated with the Savelstrov action and the claim for violations of Section 12(a)(2) has been dismissed. 

 

The parties have mediated the consolidated lawsuit and reached a settlement, providing for payment to the class of plaintiffs in the amount of $9.5 million in return for a release of all claims against the defendants, including the Company and its current and former officers and directors. The settlement is subject to final documentation and Court approval. The Company’s insurance carriers will pay the majority of the settlement amount.

Item 4. Mine Safety Disclosures.

Not applicable.

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

Our common stock has been listed on The Nasdaq Global Select Market under the symbol “MNLO” since January 24, 2018. Prior to that date, there was no public trading market for our common stock.

Holders of Common Stock

As of February 14, 2020, there were approximately 11 holders of record of our common stock. This number does not include beneficial owners whose shares are held by nominees in street name.

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Dividend Policy

We have never declared or paid cash dividends on our capital stock. We intend to retain all available funds and any future earnings, if any, to fund the development and expansion of our business and we do not anticipate paying any cash dividends in the foreseeable future. Any future determination related to dividend policy will be made at the discretion of our board of directors.

Recent Sales of Unregistered Securities

There have been no sales of unregistered securities other than those described in our Annual Report on Form 10-K filed on March 28, 2018.

Use of Proceeds

Shares of our common stock began trading on the Nasdaq Global Select Market on January 25, 2018. The shares were registered under the Securities Act on registration statement on Form S-1 (Registration No. 333-222324), which was declared effective by the SEC on January 24, 2018.

There has been no material change in the planned use of proceeds from our IPO as described in our prospectus dated January 24, 2018, filed with the SEC pursuant to Rule 424(b)(4) under the Securities Act of 1933, as amended.

Stock Performance Graph

This graph is not “soliciting material,” is not deemed “filed” with the SEC and is not to be incorporated by reference into any filing of Menlo Therapeutics Inc. under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date hereof and irrespective of any general incorporation language in any such filing.

The following graph shows the cumulative total stockholder return of an investment of $100 in cash on January 25, 2018 (the first day of trading of our common stock), through December 31, 2019 for (i) our common stock, (ii) the Nasdaq Composite Index (U.S.) and (iii) the Nasdaq Biotechnology Index. Pursuant to applicable SEC rules, all values assume reinvestment of the full amount of all dividends, however no dividends have been declared on our common stock to date. The stockholder return shown on the graph below is not necessarily indicative of future performance, and we do not make or endorse any predictions as to future stockholder returns

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Comparison of Cumulative Total Return

Among Menlo Therapeutics Inc., the Nasdaq Composite

Index, and the Nasdaq Biotechnology Index

 

 

 

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

We did not purchase any of our registered equity securities during the period covered by this Annual Report on Form 10-K.

Securities Authorized for Issuance Under Equity Compensation Plans

The information required by this Item regarding equity compensation plans is incorporated by reference to the information set forth in Part III, Item 12 of this Annual Report on Form 10 K.

 

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Item 6. Selected Financial Data.

The following selected financial data is qualified in its entirety by, and should be read in conjunction with the financial statements and the notes thereto included in Part II, Item 8 and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in Part II, Item 7 of this Report. The selected statements of income data for each of the three years in the period ended December 31, 2019, and the balance sheet data as of December 31, 2019, 2018 and 2017 have been derived from our audited financial statements.

 

 

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Overview

We are a late-stage biopharmaceutical company focused on the development and commercialization of serlopitant for the treatment of pruritus, or itch, associated with various conditions such as prurigo nodularis, or PN and psoriasis. We believe that serlopitant, a highly selective small molecule inhibitor of the neurokinin 1 receptor, or NK1-R, given as a once-daily, oral tablet, has the potential to significantly alleviate pruritus.

Since commencing operations in 2011, we have devoted substantially all of our efforts and financial resources to the clinical development of serlopitant. We have not generated any revenue from product sales and, as a result, we have never been profitable and have incurred net losses in each year since commencement of our operations. As of December 31, 2019, we had an accumulated deficit of $184.3 million, primarily as a result of research and development and general and administrative expenses. We incurred net losses of approximately $73.7 million, $51.4 million and $29.1 million in the years ended December 31, 2019, 2018 and 2017, respectively. We are focused on managing our operating expenses and maintaining adequate capital to run our business through consummation of the proposed merger with Foamix Pharmaceuticals Ltd., or Foamix (discussed below). There can be no assurance that we will be successful in completing the merger with Foamix or maintaining or raising sufficient additional capital to fund continued operations.

We have financed our operations primarily through private placements of convertible preferred stock and the sale and issuance of common stock in connection with our January 2018 initial public offering. In our initial public offering, we sold 8,050,000 shares of our common stock and received cash proceeds of approximately $125.4 million, net of underwriting commissions and related expenses. In addition, in February 2019, we filed a shelf registration statement on Form S-3, which permitted: (a) the offering, issuance and sale by us of up to a maximum aggregate offering price of $150.0 million of our common stock, preferred stock, debt securities, warrants, purchase contracts and/or units; and (b) as part of the $150.0 million, the offering, issuance and sale by us of up to a maximum aggregate offering price of $50.0 million of our common stock that may be issued and sold under a sales agreement with Cantor Fitzgerald & Co in one or more at-the-market offerings. During the year ended December 31, 2019, we issued 613,522 shares of common stock pursuant to our at-the-market offering program for aggregate net proceeds of $4.8 million after $0.1 million of commission and before $0.2 million of offering costs.

As of December 31, 2019, our cash, cash equivalents and investments totaled $76.9 million. We believe that our existing cash, cash equivalents and investments will be sufficient to fund our planned operations for at least the next 12 months from the issuance of our financial statements as of and for the year ended December 31, 2019. We have based this estimate on assumptions that may prove to be wrong.

Merger with Foamix and Change of Control

On November 10, 2019, we signed a definitive Merger Agreement with Foamix, to create a combined biopharmaceutical company, or the Combined Company, focused on the commercialization and development of therapeutics to serve patients in the dermatology space. The transaction contemplated by the Merger Agreement will result in a change in control of our company. On February 6, 2020, the Merger was approved by both our stockholders and Foamix’s shareholders. The Merger is expected to close on March 9, 2020.

The Combined Company will have a diversified portfolio including an approved product and three late-stage product candidates focused on dermatologic indications:

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See Part I, Item 1, “Business,” in this report for additional information about the Merger Agreement and proposed merger with Foamix.

Components of Operating Results

Revenue

We have not generated any revenue from the sale of products since our inception and do not expect to generate any revenue from the sale of products in the near future.

Collaboration and License Revenue

We recognized revenue pursuant to our license and collaboration agreement, referred to as the Collaboration Agreement and our services agreement with Japan Tobacco Inc. and Torii Pharmaceutical Co. Ltd., together referred to as JT Torii, in connection with the clinical development and commercialization of products covered by the collaboration, including non-refundable upfront license fees, contingent consideration payments based on the achievement of defined collaboration milestones and royalties on sales of commercialized products.

Under the Collaboration Agreement, we granted to JT Torii the right to develop and commercialize products containing serlopitant in Japan, for the treatment of diseases and conditions other than nausea or vomiting. In exchange, JT Torii paid us an upfront, non‑refundable payment of $11.0 million in August 2016. In addition, we were entitled to receive aggregate payments of up to $28.0 million upon the achievement of specified development and regulatory milestones, of which we earned and received $4.0 million, and $15.0 million upon the achievement of a commercial milestone, as well as tiered royalties from the mid-single digits up to the mid‑teens on sales of licensed products in Japan.

Revenue from the upfront payment was being amortized over the period of performance of the Collaboration Agreement, the period which we expected to provide research and development services to JT Torii.

On September 1, 2017, we entered into a services agreement with JT Torii to provide research and development services, including regulatory, chemistry and manufacturing support and related materials, that is distinct from the original Collaboration Agreement. We evaluated the services agreement and determined that the research and materials delivered to JT Torii represented a separate contractual arrangement that provided standalone value to JT Torii. The fees received under the services agreement were recognized as and when such services were performed by us and JT Torii consumed the benefits of those services.

In the second quarter of 2018, we and JT Torii agreed to terminate the Collaboration Agreement and JT Torii halted development activities in Japan. As a result, we accelerated recognition of the remaining deferred revenue balance of $8.1 million. In the second quarter of 2018, we also earned and recognized a $2.0 million milestone payment related to JT Torii’s receipt of all of the IND-enabling past clinical study reports we delivered prior to the termination of the Collaboration Agreement.

Operating Expenses

Research and Development Expenses

Substantially all of our research and development expenses consist of expenses incurred in connection with the development of serlopitant. These expenses include certain payroll and personnel expenses including stock‑based compensation, consulting costs, contract manufacturing costs and fees paid to clinical research organizations or CROs to conduct certain research and development activities on our behalf. We do not allocate our costs by each indication for which we are developing serlopitant, as a significant amount of our development activities broadly support all indications. In addition, several of our departments support our serlopitant drug candidate development program and we do not identify internal costs for each potential indication. We did not separately track costs incurred in connection with our agreements with JT Torii, which are also included in research and development expenses. Nonrefundable advance payments for goods or services that will be used or rendered for future research and development activities are deferred and capitalized and recognized as an expense as the goods are delivered or the related services are performed.

We expense both internal and external research and development expenses as they are incurred. We are focusing substantially all of our resources and development efforts on the development of serlopitant. Predicting the timing or the final cost to complete our clinical program is difficult and delays may occur because of many factors, including factors outside of our control. For example, if the U.S. Food and Drug Administration or FDA, or other regulatory authorities were to require us to conduct clinical trials beyond those that we currently anticipate, or if we experience significant delays in enrollment in any of our clinical trials, we could be required to expend significant additional financial resources and

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time on the completion of clinical development. Furthermore, we are unable to predict when or if serlopitant will receive regulatory approval in the United States and Europe with any certainty.

General and Administrative Expenses

General and administrative expenses consist principally of personnel‑related costs, including stock‑based compensation, for personnel in executive, finance, and other administrative functions, professional fees for legal, consulting, accounting services, rent and other general operating expenses not otherwise classified as research and development expenses.

Interest Income and Other Expense, Net

Interest income consists primarily of interest earned on our investments in corporate notes and government agency notes.

Results of Operations

Comparison of the Years Ended December 31, 2019 and 2018

The following table summarizes our results of operations for the periods indicated (in thousands):

 

 

Collaboration and License Revenue

Collaboration and license revenue for the year ended December 31, 2019 was zero, compared to $10.6 million for the same period in 2018. Collaboration and license revenue for the year ended December 31, 2018 primarily consisted of revenue we recognized during the period from the initial upfront payment of $11.0 million under the Collaboration Agreement with JT Torii. The Collaboration Agreement was terminated in June 2018.

Research and Development Expenses

Research and development expenses for the year ended December 31, 2019 increased to $53.8 million from $53.0 million for the same period in 2018. The increase was primarily due to increases of $0.9 million in manufacturing related costs,  $0.9 million in clinical trial expenses, $0.5 million in personnel expenses as a result of an increase in stock-based compensation expense, $0.5 million in allocated expenses, such as facilities related costs, $0.5 million in medical affairs related costs and $0.3 million in preclinical costs. These increases were partially offset by a $3.0 million milestone expense to Merck in May 2018. For the periods presented, substantially all of our research and development expenses are related to our development activity for serlopitant.

General and Administrative Expenses

General and administrative expenses for the year ended December 31, 2019 increased to $22.5 million from $12.2 million for the same period in 2018. The increase was primarily due to increases of $3.1 million in personnel expenses as a result of an increase in our employee headcount and stock-based compensation expense, $3.0 million in transaction-related expenses in connection with negotiating and executing the merger agreement with Foamix, $2.5 million in legal expenses, $1.1 million in professional and insurance fees and $0.8 million in commercial launch planning related costs.

Interest Income and Other Expense, Net

Interest income and other expense, net for the years ended December 31, 2019 and 2018 primarily consisted of interest income generated from our cash, cash equivalents and investments.

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Comparison of the Years Ended December 31, 2018 and 2017

The following table summarizes our results of operations for the periods indicated (in thousands):

 

 

Collaboration and License Revenue

Collaboration and license revenue for the year ended December 31, 2018 was $10.6 million, compared to $4.6 million for the same period in 2017. Collaboration and license revenue for the year ended December 31, 2018 primarily consisted of revenue we recognized during the period from the initial upfront payment of $11.0 million under the Collaboration Agreement with JT Torii. The increase in collaboration and license revenue was primarily due to the accelerated recognition of the initial upfront payment as a result of the termination of the Collaboration Agreement in June 2018 and a $2.0 million milestone payment related to completion of certain clinical study reports pursuant to the Collaboration Agreement which was earned and received prior to its termination.

Research and Development Expenses

Research and development expenses for the year ended December 31, 2018 increased to $53.0 million from $29.0 million for the same period in 2017. The increase was primarily due to an increase of $14.1 million in clinical trial expenses, an increase of $4.3 million in personnel expenses as a result of an increase in our employee headcount and stock-based compensation expense, and an increase of $3.3 million in manufacturing expenses. In May 2018, we made a $3.0 million milestone payment to Merck associated with the initiation of our Phase 3 clinical trials for pruritus associated with prurigo nodularis. For the periods presented, substantially all of our research and development expenses are related to our development activity for serlopitant.

General and Administrative Expenses

General and administrative expenses for the year ended December 31, 2018 increased to $12.2 million from $5.2 million for the same period in 2017. The increase was primarily due to an increase of $2.9 million in professional fees as a result of becoming a public company as well as an increase of $4.0 million in personnel expenses as a result of an increase in our employee headcount and stock-based compensation expense.

Interest Income and Other Expense, Net

Interest income and other expense, net for the years ended December 31, 2018 and 2017 primarily consisted of interest income generated from our cash, cash equivalents and investments.

Liquidity and Capital Resources

Through December 31, 2019, we have financed our operations primarily through the sale of equity securities. We received net proceeds of $109.3 million from the sale and issuance of preferred stock through December 31, 2017, including gross proceeds of $50.5 million from the sale of Series C convertible preferred stock in July 2017.  In January 2018, we completed our initial public offering. We sold 8,050,000 shares of our common stock and received cash proceeds of approximately $125.4 million, net of underwriting commissions and related expenses. As of December 31, 2019, we had cash, cash equivalents and investments of $76.9 million. Our cash, cash equivalents and investments are held in money market accounts and investments in commercial paper, corporate notes, asset backed securities, agency bonds, and government notes. We believe that our existing cash, cash equivalents and investments will be sufficient to fund our planned operations for at least the next 12 months from the issuance of our financial statements as of and for the year ended December 31, 2019. We have based this estimate on assumptions that may prove to be wrong, and we could utilize our available capital resources sooner than we expect.

On February 1, 2019, we entered into a Sales Agreement with Cantor Fitzgerald & Co., or Cantor Fitzgerald, to sell shares of the Company's common stock, from time to time, with aggregate gross sales proceeds of up to $50 million through an at-the-market equity offering program under which Cantor will act as our sales agent. The issuance and sale of shares of common stock by us pursuant to the Sales Agreement are deemed an “at-the-market” offering under the Securities Act of

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1933, as amended. Cantor Fitzgerald is entitled to compensation for its services equal to up to 3.0% of the gross proceeds of any shares of common stock sold through Cantor Fitzgerald under the Sales Agreement. During the year ended December 31, 2019, we issued 613,522 shares of common stock pursuant to our at-the-market offering program for aggregate net proceeds of $4.8 million after $0.1 million of commission and before $0.2 million of offering costs.

Our Merger Agreement with Foamix provides that, immediately following the consummation of the Merger, the executive officers of the Combined Company will be designated by Foamix and we do not anticipate that any of our current executive officers will continue to serve as executive officers of the Combined Company. We also anticipate the termination of employment during 2020 of all our employees in connection with the consummation of the Merger. As a result, and in accordance with the Executive Severance Agreements between us and each of our current executive officers and the severance arrangements for our non-officer employees approved by our board of directors, we expect to make cash severance payments to our existing employees totaling approximately $8.7 million after the Merger is completed.

 

We have incurred, and expect to incur additional, significant transaction-related expenses in connection with negotiating and executing the Merger Agreement with Foamix and completing the transactions contemplated by the Merger Agreement. Transaction-related expenses, which include legal, accounting and financial advisor fees and other service provider costs, are currently estimated to total approximately $7.2 million. We incurred $3.0 million of these costs during the fourth quarter of 2019 on our statements of operations and comprehensive loss. As of December 31, 2019, $0.7 million of these costs were accrued on our balance sheet. We expect to incur the remainder of the anticipated transaction-related expenses in the first half of 2020.

We expect to incur substantial expenditures in the foreseeable future as we advance serlopitant through clinical development, the regulatory approval process and, if approved, commercial launch activities. In the near term, we expect to incur substantial expenses relating to our ongoing clinical trials and the development and validation of our commercial manufacturing process for serlopitant drug substance and drug product. Furthermore, we expect to continue to incur additional costs associated with operating as a public company, including significant legal, accounting, investor relations and other expenses that we did not incur as a private company. We also expect to incur expenses related to the recruitment and retention of personnel, working capital and other general corporate purposes. We may incur additional expenses in connection with expanding our pipeline, including by pursuing additional indications for serlopitant or the in-license or acquisition of additional drug candidates or commercial products. In November 2018 and January 2019, putative securities class action complaints were filed against us, certain of our current executive officers and directors, and certain underwriters in our initial public offering alleging violations of Sections 11, 12(a)(2) and 15 of the Securities Act of 1933 due to allegedly false and misleading statements in connection with the initial public offering. The parties have mediated the consolidated lawsuit and reached a settlement. The settlement is subject to final documentation and Court approval. This litigation could divert management’s attention, as well as resources, from our business.

We will need substantial additional funding to support our continuing operations and pursue our growth strategy. Until such time as we can generate significant revenue from sales of serlopitant, if ever, we expect to finance our operations through the sale of equity, debt financings or other capital sources, including potential collaborations with other companies or other strategic transactions. Adequate funding may not be available to us on acceptable terms, or at all. If we fail to raise capital or enter into such agreements as, and when, needed, we may have to significantly delay, scale back, or discontinue the development and commercialization of serlopitant for one or more indications or delay our efforts to expand our product pipeline. Our failure to raise capital as and when needed could have a negative impact on our financial condition and our ability to pursue our business strategies. We anticipate that we will need to raise substantial additional capital, the requirements of which will depend on many factors, including:

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If the Merger is successfully completed, the size and timing of the Combined Company’s future funding requirements would depend on many similar factors as applicable to the combined company’s and the status of its collective products and product candidates. If we raise additional funds by issuing equity securities, our stockholders may experience dilution. Any future debt financing into which we enter may impose upon us additional covenants that restrict our operations, including limitations on our ability to incur liens or additional debt, pay dividends, repurchase our common stock, make certain investments and engage in certain merger, consolidation or asset sale transactions. Any debt financing or additional equity that we raise may contain terms that are not favorable to us or our stockholders. If we are unable to raise additional funds when needed, we may be required to delay, reduce, or terminate some or all of our development programs and clinical trials. We may also be required to sell or license to others, rights to serlopitant in certain territories or indications that we would prefer to develop and commercialize ourselves.

See “Risk Factors” for additional risks associated with our substantial capital requirements.

Summary Statement of Cash Flows

The following table sets forth the primary sources and uses of cash for each of the periods presented below (in thousands):

 

 

Cash Used In Operating Activities

Cash used in operating activities for the year ended December 31, 2019 was $65.1 million, primarily due to the net loss of $73.7 million, offset by stock-based compensation of $6.7 million and changes in operating assets and liabilities, including a decrease in prepaids and other current assets of $1.9 million.

Cash used in operating activities for the year ended December 31, 2018 was $52.7 million, primarily due to the net loss of $51.4 million, offset by stock-based compensation of $3.6 million and changes in operating assets and liabilities, including a decrease in deferred revenue of $8.5 million, an increase in accrued expenses and other current liabilities of $2.7 million, and an increase in accounts payable of $0.8 million.

Cash used in operating activities for the year ended December 31, 2017 was $28.2 million, primarily due to the net loss of $29.1 million, offset by stock-based compensation of $1.5 million and changes in operating assets and liabilities, including

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an increase in prepaid and other assets of $1.8 million, a decrease in deferred revenue of $1.8 million and an increase in accounts payable and accrued expenses and other current liabilities of $3.6 million.

Cash Provided by (used in) Investing Activities

Cash provided by investing activities for the year ended December 31, 2019 represented purchases of investments of $83.4 million, offset by proceeds received from maturities and sales of investments of $124.8 million. Cash used in investing activities for the year ended December 31, 2018 represented purchases of investments of $126.7 million, offset by proceeds received from maturities and sales of investments of $93.0 million. Cash used in investing activities for the year ended December 31, 2017 represented purchases of investments of $64.1 million, offset by proceeds received from maturities and sales of investments of $49.1 million.

Cash Provided by Financing Activities

During the year ended December 31, 2019 cash provided by financing activities primarily consisted of $4.5 million from our at-the-market offering program after $0.1 million of commission and $0.2 million of offering costs and $0.4 million in proceeds from the issuance of common shares under the Employee Stock Purchase Plan. During the year ended December 31, 2018 cash provided by financing activities consisted of $125.4 million of net proceeds from our initial public offering and $0.5 million in proceeds from the exercise of stock options. During the year ended December 31, 2017 cash provided by financing activities was $50.4 million, consisting primarily of net proceeds from the sale of Series C convertible preferred stock.  

Contractual Obligations and Commitments

The following table summarizes our contractual obligations as of December 31, 2019 (in thousands):

 

 

In December 2012, we entered into an exclusive worldwide royalty‑free license agreement with Merck for exclusive worldwide rights for the development and commercialization of serlopitant and two other NK₁ receptor antagonists in all human diseases, disorders or conditions, except for the treatment and prevention of nausea or vomiting. We have agreed to make aggregate payments of up to $25.0 million dollars upon the achievement of specified development and regulatory milestones for serlopitant, of which, $3.0 million was paid in May 2018. However, because the achievement of these milestones is not fixed and determinable, such commitments have not been included on our balance sheet or in the Contractual Obligations and Commitments table above.

We enter into contracts in the normal course of business with CROs for clinical trials, non‑clinical studies and testing, manufacturing and other services and products for operating purposes. These contracts generally provide for termination upon notice, and therefore we believe that our non‑cancelable obligations under these agreements are not material.

Critical Accounting Policies, Significant Judgments and Use of Estimates

Our financial statements have been prepared in accordance with U.S. generally accepted accounting principles, or GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported expenses incurred during the reporting periods. Our estimates are based on our historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We believe that the accounting policies discussed below are critical to understanding our historical and future performance, as these policies relate to the more significant areas involving management’s judgments and estimates.

While our significant accounting policies are described in the Notes to our financial statements, we believe that the following critical accounting policies are most important to understanding and evaluating our reported financial results.

Revenue Recognition

We record revenue based on a five-step model in accordance with Accounting Standards Codification ("ASC") 606, Revenue from Contracts with Customers ("ASC 606"). For the Collaboration Agreement under ASC 606, we identify the performance obligations, determine the transaction price, allocate the contract transaction price to the performance obligations, and recognize the revenue when (or as) the performance obligation is satisfied.

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We identify the performance obligations included within the agreement and evaluate which performance obligations are distinct. Upfront payments for licenses are evaluated to determine if the license is capable of being distinct from the obligations to participate on certain development and/or commercialization committees with the collaboration partners and supply manufactured drug product for clinical trials. For performance obligations that are satisfied over time, we utilize the input method and revenue is recognized by consistently applying a method of measuring progress toward complete satisfaction of that performance obligation. We periodically review our estimated periods of performance based on the progress under each arrangement and account for the impact of any changes in estimated periods of performance on a prospective basis.

Milestone payments are a form of variable consideration as the payments are contingent upon achievement of a substantive event. Milestone payments are estimated and included in the transaction price when we determine that it is probable that there will not be a significant reversal of cumulative revenue recognized in future periods.

Research and development revenues and cost reimbursements are based upon negotiated rates for our full-time employee equivalents (“FTE”) and actual out-of-pocket costs. FTE rates are set based upon our costs, and which we believe approximate fair value. None of the revenues recognized to date are refundable if the relevant research effort is not successful.

Research and Development Expenses

Research and development costs are expensed as incurred. Nonrefundable advance payments for goods or services that will be used or rendered for future research and development activities are deferred and capitalized and recognized as an expense as the goods are delivered or the related services are performed.

We estimate non‑clinical study and clinical trial expenses based on the services performed pursuant to contracts with research institutions and clinical research organizations that conduct and manage non‑clinical studies and clinical trials on our behalf. In accruing service fees, we estimate the time period over which services will be performed and the level of effort to be expended in each period. If the actual timing of the performance of services or the level of effort varies from the estimate, we will adjust the accrual accordingly. Payments made to third parties under these arrangements in advance of the receipt of the related services are recorded as prepaid expenses until the services are rendered.

Stock-Based Compensation Expense

We measure and recognize compensation expense for all stock‑based awards made to employees, directors and non‑employees, based on estimated fair values recognized using the straight‑line method over the requisite service period.

The fair value of options to purchase common stock granted to employees, directors and non-employees is estimated on the grant date using the Black‑Scholes option valuation model. The calculation of stock‑based compensation expense requires us to make certain assumptions and judgments about a number of complex and subjective variables used in the Black‑Scholes model, including the expected term, expected volatility of the underlying common stock, risk‑free interest rate, as well as estimating future forfeitures of unvested stock options. To the extent actual forfeiture results differ from the estimates, the difference will be recorded as a cumulative adjustment in the period the estimates are revised. Such value is recognized as an expense over the requisite service period using the straight-line method.

The fair value of restricted stock units used in the Company’s expense recognition method is based on the closing price of the Company’s common stock on the date of the grant. Such value is recognized as an expense over the requisite service period using the straight-line method.

Stock-based compensation expense related to the ESPP is recognized based on the fair value of each award estimated on the first day of the offering period using the Black-Scholes option pricing model and recorded as expense over the service period using the straight-line method.

Common Stock Valuations

Prior to our initial public offering, we were required to periodically estimate the fair value of our common stock when issuing stock options and computing our estimated stock-based compensation expense. The fair value of our common stock was determined on a periodic basis by our board of directors, with the assistance of an independent third-party valuation expert. The assumptions underlying these valuations represented management’s best estimates, which involved inherent uncertainties and the application of significant levels of management judgment. As a result, if factors or expected outcomes change and we use significantly different assumptions or estimates, our stock-based compensation could be materially different. In determining the fair value of our common stock, our board of directors considered valuation

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methods intended to comply with Section 409A of the Internal Revenue Code that create a presumption that the resulting valuation is reasonable for federal tax purposes.

The fair value of the common stock underlying our stock options was estimated at each grant date by our board of directors. Our board of directors intended all options granted to be exercisable at a price per share not less than the estimated per share fair value of our common stock underlying those options on the date of grant. The valuations of our common stock were determined in accordance with the guidelines outlined in the American Institute of Certified Public Accountants Practice Aid, Valuation of Privately-Held-Company Equity Securities Issued as Compensation.

Income Taxes

We provide for income taxes under the asset and liability method. Current income tax expense or benefit represents the amount of income taxes expected to be payable or refundable for the current year. Deferred income tax assets and liabilities are determined based on differences between the financial statement reporting and tax bases of assets and liabilities and net operating loss and credit carryforwards, and are measured using the enacted tax rates and laws that will be in effect when such items are expected to reverse. We record a valuation allowance to reduce our deferred tax assets to reflect the net amount that we believe is more likely than not to be realized. Realization of our deferred tax assets is dependent on the generation of future taxable income, the amount and timing of which are uncertain. The valuation allowance requires an assessment of both positive and negative evidence when determining whether it is more likely than not that deferred tax assets are recoverable. Based upon the weight of available evidence at December 31, 2019, we continue to maintain a full valuation allowance against all of our deferred tax assets after management considered all available evidence both positive and negative, including but not limited to our historical operating results, income or loss in recent periods, cumulative income in recent years, forecasted earnings, future taxable income, and significant risk and uncertainty related to forecasts.

We account for uncertain tax positions in accordance with ASC 740‑10, Accounting for Uncertainty in Income Taxes. We recognize the tax effects of an uncertain tax position only if it is more likely than not to be sustained based solely on its technical merits as of the reporting date and only in an amount more likely than not to be sustained upon review by the tax authorities. We evaluate uncertain tax positions on a quarterly basis and adjust the liability for changes in facts and circumstances, such as new regulations or interpretations by the taxing authorities, new information obtained during a tax examination, significant amendment to an existing tax law, or resolution of an examination. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will impact the income tax provision in the period in which such determination is made. The resolution of our uncertain income tax positions is dependent on uncontrollable factors such as law changes, new case law, and the willingness of the income tax authorities to settle, including the timing thereof and other factors. Although we do not anticipate significant changes to our uncertain income tax positions in the next 12 months, items outside of our control could cause our uncertain income tax positions to change in the future, which would be recorded in our consolidated statements of operations. Interest and/or penalties related to income tax matters are recognized as a component of income tax expense.

As of December 31, 2019 our total deferred tax assets were $44.2 million. Due to our lack of earnings history and uncertainties surrounding our ability to generate future taxable income, the net deferred tax assets have been fully offset by a valuation allowance. The deferred tax assets were primarily comprised of federal and state tax net operating losses, or NOLs. Utilization of NOLs may be limited by the “ownership change” rules, as defined in Section 382 of the Code. Similar rules may apply under state tax laws. Our ability to use our remaining NOLs may be further limited if we experience an ownership change in connection with future offerings, future offerings or as a result of future changes in our stock ownership.

Investment Securities

We have an investment policy which limits us to investing in highly rated corporate and government notes, and no individual investment may comprise more than 5% of the total portfolio.

We classify our investment securities as available‑for‑sale. Those investments with maturities less than 12 months at the date of purchase are considered short‑term investments. Those investments with maturities greater than 12 months at the date of purchase are considered long‑term investments. Our investment securities classified as available‑for‑sale are recorded at fair value based upon quoted market prices at period end. Unrealized gains and losses, deemed temporary in nature, are reported as a separate component of comprehensive income or loss.

A decline in the fair value of any security below cost that is deemed other than temporary results in a charge to earnings and the corresponding establishment of a new cost basis for the security. Premiums (discounts) are amortized (accreted) over the life of the related security as an adjustment to yield using the straight‑line interest method. Dividend and interest

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income are recognized when earned. Realized gains and losses are included in earnings and are derived using the specific identification method for determining the cost of securities sold.

We determine the fair value of our assets and liabilities based on 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 maximize the use of observable inputs and minimize the use of unobservable inputs. We use a fair value hierarchy with three levels of inputs, of which the first two are considered observable and the last unobservable, to measure fair value:

Off-Balance Sheet Arrangements

Since our inception, we have not engaged in any off‑balance sheet arrangements, as defined in the rules and regulations of the SEC. See Note 6 of our financial statements included in this Annual Report on Form 10-K, Commitments and Contingencies, regarding our guarantees and indemnifications.

Indemnification

As permitted under Delaware law and in accordance with our bylaws, we are required to indemnify our officers and directors for certain events or occurrences while the officer or director is or was serving in such capacity. We are also party to indemnification agreements with our directors. We believe the fair value of the indemnification rights and agreements is minimal. Accordingly, we have not recorded any liabilities for these indemnification rights and agreements as of December 31, 2019.

JOBS Act Accounting Election

The Jumpstart Our Business Startups Act of 2012, or the JOBS Act, permits an “emerging growth company” such as us to take advantage of an extended transition period to comply with new or revised accounting standards applicable to public companies. We are choosing to “opt out” of this provision and, as a result, we will comply with new or revised accounting standards as required when they are adopted. This decision to opt out of the extended transition period under the JOBS Act is irrevocable.

Recently Issued and Adopted Accounting Pronouncements

See “Recent Accounting Pronouncements” in Note 2, “Significant Accounting Policies” in the Notes to Financial Statements for a discussion of recently adopted accounting pronouncements and accounting pronouncements not yet adopted, and their expected impact on our financial position and results of operations.

Item 7A. Quantitative and Qualitative Disclosures about Market Risk.

The market risk inherent in our financial instruments and in our financial position represents the potential loss arising from adverse changes in interest rates or exchange rates. As of December 31, 2019, we had cash, cash equivalents and investments of $76.9 million, consisting of interest‑bearing money market accounts and investments in corporate notes and government securities, which would be affected by changes in the general level of United States interest rates. However, due to the short‑term maturities and the low‑risk profile of our investments, an immediate 100 basis point change in interest rates would not have a material effect on the fair market value of our cash, cash equivalents and investments.

We do not believe that inflation, interest rate changes, or exchange rate fluctuations had a significant impact on our results of operations for any periods presented herein.

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Index to Financial Statements

Menlo Therapeutics Inc.

 

 

 

 

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Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders of Menlo Therapeutics Inc.

 

Opinion on the Financial Statements

 

We have audited the accompanying balance sheets of Menlo Therapeutics Inc. (“Company”) as of December 31, 2019 and 2018, and the related statements of operations and comprehensive loss, convertible preferred stock and stockholders’ equity (deficit), and cash flows for each of the three years in the period ended December 31, 2019, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019, in conformity with accounting principles generally accepted in the United States of America.

 

Basis for Opinion

 

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.

 

Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

 

/s/ Mayer Hoffman McCann P.C.

 

We have served as the Company's auditor since 2016.

San Diego, California

March 3, 2020

 

 

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Menlo Therapeutics Inc.

Balance Sheets

(in thousands, except share and per share data)

 

 

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Menlo Therapeutics Inc.

Statements of Operations and Comprehensive Loss

(in thousands, except share and per share data)

 

 

 

 

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Menlo Therapeutics Inc.

Statements of Convertible Preferred Stock and Stockholders’ Equity (Deficit)

(in thousands, except share data)

 

 

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Menlo Therapeutics Inc.

Statements of Cash Flows (in thousands)

 

 

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Menlo Therapeutics Inc.

Notes to Financial Statements

Menlo Therapeutics Inc., or the Company is a late‑stage biopharmaceutical company focused on the development and commercialization of serlopitant for the treatment of pruritus, or itch, associated with various conditions such as prurigo nodularis, or PN and psoriasis. The Company believes that serlopitant, a highly selective small molecule inhibitor of the neurokinin 1 receptor, or NK 1-R, given as a once-daily, oral tablet, has the potential to significantly alleviate pruritus.

The Company was incorporated in Delaware in October 2011. Since commencing operations, the Company has devoted substantially all of its resources to developing its product candidate, serlopitant, including conducting clinical trials and providing general and administrative support for these operations.

On November 10, 2019, the Company signed a definitive Merger Agreement with Foamix Pharmaceuticals Ltd., or Foamix, to create a combined biopharmaceutical company, or the Combined Company, focused on the commercialization and development of therapeutics to serve patients in the dermatology space.  The transaction contemplated by the Merger Agreement will result in a change in control of the Company as described below. On February 6, 2020, the Merger was approved by both the Company stockholders and Foamix’s shareholders. The Merger is expected to close on March 9, 2020.  

The Combined Company will have a diversified portfolio including an approved product and three late-stage product candidates focused on dermatologic indications:

The transaction is structured as a stock-for-stock exchange, enabling the Foamix and the Company shareholders to share in the upside advantages of combining the companies. Under the terms of the Merger Agreement, at closing, each ordinary share of Foamix will be exchanged for 0.5924 of a share of the Company’s common stock and a non-transferrable contingent stock right, or CSR. The number of shares of the Company common stock to be received by Foamix shareholders will be subject to upwards adjustment via a CSR to 1.2739 or 1.8006 shares of the Company’s common stock for each ordinary share of Foamix if (a) on or prior to May 31, 2020, proof of statistically significant superiority of serlopitant treatment over placebo treatment on the primary endpoint, as set out in the Merger Agreement (“Serlopitant Significance”), was achieved in one Phase III PN trial but was not achieved (or has not been determined) in the other Phase III PN trial or (b) on or prior to May 31, 2020, Serlopitant Significant was not achieved in either Phase III PN trial or if the Efficacy Determination has not been delivered on or before May 31, 2020, respectively.

After the completion of the Merger, the Company will continue as a public company, with its common stock continuing to be listed and traded on Nasdaq, and will serve as the parent company of Foamix. The Company’s headquarters will be moved to Bridgewater, New Jersey (the location of Foamix’s current U.S. headquarters). The Company will continue as a Delaware corporation and will continue to be governed by its existing Amended and Restated Certificate of Incorporation, Amended and Restated Bylaws and the Delaware General Corporation Law (DGCL). The Combined Company will be led by David Domzalski, CEO of Foamix, and the other members of the Foamix management team. The board of the Combined Company will consist of five members designated by Foamix (including Mr. Domzalski) and two members designated by the Company (including Steve Basta, the Company’s current CEO).

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Initial Public Offering

In January 2018, the Company completed its initial public offering (“IPO”) of shares of its common stock, pursuant to which the Company issued 8,050,000 shares of common stock, which includes 1,050,000 shares issued pursuant to the over-allotment option granted to its underwriters and received net proceeds of approximately $125.4 million, after deducting underwriting discounts, commissions and offering expenses. In connection with the completion of the Company's IPO, all shares of convertible preferred stock converted into 9,629,405 shares of common stock.

Liquidity and Capital Resources

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business. The financial statements do not reflect any adjustments relating to the recoverability and reclassification of assets and liabilities that might be necessary if the Company is unable to continue as a going concern. Since inception, the Company has incurred losses and negative cash flows from operations. For the year ended December 31, 2019, the Company incurred a net loss of $73.7 million and used $65.1 million of cash in operations. As of December 31, 2019, the Company had cash, cash equivalents and investments of $76.9 million and an accumulated deficit of $184.3 million.

The Company is focused on managing its operating expenses and maintaining adequate capital to run its business through consummation of the proposed merger with Foamix. The Company believes that its existing cash, cash equivalents and investments as of December 31, 2019 will provide sufficient funds to enable it to meet its obligations for at least the next 12 months from the issuance of the Company’s financial statements as of and for the year ended December 31, 2019.

 

Basis of Presentation

These financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and include all adjustments necessary for the fair presentation of the Company’s financial position for the periods presented.

Reverse Stock Split

On January 8, 2018, the Company effected a reverse split of shares of the Company’s common stock at a ratio of 1-for-2.6975 pursuant to an amendment to the amended and restated certificate of incorporation approved by the Company’s board of directors and stockholders. The par value and the authorized shares of the common stock were not adjusted as a result of the reverse split. All issued and outstanding common stock share and per share amounts contained in the financial statements have been retroactively adjusted to reflect this reverse split for all periods presented, and the conversion ratio of the preferred stock was adjusted accordingly.

Segments

The Company operates in one segment. Management uses one measurement of profitability and does not segregate its business for internal reporting. All long‑lived assets are maintained in the United States of America.

Use of Estimates

Preparation of financial statements in conformity with U.S. GAAP, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of expenses during the reporting periods covered by the financial statements and accompanying notes. On an ongoing basis, management evaluates its estimates, including those related to revenue recognition, stock‑based compensation expense, the resolution of uncertain tax positions and valuation allowance,  and accruals for research and development costs. Management bases its estimates on historical experience on various assumptions that are believed 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 could differ materially from those estimates.

Risk and Uncertainties

The Company’s future results of operations involve a number of risks and uncertainties. Factors that could affect the Company’s future operating results and cause actual results to vary materially from expectations include, but are not limited to, uncertainty of results of clinical trials and reaching milestones, uncertainty of regulatory approval of the Company’s potential drug candidate, uncertainty of market acceptance of the Company’s product candidate, competition from substitute products and larger companies, securing and protecting proprietary technology, strategic relationships and dependence on key individuals and sole source suppliers.

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The Company’s product candidate requires clearances from the U.S. Food and Drug Administration (“FDA”) or other international regulatory agencies prior to commercial sales. There can be no assurance that the product candidate will receive the necessary clearances. If the Company was denied clearance, clearance was delayed or the Company was unable to maintain clearance, it could have a materially adverse impact on the Company.

 

Cash Equivalents

Cash equivalents are stated at fair value. Cash equivalents include only securities having an original maturity of three months or less at the time of purchase. The Company limits its credit risk associated with cash equivalents by placing its investments with an institution it believes is highly creditworthy and with highly rated money market funds. As of December 31, 2019 and 2018, cash equivalents consisted of bank deposits, cash equivalents and investments in money market funds.

Investment Securities

The Company classifies its investment securities as available‑for‑sale. Those investments with maturities less than 12 months at the date of purchase are considered short‑term investments. Those investments with maturities greater than 12 months at the date of purchase are considered long‑term investments. The Company’s investment securities classified as available‑for‑sale are recorded at fair value based upon quoted market prices at period end. Unrealized gains and losses, deemed temporary in nature, are reported as a separate component of comprehensive income or loss.

A decline in the fair value of any security below cost that is deemed other than temporary results in a charge to earnings and the corresponding establishment of a new cost basis for the security. Premiums (discounts) are amortized (accreted) over the life of the related security as an adjustment to yield using the straight‑line interest method. Dividend and interest income are recognized when earned. Realized gains and losses are included in earnings and are derived using the specific identification method for determining the cost of securities sold.

Property and Equipment, Net

Property and equipment are stated at cost and depreciated using the straight‑line method over the estimated useful lives of the assets, generally between three and five years. Maintenance and repairs are charged to expense as incurred, and improvements are capitalized. When assets are retired or otherwise disposed of, the cost and accumulated depreciation are removed from the balance sheet and any resulting gain or loss is reflected in operations in the period realized.

Fair Value of Financial Instruments

The carrying amounts of the Company’s financial instruments, which include cash, accounts payable and accrued liabilities and other current liabilities, and deferred revenue approximate their fair values due to their short maturities.

Concentration of Credit Risk

Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash, cash equivalents and investments. As of December 31, 2019 and 2018, the majority of our cash, cash equivalents and investments are held by two U.S. financial institutions in excess of federally insured limits. We invest cash in excess of our current needs in United States Treasury and government agency securities, highly‑rated short or medium‑term debt securities and money market funds and, by policy, diversify our investments to limit the amount of credit exposure. The Company has an investment policy which limits the Company to investing in highly rated corporate and government notes, and no individual investment may comprise more than 5% of the total portfolio except for securities issued by the U.S. Treasury, U.S. government agencies and money market funds, which are exempt from this restriction.

Income Taxes

The Company accounts for income taxes under the asset and liability method which requires, among other things, that deferred income taxes be provided for temporary differences between the tax basis of the Company’s assets and liabilities and their financial statement reported amounts. Management makes estimates, assumptions and judgments to determine the Company’s provision for income taxes and also for deferred tax assets and liabilities, and any valuation allowances recorded against the Company’s deferred tax assets. The Company assesses the likelihood that its deferred tax assets will be recovered from future taxable income and to the extent the Company believes that recovery is not more likely than not, the Company must establish a valuation allowance.

The Company has adopted ASC 740-10, Accounting for Uncertainty in Income Taxes, that prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of uncertain tax positions taken or expected to be taken in the Company’s income tax return, and also provides guidance on derecognition,

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classification, interest and penalties, accounting in interim periods, disclosure and transition. To date, there have been no interest or penalties charged in relation to the unrecognized tax benefits.

Research and Development Expenses

Research and development costs are expensed as incurred. Substantially all of our research and development expenses consist of expenses incurred in connection with the development of serlopitant. These expenses include certain payroll and personnel expenses including stock‑based compensation expense, consulting costs, contract manufacturing costs, and fees paid to clinical research organizations, or CROs, to conduct research and development. Nonrefundable advance payments for goods or services that will be used or rendered for future research and development activities are deferred and capitalized and recognized as an expense as the goods are delivered or the related services are performed.

The Company estimates non‑clinical study and clinical trial expenses based on the services performed pursuant to contracts with research institutions and CROs that conduct and manage non‑clinical studies and clinical trials on its behalf. In accruing service fees, the Company estimates the time period over which services will be performed and the level of effort to be expended in each period. If the actual timing of the performance of services or the level of effort varies from the estimate, the Company will adjust the accrual accordingly. Payments made to third parties under these arrangements in advance of the receipt of the related services are recorded as prepaid expenses until the services are rendered.

Leases

On January 1, 2019, the Company adopted Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 842, Leases (“ASC 842”), using the modified retrospective method for all lease arrangements at the beginning of the period of adoption. Results for reporting periods beginning January 1, 2019 are presented under ASC 842, while prior period amounts were not adjusted and continue to be presented in accordance with the Company’s historical accounting under ASC Topic 840, Leases. ASC 842 had an impact on the Company’s balance sheet but did not have a significant impact on the Company’s net loss. 

Under ASC 842, the Company determines if an arrangement is a lease at inception. Leases with a term greater than one year are recognized on the balance sheet as right-of-use assets, lease liabilities and, if applicable, long-term lease liabilities. The Company has elected not to recognize on the balance sheet leases with terms of one-year or less. Lease liabilities and their corresponding right-of-use assets are recorded based on the present value of lease payments over the expected lease term. The interest rate implicit in lease contracts is typically not readily determinable. As such, the Company estimates the incremental borrowing rate based on industry peers in determining the present value of lease payments. The Company’s facility operating lease has one single component. The lease component results in a right-of-use asset being recorded on the balance sheet and amortized as lease expense on a straight-line basis in the Company’s statements of operations.

Stock-Based Compensation

The Company maintains an equity incentive plan under which incentive stock options, restricted stock awards, and restricted stock units may be granted to employees, directors, and non-employees. In addition, the Company maintains an employee stock purchase plan (“ESPP”) under which employees may purchase shares of our common stock through payroll deductions.

The fair value of options to purchase common stock granted to employees, directors and non-employees is estimated on the grant date using the Black‑Scholes option valuation model. The calculation of stock‑based compensation expense requires that the Company make certain assumptions and judgments about a number of complex and subjective variables used in the Black‑Scholes model, including the expected term, expected volatility of the underlying common stock, and risk‑free interest rate. Such value is recognized as an expense over the requisite service period using the straight-line method.

The fair value of restricted stock units used in the Company’s expense recognition method is based on the closing price of the Company’s common stock on the date of the grant. Such value is recognized as an expense over the requisite service period using the straight-line method.

Stock-based compensation expense related to the ESPP is recognized based on the fair value of each award estimated on the first day of the offering period using the Black-Scholes option pricing model and recorded as expense over the service period using the straight-line method.

In June 2018, the FASB issued ASU 2018-07 Improvements to Nonemployee Share-Based Payment Accounting (Topic 718) that expands the scope of Topic 718 to include share-based payment transactions for acquiring goods and services

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from nonemployees. The new standard has been adopted effective January 1, 2019 and did not have a material impact on the Company’s statements of operations and its balance sheet. Prior period amounts were not adjusted and continue to be presented in accordance with the Company’s historical accounting under ASC Topic 718, Stock Based Compensation. 

Convertible Preferred Stock

The Company recorded convertible preferred stock at fair value on the dates of issuance, net of issuance costs. The convertible preferred stock was recorded outside of stockholders’ equity (deficit) because, in the event of certain deemed liquidation events considered not solely within the Company’s control, such as a merger, acquisition and sale of all or substantially all of the Company’s assets, the convertible preferred stock would have become redeemable at the option of the holders. All outstanding convertible preferred stock converted into common stock in January 2018 upon the effectiveness of the IPO.

Comprehensive Income (Loss)

Comprehensive income (loss) is defined as the change in equity of the Company during a period from transactions and other events and circumstances excluding transactions resulting from investments and distributions to owners. Comprehensive loss consists of the net loss and changes in accumulated other comprehensive income, which are comprised of unrealized gains (losses) on available‑for‑sale investments.

Revenue Recognition

The Company records revenue based on a five-step model in accordance with Accounting Standards Codification ("ASC") 606, Revenue from Contracts with Customers ("ASC 606"). For the Company’s collaboration agreement, which is discussed further under Note 5, the Company identifies the performance obligations, determines the transaction price, allocates the contract transaction price to the performance obligations, and recognizes the revenue when (or as) the performance obligation is satisfied.

The Company identifies the performance obligations included within the agreement and evaluates which performance obligations are distinct. Upfront payments for licenses are evaluated to determine if the license is capable of being distinct from the obligations of the Company to participate on certain development and/or commercialization committees with the collaboration partners and supply manufactured drug product for clinical trials. For performance obligations that the Company satisfies over time, the Company utilizes the input method and revenue is recognized by consistently applying a method of measuring progress toward complete satisfaction of that performance obligation. The Company periodically reviews its estimated periods of performance based on the progress under each arrangement and accounts for the impact of any changes in estimated periods of performance on a prospective basis.

Milestone payments are a form of variable consideration as the payments are contingent upon achievement of a substantive event. Milestone payments are estimated and included in the transaction price when the Company determines that it is probable that there will not be a significant reversal of cumulative revenue recognized in future periods. The transaction price is then allocated to each performance obligation on a relative stand-alone selling price basis, for which the Company recognizes revenue as or when the performance obligations under the contract are satisfied. At the end of each subsequent reporting period, the Company re-evaluates the probability of achievement of such milestones and any related constraint, and if necessary, adjusts the 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.

Research and development revenues and cost reimbursements are based upon negotiated rates for the Company’s full-time employee equivalents (“FTE”) and actual out-of-pocket costs. FTE rates are set based upon the Company’s costs, and which the Company believes approximate fair value. None of the revenues recognized to date are refundable if the relevant research effort is not successful.

In accordance with ASC 606, the Company is required to adjust the transaction price for the effects of the time value of money if the timing of payments agreed to by the parties to the contract, explicitly or implicitly, provides the Company or its customer with a significant benefit of financing the transfer of goods or services. The Company concluded that its collaboration agreement did not contain a significant financing component because the payment structure of its agreements arise from reasons other than providing a significant benefit of financing.

Net Loss per Share of Common Stock

Basic net loss per common share is calculated by dividing the net loss attributable to common stockholders by the weighted‑average number of common shares outstanding during the period, without consideration for potentially dilutive securities. Diluted net loss per share is computed by dividing the net loss attributable to common stockholders by the weighted‑average number of common shares and potentially dilutive securities outstanding for the period. For purposes of

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the diluted net loss per share calculation, convertible preferred stock and common stock options are considered to be potentially dilutive securities. Because the Company has reported a net loss for the years ended December 31, 2019, 2018 and 2017, diluted net loss per common share is the same as basic net loss per common share for those periods.

Recent Accounting Pronouncements

In February 2016, the FASB issued ASU 2016‑02, Leases (ASC 842), which set out the principles for the recognition, measurement, presentation and disclosure of leases for both parties to a contract (i.e., lessees and lessors). The new standard required lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase by the lessee. This classification determined whether lease expense is recognized based on an effective interest method or on a straight‑line basis over the term of the lease, respectively. A lessee is also required to record a right‑of‑use asset and a lease liability for all leases with a term of greater than 12 months regardless of their classification. ASC 842 supersedes the previous leases standard, ASC 840 Leases. In August 2018, the FASB issued ASU 2018-11, Targeted Improvements to ASC 842, which provided a transition option in which an entity initially applies ASU 2016-02 at the adoption date and recognizes a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. The new standard has been adopted using the modified retrospective approach in the first quarter of 2019. The adoption did not have a material impact on the Company’s statements of operations. The new standard has required the Company to establish liabilities and corresponding right-of-use assets on its balance sheet for operating leases of $0.8 million that existed as of the January 1, 2019 adoption date. 

In June 2016, the FASB issued ASU 2016-13, Financial Instruments — Credit Losses — Measurement of Credit Losses on Financial Instruments. ASU 2016-13 changes the impairment model for most financial assets and certain other instruments. ASU 2016-13 is effective for annual and interim reporting periods beginning after December 15, 2019. The Company does not expect the adoption of this final rule to have a material impact on its financial statements.

In June 2018, the FASB issued ASU 2018-07 Improvements to Nonemployee Share-Based Payment Accounting (Topic 718) that expands the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from nonemployees. An entity should apply the requirements of Topic 718 to nonemployee awards except for certain exemptions specified in the amendment. The guidance is effective for fiscal years beginning after December 15, 2018, including interim reporting periods within that fiscal year. The new standard has been adopted effective January 1, 2019 and did not have a material impact on the Company’s statements of operations and its balance sheet.

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820) which changes the fair value measurement disclosure requirements of ASC 820. The guidance is effective for fiscal years beginning after December 15, 2019, including interim reporting periods within that fiscal year. Early adoption is permitted. The Company does not expect the adoption of this final rule to have a material impact on its financial statements.

In December 2019, the FASB issued ASU 2019-12, Simplifying the Accounting for Income Taxes, which is intended to simplify the accounting for income taxes by eliminating certain exceptions related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period and the recognition of deferred tax liabilities for outside basis differences. The new guidance also simplifies aspects of the accounting for franchise taxes and enacted changes in tax laws or rates and clarifies the accounting for transactions that result in a step-up in the tax basis of goodwill. The standard is effective for annual periods beginning after December 15, 2020 and interim periods within, with early adoption permitted. Adoption of the standard requires certain changes to primarily be made prospectively, with some changes to be made retrospectively. The Company is currently assessing the impact of this standard on its financial statements and disclosures.

 

 

The fair value of our financial instruments reflects the amounts that we estimate we would receive in connection with the sale of an asset or pay in connection with the transfer of a liability in an orderly transaction between market participants at the measurement date (exit price). We disclose and recognize the fair value of our assets and liabilities using a hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to valuations based upon unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to valuations based upon unobservable inputs that are significant to the valuation (Level 3 measurements). The guidance establishes three levels of the fair value hierarchy as follows:

Level 1 ‑ Inputs that reflect unadjusted quoted prices in active markets for identical assets or liabilities that we have the ability to access at the measurement date;

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Level 2 ‑ Inputs other than quoted prices that are observable for the assets or liability either directly or indirectly, including inputs in markets that are not considered to be active;

Level 3 ‑ Inputs that are unobservable.

Assets and liabilities measured at fair value are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires management to make judgments and consider factors specific to the asset or liability.

The Company recognizes transfers between levels of the fair value hierarchy as of the end of the reporting period. There were no transfers within the hierarchy during the years ended December 31, 2019 and 2018.

A summary of the assets and liabilities carried at fair value in accordance with the hierarchy defined above is as follows (in thousands):

 

 

 

The Company uses a market approach for determining the fair value of all its Level 1 and Level 2 money market funds and marketable securities. To value its money market funds, the Company values the funds at $1 stable net asset value, which is the market pricing convention for identical assets that the Company has the ability to access.

The investments are classified as available‑for‑sale securities. At December 31, 2019 and 2018, the balance in the Company’s accumulated other comprehensive income (loss) was comprised solely of activity related to the Company’s available‑for‑sale securities. There were no realized gains or losses recognized on the sale or maturity of available‑for‑sale securities for the years ended December 31, 2019 and 2018 and as a result, the Company did not reclassify any amounts out of accumulated other comprehensive income (loss) for the year. The Company has a limited number of available‑for‑sale securities in insignificant loss positions as of December 31, 2019 and 2018, which the Company does not intend to sell and has concluded it will not be required to sell before recovery of the amortized cost for the investment at maturity.

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The following table summarizes the available‑for‑sale securities (in thousands):

 

 

 

Accrued Expenses and Other Current Liabilities

Accrued expenses and other current liabilities consisted of the following (in thousands):

 

 

In December 2012, the Company entered into an exclusive worldwide royalty free license agreement with Merck Sharp & Dohme Corp., or “Merck” for exclusive worldwide rights for the development and commercialization of serlopitant and two other NK₁‑R antagonists in all human diseases, disorders or conditions, except for the treatment and prevention of nausea or vomiting. The Company paid Merck an upfront non‑refundable, non‑creditable licensing fee of $1.0 million dollars and issued to Merck shares of its common stock. In addition, the Company has agreed to make aggregate payments of up to $25.0 million dollars upon the achievement of specified development and regulatory milestones.

In May 2018, the Company paid a $3.0 million milestone payment associated with the initiation of the Company’s Phase 3 clinical program for pruritus associated with prurigo nodularis. Future milestone payments are considered a form of

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variable consideration and accrued for when the Company determines that it is probable that there will not be a significant reversal of the accrual in future periods.  

JT Torii Collaboration Agreement

In August 2016, the Company entered into a license and collaboration agreement (the “Collaboration Agreement”) with Japan Tobacco Inc. and Torii Pharmaceutical Co. Ltd. (together referred to as “JT Torii”). Under the Collaboration Agreement, the Company granted to JT Torii the rights to develop and commercialize products containing serlopitant in Japan, for the treatment of diseases and conditions other than nausea or vomiting. In exchange, JT Torii paid the Company an upfront, non‑refundable payment of $11.0 million. In addition, the Company was entitled to receive aggregate payments of up to $28.0 million upon the achievement of specified development and regulatory milestones, and $15.0 million upon the achievement of a commercial milestone, as well as tiered royalties from the mid-single digits up to the mid‑teens on sales of licensed products in Japan. The Company’s performance obligations under the license agreement included the transfer of intellectual property rights in the form of licenses, obligations to participate on certain development and/or commercialization committees with the collaboration partners and supply manufactured drug product for clinical trials.

In the second quarter of 2018, the Company and JT Torii agreed to terminate the Collaboration Agreement and JT Torii halted development activities in Japan. As a result, the Company has reacquired full ownership of the development and commercialization rights to serlopitant in Japan and accelerated recognition of the remaining deferred revenue of $8.1 million during the quarter. In the second quarter of 2018, the Company also earned and recognized a $2.0 million milestone payment related to JT Torii’s receipt of investigational new drug application (“IND”) enabling past clinical study reports delivered by the Company under the Collaboration Agreement.

Under the Collaboration Agreement, the Company was reimbursed by JT Torii for the non-commercial supplies of serlopitant at the same rate it was charged by the third-party manufacturer for such supplies, which price did not include a significant or incremental discount for JT Torii. The assessment of performance obligations required judgment in order to determine the allocation of revenue to each deliverable and the appropriate period of time over which the revenue should be recognized.

Under the Collaboration Agreement, the Company determined that the license was not distinct from the research and development services because JT Torii could not use the license with its available resources to obtain any economic value without the Company’s participation. The license and the services were combined as one unit of accounting and upfront payments were recorded initially as deferred revenue in the balance sheet. Revenue was then recognized over an estimated performance period as performance of services was being completed. The Company recognized the upfront fee based on performance of the obligation using input method over the period of performance, which represented the estimated development period in the territories based on the initial development plan managed by the joint steering committee. The original term of the agreement was through the expiration of the patents associated with serlopitant.

Under the Collaboration Agreement, two of the milestones, which amount to $2.0 million each, related to the preparation of an IND for submission to regulatory authorities in the territory were considered substantive given that they are triggered by the Company’s performance relative to the achievement of pre-specified, “at risk” milestone events, including the submission of all completed trials clinical data packages and the validation of the manufacturing process. The Company earned and recognized a $2.0 million milestone payment during each of the years ended December 31, 2018 and 2017.

On September 1, 2017, the Company entered into a new services agreement with JT Torii to provide research and development services, including regulatory, chemistry and manufacturing support and related materials that is distinct from the original Collaboration Agreement. The Company evaluated the new services agreement and determined that the research and materials delivered to JT Torii represented another contract that provides distinct goods and services to JT Torii. The fees received under the services agreement were recognized as and when such services were performed by the Company and JT Torii consumed the benefits of those services. During the years ended December 31, 2019, 2018, and 2017, the Company recognized revenue of zero, $10.6 million, and $4.6 million respectively in the statement of operations related to the services agreement and Collaboration Agreement. The services agreement terminated upon the termination of the Collaboration Agreement.

 

 

Legal Matters

The Company’s industry is characterized by frequent claims and litigation, including claims regarding intellectual property. As a result, the Company may be subject to various legal proceedings from time to time. The results of any future

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litigation cannot be predicted with certainty, and regardless of the outcome, litigation can have an adverse impact on the Company because of defense and settlement costs, diversion of management resources and other factors.

On November 8, 2018, a putative securities class action complaint captioned Pavel Savelstrov v. Menlo Therapeutics, Inc., et al., Case No.18-CIV-06049, was filed in state court in the Superior Court of the State of California, County of San Mateo, against the Company, certain of its current executive officers and its directors, and certain underwriters in the Company’s initial public offering..

On January 28, 2019, a putative securities class action complaint captioned Hugh McKay v. Menlo Therapeutics, Inc., et al., Case No.19-CIV-00574, was filed in state court in the Superior Court of the State of California, County of San Mateo, against the Company, certain of its current executive officers and its directors, and certain underwriters in the Company’s initial public offering..

The complaints alleged violations of Sections 11, 12(a)(2) and 15 of the Securities Act of 1933 due to allegedly false and misleading statements in connection with the Company’s initial public offering. The McKay action has been consolidated with the Savelstrov action and the claim for violations of Section 12(a)(2) has been dismissed.

 

The parties have mediated the consolidated lawsuit and reached a settlement, providing for payment to the class of plaintiffs in the amount of $9.5 million in return for a release of all claims against the defendants, including the Company and its current and former officers and directors. The settlement is subject to final documentation and Court approval. The Company’s insurance carriers will pay the majority of the settlement amount. The Company accrued for the remaining settlement amount that is not covered by insurance carriers as of December 31, 2019, which does not have a material impact on its financial statements.

 

 

Merger Related Legal Proceedings

On December 11, 2019, a purported Foamix shareholder filed a putative class action lawsuit in the United States District Court for the District of Delaware against Foamix, the members of the Foamix Board, Menlo and Merger Sub, claiming generally that the joint proxy statement/prospectus issued in connection with the Merger omitted material information in violation of Sections 14(a) and 20(a) of the Exchange Act. The action, captioned Sabatini v. Foamix Pharmaceuticals Ltd., et al., Case No. 1:19-cv-02257 (D. Del.), or the Sabatini Action, purports to be brought on behalf of all public shareholders of Foamix, excluding defendants and certain affiliated persons or entities, and seeks, among other things, to enjoin consummation of the Merger, or alternatively rescission or rescissory damages; to compel the individual defendants to disseminate a joint proxy statement/prospectus that does not contain any untrue statements of material fact and that states all material facts required in it or necessary to make the statements contained therein not misleading; a declaration that defendants violated Sections 14(a) and/or 20(a) of the Exchange Act; and an award of costs, including attorneys’ and experts’ fees and expenses.

On December 12 and 17, 2019, respectively, two purported Foamix shareholders filed lawsuits in the United States District Court for the District of New Jersey (the “New Jersey District Court”) and the United States District Court for the Southern District of New York (the “Southern District of New York District Court”) against Foamix and the members of the Foamix Board. The actions, captioned Wang v. Foamix Pharmaceuticals Ltd., et al., Case No. 19-21316 (D.N.J.), or the Wang Action, and Simms v. Foamix Pharmaceuticals Ltd., et al., Case No. 1:19-cv-11529 (S.D.N.Y.), or the Simms Action, each purport to be brought on behalf of the named plaintiff only and allege substantially similar claims and seek substantially similar relief as the Sabatini Action, as well as an accounting of damages allegedly suffered by the plaintiff.

On December 18, 2019, a purported Foamix shareholder filed a putative class action lawsuit in the New Jersey District Court against Foamix, the members of the Foamix Board, Menlo and Merger Sub, alleging generally claims for breach of fiduciary duty, aiding and abetting breaches of fiduciary duty, and violations of Sections 14(a) and 20(a) of the Exchange Act. The action, captioned Wilson v. Foamix Pharmaceuticals Ltd., et al., Case No. 3:19-cv-21563 (D.N.J.), or the Wilson Action, purports to be brought on behalf of all public shareholders of Foamix, excluding defendants and certain affiliated persons or entities, and alleges, among other things, that certain members of the Foamix Board and management are conflicted because they will receive unique benefits in connection with the Merger, that the Merger Agreement contains preclusive deal protection provisions, that the disclosures issued in connection with the Merger are false and misleading, and that the Merger consideration is inadequate. The Wilson Action seeks, among other things, to enjoin the Merger, or alternatively rescission or rescissory damages; a declaration that the Merger Agreement was entered into in breach of fiduciary duty and is therefore invalid and unenforceable; an order directing the individual defendants to commence a sale process for Foamix and obtain a transaction; an accounting of damages allegedly suffered by plaintiff and the putative class; and an award of costs, including attorneys’ and experts’ fees and expenses.

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On December 20, 2019, a purported Foamix shareholder filed a lawsuit in the Southern District of New York District Court against Foamix and the members of the Foamix Board. The action, captioned Miller v. Foamix Pharmaceuticals Ltd., et al., Case No. 1:19-cv-1169 (S.D.N.Y.), or the Miller Action, purports to be brought on behalf of the named plaintiff only and alleges substantially similar claims and seeks substantially similar relief as the Sabatini, Wang, Simms and Wilson Actions.

On January 7, 2020, a purported shareholder of Foamix filed a lawsuit against Foamix and the members of the Foamix Board in the United States District Court for the District of New Jersey, alleging that the joint proxy statement/prospectus issued in connection with the Merger omitted material information in violation of Section 14(a) and Section 20(a) of the Exchange Act and Rule 14a-9 promulgated thereunder. The action, captioned Bushansky v. Foamix Pharmaceuticals Ltd., et al., Case No. 3:20-cv-00256 (D.N.J.), or the Bushansky Action, purports to be brought on behalf of the named plaintiff only and seeks, among other things, injunctive or other equitable relief, including to enjoin consummation of the Merger, or alternatively rescission or rescissory damages, a declaration that the defendants violated Sections 14(a) and/or 20(a) of the Exchange Act, and an award of costs, including attorneys’ and experts’ fees and expenses.

On January 21, 2020, a purported shareholder of Foamix filed an individual action against Foamix and the Foamix Board in the United States District Court for the District of New Jersey under the caption Nam v. Foamix Pharmaceuticals Ltd., et al., Case No. 3:20-cv-00670 (D.N.J.), (the “Nam Action” and together with the Sabatini, Wang, Simms, Wilson, Miller and Bushansky Actions, the “Lawsuits”). The Nam Action generally claims that the joint proxy statement/prospectus issued in connection with the Merger omitted material information in violation of Sections 14(a) and 20(a) of the Exchange Act. The Nam Action seeks, among other things, injunctive relief to prevent consummation of the Merger, rescission or rescissory damages in the event the Merger is consummated, a declaration that defendants violated Sections 14(a) and/or 20(a) of the Exchange Act, costs, including attorneys’ fees and such other and further relief as the court may deem just and proper. In addition, the Nam Action requests an order directing the individual defendants to disseminate a proxy statement that does not contain any untrue statements of material fact and that states all material facts necessary to make the statements contained therein not misleading.

The Company believes that the lawsuits are without merit and intends to vigorously defend itself. Accordingly, the Company cannot reasonably estimate any range of potential future charges, and the Company has not recorded any accrual for a contingent liability associated with these legal proceedings.

Leases

The Company conducts its operations using leased office facilities. In September 2017, the Company entered into a lease agreement. The 30 month lease, beginning on October 1, 2017, provides approximately 14,000 square feet of office space in Redwood City, California. Base annual rent is approximately $55,000 per month, with annual increases. On April 12, 2019, the Company entered into an amendment to its lease agreement for its current location, which was effective on April 23, 2019, the date landlord consent was received. Under the amendment, the lease was extended for an additional nine months, from March 31, 2020 to December 31, 2020. The base rent during the extended term will be approximately $60,000 per month.

The Company recognized a right-of-use asset and corresponding lease liability on January 1, 2019, which was remeasured in April 2019 as a result of the amendment to its lease agreement by calculating the present value of lease payments, discounted at 8.41%, the Company’s estimated incremental borrowing rate, over the 1.7 year expected remaining term. As the Company does not have any borrowings, the Company estimated the incremental borrowing rate based on industry peers. Industry peers consist of several public companies in the biotechnology industry with comparable characteristics, including clinical trials progress and therapeutic indications. Amortization of the operating lease right-of-use asset for the current location amounted to $0.6 million for the year ended December 31, 2019 and was included in operating expenses. As of December 31, 2019, the remaining lease term was 1 year.

The Company recognizes rent expense on a straight‑line basis over the respective lease period. Lease expense was $0.7 million, $0.8 million and $0.4 million, respectively, for the years ended December 31, 2019, 2018 and 2017. As of December 31, 2019, maturities of lease liability due under the Company’s lease are as follows (in thousands):

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As of December 31, 2019, total future minimum lease payments under our operating leases are as follows (in thousands):

 

 

Indemnification

As permitted under Delaware law and in accordance with the Company’s bylaws, the Company is required to indemnify its officers and directors for certain events or occurrences while the officer or director is or was serving in such capacity. The Company is also party to indemnification agreements with its directors. The Company believes the fair value of the indemnification rights and agreements is minimal. Accordingly, the Company has not recorded any liabilities for these indemnification rights and agreements as of December 31, 2019.

Contingencies

From time to time, we may have certain contingent liabilities that arise in the ordinary course of our business activities. We accrue a liability for such matters when it is probable that future expenditures will be made and such expenditures can be reasonably estimated.

As of December 31, 2017, the Company’s Certificate of Incorporation, as amended, authorized the Company to issue up to 28,322,761 shares of convertible preferred stock, par value of $0.001, of which 14,300 were designated Series A convertible preferred stock and 14,106,583 are designated Series B convertible preferred stock, and 14,201,878 shares are designated Series C convertible preferred stock.

In July 2017, the Company issued 11,854,463 shares of Series C convertible preferred stock to investors at $4.26 per share with gross proceeds of $50.5 million.

In January 2018, the Company completed its initial public offering (“IPO”) of shares of its common stock, pursuant to which the Company issued 8,050,000 shares of common stock, which includes 1,050,000 shares issued pursuant to the over-allotment option granted to its underwriters and received net proceeds of approximately $125.4 million, after deducting underwriting discounts, commissions and offering expenses. In connection with the completion of the Company's IPO, all shares of convertible preferred stock converted into 9,629,405 shares of common stock. As of December 31, 2019, the Company had no outstanding convertible preferred stock.

 

Liquidation Preference

In the event of any liquidation, dissolution, or winding up of the Company, either voluntary or involuntary, the holders of the then outstanding shares of Series A convertible stock and Series B convertible preferred stock and Series C convertible preferred stock were first entitled to receive the amount of $1,000 and $3.19 and $4.26 per share, respectively plus all declared but unpaid dividends for such shares, prior and in preference to any distribution of any assets of the Company to the holders of the common stock. Upon the occurrence of such event, the proceeds distributed among the holders of the Series A, B and C convertible preferred stock were insufficient to permit the full payment of the aforesaid preferential amounts to each holder the convertible preferred stock, then the entire proceeds legally available for distribution to the convertible preferred stock were to be distributed ratably among the holders of the Series A, B and C convertible preferred stock in proportion to the full preferential amount that each such holder of convertible preferred stock is otherwise entitled to receive.

Upon completion of the distributions required by the above‑mentioned liquidation preferences, any remaining proceeds were to be distributed among the holders of Series B and C convertible preferred stock and common stock pro rata based on the number of shares of common stock held by each, assuming full conversion of the Series B and C convertible preferred stock to common stock at the then‑effective conversion price for such shares.

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Dividends

The holders of shares of Series A, B and C convertible preferred stock were entitled to receive non‑cumulative dividends, out of any assets legally available, prior and in preference to any declaration or payment of any dividend on the common stock, at the applicable dividend rate of $80.00 per annum for each share of Series A convertible preferred stock, $0.2552 per annum for each share of Series B convertible preferred stock and $0.3408 per share per annum for each share of Series C convertible preferred stock, all subject to adjustment from time to time for recapitalizations, payable when and if declared by the Company’s board of directors. The Company has never declared any dividends on its convertible preferred stock.

Voting

The holder of each share of Series B and C convertible preferred stock were entitled to one vote for each share of common stock into which such preferred stock could then be converted and, with respect to such vote, such holder has full voting rights and powers equal to the voting rights and powers of the holders of common stock and was entitled to notice of any stockholders’ meeting in accordance with the Company’s bylaws. The holders of shares of Series A convertible preferred stock did not have a right to vote, other than as required by Delaware law and for certain directors, as set forth below.

The holders of shares of Series A convertible preferred stock were entitled to elect two of the Company’s directors. The holders of Series B convertible preferred stock were entitled to elect two of the Company’s directors. The holders of Series C convertible preferred stock were entitled to elect one of the Company’s directors. The holders of outstanding common stock were entitled to elect three of the Company’s directors. The holders of convertible preferred stock and common stock, voting together as a single class, and not as separate series, and on an as converted basis, were entitled to elect any remaining directors of the Company, subject to the approval of the then serving members of the Company’s directors.

Conversion

The holder of each share of convertible preferred stock had the option to convert each share of convertible preferred stock into such number of fully paid and nonassessable shares of common stock as is determined by dividing the applicable original issue price for such series by the applicable conversion price for such series in effect on the date the certificate is surrendered for conversion. Each share of convertible preferred stock automatically converted into shares of common stock at the conversion rate at the time in effect for such series of convertible preferred stock immediately pursuant to a registration statement under the Securities Act of 1933, with gross proceeds of not less than $40.0 million in the aggregate and an offering price to the public of no less than $17.21 per share.

The conversion price of the convertible preferred stock was initially set at an amount equal to the issue price. The Series B and C convertible preferred stock conversion price was subject to adjustment for stock dividends, stock splits, re‑capitalization and upon the occurrence of certain triggering events related to anti‑dilution protection rights. In the event that a future preferred stock financing should occur at a price lower than the last preferred financing round, the conversion ratios of the existing preferred stock are changed to protect the ownership position of existing investors.

As of December 31, 2019, the Company’s Certificate of Incorporation, as amended, authorizes the Company to issue 300,000,000 shares of $0.0001 par value common stock. Each share of common stock is entitled to one vote. The holders of common stock are also entitled to receive dividends whenever funds are legally available and when and if declared by the board of directors, subject to the prior rights of holders of all classes of preferred stock outstanding. The Company has never declared any dividends on common stock.

Under the Company’s 2011 Stock Incentive Plan (the “2011 Plan”), the Company may grant restricted stock units, options to purchase common stock, restricted stock awards, or directly issue shares of common stock to employees, directors and consultants of the Company. Under the 2011 Plan, options granted are exercisable over a maximum term of 10 years from the date of grant and generally vest over a period of four years. Following the closing of the Company’s initial public offering in January 2018, the Company has retired and has made no further awards under the 2011 Plan. The Company adopted a 2018 Omnibus Incentive Plan (the “2018 Plan”), effective January 2018. The 2018 Plan provides for the grant of incentive stock options, non-qualified stock options, stock appreciation rights, restricted stock, restricted stock units, dividend equivalent rights and other stock and cash-based awards (including annual cash incentives and long-term cash incentives). Pursuant to the terms of the 2018 Plan in January 2019, the 2018 Plan share reserve automatically increased by 929,327 shares of common stock issuable. As of December 31, 2019, the Company has 1,118,543 shares of common stock available for issuance under the 2018 Plan.

The Company adopted a 2018 Employee Stock Purchase Plan, or ESPP in January 2018. The ESPP enables eligible employees of the Company and designated affiliates to purchase shares of common stock at a discount of 15%. Six month offer periods under the ESPP commenced on September 1, 2018. Pursuant to the terms of the ESPP in January 2019, the

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ESPP share reserve automatically increased by 232,332 shares of common stock. As of December 31, 2019, the Company has reserved 480,634 shares of common stock for issuance under the ESPP.

Total stock‑based compensation expense for employees and non‑employees recognized in the statements of operations was as follows (in thousands):

 

 

In connection with services rendered by non-employees, the Company recorded stock-based compensation expense of $0.2 million, $0.5 million, and $0.6 million in 2019, 2018 and 2017, respectively.

 

At December 31, 2019, there was approximately $9.2 million of unamortized compensation expense related to stock options, which was expected to be recognized over a weighted average period of 2.2 years. Total unrecognized stock-based compensation expense related to non-vested restricted stock units at December 31, 2019 was $1.7 million with a weighted average remaining contractual term of 1.6 years.

2011 and 2018 Plan

The table below summarizes stock option and restricted award activity under the 2011 Plan and 2018 Plan:

 

 

Upon vesting of restricted shares and exercise of options, the Company issues common stock from its authorized shares. During the years ended December 31, 2019, 2018 and 2017, the Company received $710,000, $496,000 and $34,000 upon the exercise of stock options, respectively. As of December 31, 2019 and 2018, the Company had recorded a liability of zero and $18,000, respectively for the early exercise of stock options, recorded as other current liabilities and other non‑current liabilities. When options are subject to the Company’s repurchase right, the Company may buy back any unvested shares at their original exercise price in the event of an employee’s termination prior to full vesting.

The aggregate intrinsic value of shares exercised during the years ended December 31, 2019, 2018 and 2017 was $0.4 million, $1.8 million and $0.2 million, respectively. The weighted average grant date fair value of stock options granted was $3.81, $5.00 and $5.56 per share during the years ended December 31, 2019, 2018, and 2017, respectively

During the year ended December 31, 2019, the Company granted 966,040 restricted stock units, which had a weighted-average award date fair value of $4.08 per share and vests over 2 years. 33,400 restricted stock units were cancelled during the year and vesting of 423,490 restricted stock units held by the Company’s named executive officers were accelerated in full on December 11, 2019 in connection with the pending Merger in order to mitigate potential negative tax consequences

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to both the Company and the named executive officer under Section 280G and 4999 of the Internal Revenue Code. As of December 31, 2019, 509,150 restricted stock units remain unvested.

Stock Awards Granted to Employees and Directors

Stock‑based compensation expense is based on the grant date fair value. The Company recognizes compensation expense for all stock‑based options and restricted awards on a straight‑line basis over the requisite service period of the awards, which is generally the option vesting term of four years. The fair value of restricted stock units used in the Company’s expense recognition method is based on the closing price of the Company’s common stock on the date of the grant. Such value is recognized as an expense over the requisite service period using the straight-line method.

The fair value of each option award is estimated on the date of grant using the Black-Scholes option valuation model. The Company determines the price volatility based on the historical volatilities of industry peers as it has no trading history for its common stock price during the expected term. Industry peers consist of several public companies in the biotechnology industry with comparable characteristics, including clinical trials progress and therapeutic indications.

The expected term of the options is based on the average period the stock options are expected to remain outstanding. As the Company does not have sufficient historical information to develop reasonable expectations about future exercise patterns and post-vesting employment termination behavior, the expected term is calculated as the midpoint between the weighted-average vesting term and the contractual expiration period also known as the simplified method. The risk-free rate is based on U.S. Treasury zero coupon issues with remaining terms consistent with the expected terms of the stock options, as determined at the time of grant. To date, the Company has not declared or paid any cash dividends and does not have any plans to do so in the future. Therefore, the Company used an expected divided yield of zero.

 

The following assumptions were used to calculate the fair value of option awards granted to employees and directors during the years indicated:

 

 

Stock-Based Compensation for Non-employees

Stock‑based compensation expense related to stock awards granted to non‑employees is recognized over the requisite service period using the straight-line method. The Company believes that the fair value of the stock‑based awards granted is more reliably measurable than the fair value of the services received. The fair value of stock option awards granted is calculated using the Black‑Scholes option valuation model.

The fair values of common stock option awards granted to non‑employees were calculated using the following assumptions for the periods presented:

 

 

Employee Stock Purchase Plans

 

The fair value of each ESPP award is estimated on the first day of the offering period using the Black-Scholes option pricing model and is recognized in expense over the service period using the straight-line method. The key input assumptions used to estimate fair value of these awards include the exercise price of the award, the expected option term of 0.5 years, the expected volatility of the Company’s stock over the option’s expected term of 76%, the risk-free interest rate over the option’s expected term of 2.18%, and the Company’s expected dividend yield at zero.    

 

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The following table sets forth the computation of basic and diluted net loss per share attributable to common stockholders (in thousands, except share and per share data):

 

 

The following outstanding shares of potentially dilutive securities were excluded from the computation of diluted net loss per share attributable to common stockholders for the periods presented because including them would have been antidilutive:

 

 

The Company did not record a provision or benefit for income taxes during the years ended December 31, 2019, 2018 and 2017.

The tax effect of temporary differences and carryforwards that give rise to significant portions of the deferred tax assets are as follows (in thousands):

 

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Realization of deferred tax assets is dependent upon future earnings, if any, the timing and amount of which are uncertain. Accordingly, the net deferred tax assets have been fully offset by a valuation allowance. The net change in the total valuation allowance for the years ended December 31, 2019, 2018 and 2017 was an increase of approximately $16.6 million, $12.6 million, and $3.4 million, respectively.

As of December 31, 2019, the Company had net operating loss carryforwards for federal income tax purposes of $165.8 million, with $44.3 million expiring beginning in the year 2031 and $121.5 million available indefinitely. As of December 31, 2018, the Company had net operating loss carryforwards for federal income tax purposes of $100.6 million, with $44.3 million expiring beginning in the year 2031. The Company also has federal research and development tax credits of $7.1 million and $4.1 million, respectively which expire beginning in the year 2031.

As of December 31, 2019 and 2018, the Company had net operating loss carryforwards for state income tax purposes of $17.6 million and $16.8 million, respectively which expire beginning in the year 2031 and state research and development tax credits of $2.1 million and $1.4 million, respectively which do not expire.

Federal and state tax laws impose substantial restrictions on the utilization of the net operating loss and credit carryforwards in the event of an ownership change as defined in Section 382 of the Internal Revenue Code. Accordingly, the Company’s ability to utilize these carryforwards may be limited as a result of such ownership change. Such a limitation could result in the expiration of carryforwards before they are utilized.

The Company has adopted ASC 740-10, Accounting for Uncertainty in Income Taxes, that prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of uncertain tax positions taken or expected to be taken in the Company’s income tax return, and also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. To date, there have been no interest or penalties charged in relation to the unrecognized tax benefits.

The Company recognizes interest and penalties related to uncertain tax positions in income tax expense. To the extent accrued interest and penalties do not ultimately become payable, amounts accrued will be reduced and reflected as a reduction of the provision for income taxes in the period that such determination is made. As of December 31, 2019 and 2018, the Company had no accrued interest and penalties related to uncertain tax positions.

The Company filed US and California tax returns with varying statues of limitations. The federal and California tax years from 2011 to 2018 remain open to examination due to the carryover of unused net operating losses and tax credits. The Company does not expect any material changes to the estimated amount of liability associated with its uncertain tax positions within the next 12 months.

Uncertain Tax Positions

The following table summarizes the activity related to unrecognized tax benefits (in thousands):

 

 

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The following tables show a summary of the Company’s unaudited quarterly financial data for each of the four quarters of 2019 and 2018 (in thousands, except per share amounts):

 

 

 

 

 

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13. Subsequent Event

Merger Agreement with Foamix

As discussed in Note 1, “Description of Business,” on November 10, 2019, the Company signed a definitive merger agreement with Foamix.  The transaction contemplated by the Merger Agreement will result in a change in control of the Company. On February 6, 2020, the Merger was approved by both the Company stockholders and Foamix’s shareholders. The material terms of the Merger Agreement are further described in Part I, Item 1, “Business,” in this annual report.  

The Company expects to incur severance expense upon the consummation of the proposed merger with Foamix because the Company anticipates that all of its full-time employees will be involuntarily terminated. In accordance with the offer letters between the Company and each of the Company’s named executive officers entered into and the severance arrangements for the Company’s non-officer employees, the Company expects to make cash severance payments to the Company’s existing employees totaling approximately $8.7 million upon termination.

The Company has incurred, and expects to incur additional, significant transaction-related expenses in connection with negotiating and executing the Merger Agreement with Foamix and completing the transactions contemplated by the Merger Agreement. Transaction-related expenses, which include legal, accounting and financial advisor fees, and other service provider costs, are currently estimated to total approximately $7.2 million. The Company incurred $3.0 million of these costs during the fourth quarter of 2019 and recorded that amount as transaction-related expenses on the Company’s statements of operations and comprehensive loss. As of December 31, 2019, $0.7 million of these costs were accrued on the Company’s balance sheet. The Company expects to incur the remainder of the anticipated transaction-related expenses in the first half of 2020.

 

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Item 9.  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

None.

Item 9A. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act refers to controls and procedures that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. Our management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and our management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Our disclosure controls and procedures are designed to provide reasonable assurance of achieving their control objectives.

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures as of December 31, 2019, the end of the period covered by this Annual Report on Form 10-K. Based upon such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective at the reasonable assurance level as of such date.

Management’s Annual Report on Internal Control Over Financial Reporting

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of consolidated financial statements for external purposes in accordance with U.S. generally accepted accounting principles (“GAAP”). Internal control over financial reporting is a process designed by, or under the supervision of, our Chief Executive Officer and Chief Financial Officer, and effected by our Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:

 

Management assessed our internal control over financial reporting as of December 31, 2019, the end of our fiscal year. Management based its assessment on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework). Management’s assessment included evaluation of elements such as the design and operating effectiveness of key financial reporting controls, process documentation, accounting policies, and our overall control environment.

Based on this assessment, management has concluded that our internal controls over financial reporting were effective as of December 31, 2019 and provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with GAAP. We reviewed the results of management’s assessment with the Audit Committee of our Board of Directors.

Internal control over financial reporting has inherent limitations. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over financial reporting also can be circumvented by collusion or improper management override. Because of such limitations, there is a risk that material misstatements will not be prevented or detected on a timely basis by internal control over financial reporting. However, these inherent limitations are known features of the financial reporting process. Therefore, it is possible to design into the process safeguards to reduce, though not eliminate, this risk.

 

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Attestation Report of the Registered Public Accounting Firm

This Annual Report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Our report was not subject to attestation by our independent registered public accounting firm pursuant to the rules of the Securities and Exchange Commission that permit us to provide only management’s report in this report.

Changes in Internal Control over Financial Reporting

There was no change in our internal control over financial reporting (as defined in Rules 13a-15(d) and 15d-15(d) of the Exchange Act) that occurred during the most recent fiscal quarter covered by this Annual Report on Form 10-K that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Item 9B.  Other Information.

None

 

Item 10. Directors, Executive Officers and Corporate Governance.

Executive Officers and Directors

The following table sets forth information regarding our executive officers, directors and key employees as of February 15, 2020:

 

 

 

Executive Officers and Employee Directors

Steven Basta has served as our President and Chief Executive Officer and member of our board of directors since September 2015. From October 2011 until August 2015, Mr. Basta served as Chief Executive Officer of AlterG, a privately held medical device company. From November 2002 to February 2010, Mr. Basta served as Chief Executive Officer of BioForm Medical, a publicly listed medical aesthetics company acquired by Merz, and from February 2010 to September 2011 served as Chief Executive Officer of Merz Aesthetics, the successor to BioForm Medical. Mr. Basta is currently a board member of the publicly listed company, Viveve Medical (since September 2018) and serves as Chairman of the Board of Viveve (since January 2019). Mr. Basta previously served on the board of Carbylan from September 2009 to November 2016. Mr. Basta served on the board of RF Surgical (acquired by Medtronic) from December 2013 to August 2015. Mr. Basta received a B.A. from The Johns Hopkins University and an M.B.A. from the Kellogg Graduate School of Management at Northwestern University. We believe Mr. Basta is qualified to serve as our President and Chief Executive Officer and on our board of directors because of his extensive experience in leadership and management roles at various life sciences companies.

 

Kristine Ball has served as our Senior Vice President, Corporate Strategy and Chief Financial Officer since September 2017. From November 2012 through October 2016, Ms. Ball served as Chief Financial Officer and Senior Vice President of Relypsa, Inc., a publicly-listed pharmaceutical company acquired by Galenica. Prior to Relypsa, Ms. Ball was an independent consultant from June 2011 to October 2012, advising start-up life science companies on various strategic and

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operational business matters. Prior to being a consultant, Ms. Ball was Senior Vice President of Finance and Administration and Chief Financial Officer of KAI Pharmaceuticals, Inc. (acquired by Amgen), a drug discovery company, from February 2005 to January 2011, where she was responsible for finance, administration and strategic planning and was involved in a venture capital financing, pharmaceutical partnerships and, as a consultant, KAI’s acquisition. Prior to KAI, Ms. Ball served as Vice President of Finance at Exelixis, Inc., a biotechnology company, from 2000 to 2005, where she was involved in four acquisitions and Exelixis’ initial public offering and other financings. Prior to Exelixis, Ms. Ball was a senior manager in Ernst & Young’s life sciences audit practice. Ms. Ball is currently a board member of the publicly listed company, Forty Seven (since February 2018). Ms. Ball holds a B.S. from Babson College.

 

Paul Kwon, M.D. has served as our Chief Scientific Officer since May 2018. Prior to that, he served as our Chief Medical Officer since January 2016. Dr. Kwon previously served as Chief Medical Officer at Nora Therapeutics, a biotechnology company focused on developing therapeutics to address significant unmet needs in reproductive medicine from November 2010 to November 2015. Prior to joining Nora Therapeutics, Dr. Kwon held numerous positions at Genentech, where he was most recently head of the non-oncology early clinical development group. Dr. Kwon was in clinical practice

as a dermatologist from 2001 to 2003 and from 2009 to 2010 with the Permanente Medical Group in Northern California, where he served as a consultant for the Permanente Technology Group. Dr. Kwon served as Assistant Clinical Professor of Dermatology at the University of California at San Francisco from 2004 to 2014. Dr. Kwon earned his B.A. in Human Biology from Stanford University and an M.D. from the University of California at San Francisco. He is a diplomate of the American Board of Dermatology and a fellow of the American Academy of Dermatology.

 

Ronald A. Krasnow has served as our General Counsel and Chief Compliance Officer since June 2019. Prior to that, Mr. Krasnow served as General Counsel, Chief Strategy Officer and Secretary at Kinestral Technologies, Inc., a company focused on bringing cutting edge technology to the home and commercial construction markets, from December 2017 to December 2019. Prior to Kinestral, Mr. Krasnow spent approximately ten years as General Counsel at Relypsa, Inc. from 2007 to 2017, overseeing legal activities as the biotech company grew from a start-up, through its IPO, commercialization of its drug and its acquisition by Galenica.  Prior to joining Relypsa, Mr. Krasnow spent ten years at Symyx Technologies, Inc. from 1997 to 2007 in various positions, including Senior Vice President, Intellectual Property.  Earlier in his career, Mr. Krasnow was an attorney at Fish & Neave (now Ropes & Gray LLP) representing clients in complex patent litigation and interferences.  Mr. Krasnow received his J.D. from The George Washington University Law School and his B.S. in Materials and Metallurgical Engineering from The University of Michigan.

Non-Employee Directors

Paul Berns has served as a member of our board of directors since November 2017. Mr. Berns has been a consultant to the pharmaceutical industry since July 2016, as well as from August 2012 to March 2014 and from July 2005 to March 2006. From March 2014 to June 2016, Mr. Berns served as President and Chief Executive Officer and Chairman of the Board at Anacor Pharmaceuticals, Inc. a biopharmaceutical company, which was acquired by Pfizer Inc. in 2016. Previously, Mr. Berns served as President and Chief Executive Officer of Allos Therapeutics, Inc., a biopharmaceutical company, from March 2006 to September 2012, when it was acquired by Spectrum Pharmaceuticals, Inc. Mr. Berns was President and Chief Executive Officer of Bone Care International, Inc., a specialty pharmaceutical company, from June 2002 to July 2005, when it was acquired by Genzyme Corporation. Prior to that, Mr. Berns was Vice President and General Manager of the Immunology, Oncology and Pain Therapeutics business unit of Abbott Laboratories from 2001 to 2002, and from 2000 to 2001, he served as Vice President, Marketing of BASF Pharmaceuticals/Knoll, when it was acquired by Abbott Laboratories in 2001. Earlier in his career, Mr. Berns held various positions, including senior management roles, at Bristol-Myers Squibb Company from 1990 to 2000. Mr. Berns is currently a board member of the privately held company, Gideon Health (since August 2019), the privately held company, BlackThorn Therapeutics (since November 2018), the privately held company, MC2 Therapeutics (since May 2017), and the publicly held company, Jazz Pharmaceuticals, PLC (since April 2010) and the publicly held company, Unity Biotechnology, Inc. (since March 2018). Mr. Berns previously served on the boards of Anacor Pharmaceuticals, Inc. (from June 2012 to June 2016), XenoPort, Inc. (from November 2005 to May 2016), Allos Therapeutics, Inc. (from March 2006 to September 2012) and Bone Care International, Inc. (from June 2002 to July 2005). Mr. Berns received his B.S. in Economics from the University of Wisconsin. We believe that Mr. Berns is qualified to serve on our board of directors because of his extensive experience in the biopharmaceutical industry and his service as a director of a number of public pharmaceutical companies.

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Ted Ebel has served as a member of our board of directors since March 2014. Mr. Ebel has served as Chief Business Officer at Colorescience since March 2013. Prior to that, he was Senior Vice President of Corporate Development for SkinMedica, Inc. from March 2006 to December 2012, having responsibility for mergers and acquisitions, licensing, intellectual property management, market research and establishing the company’s international operations. Previously, Mr. Ebel served as the Executive Director of Corporate Development at CancerVax Corporation, a biotechnology company focused on cancer immunotherapy, and as the Vice President of Strategic Ventures for MP3.com, a publicly traded internet and entertainment company. In addition, Mr. Ebel held positions in marketing and corporate development at Amgen, Inc. and began his career as a consultant in the health care practice of the management consulting firm Arthur D. Little. Mr. Ebel also currently serves as a member of the board of directors of Vitamedica Corporation, a privately company. Mr. Ebel earned an A.B., Magna Cum Laude from Duke University and his M.B.A. from the Wharton School at the University of Pennsylvania. We believe that Mr. Ebel is qualified to serve on our board of directors because of his background working in the dermatology industry and his experience in strategic planning, business transactions, sales operations and executive leadership.

 

David McGirr has served as a member of our board of directors since November 2017. From March 2013 until June 2014, Mr. McGirr was Senior Advisor to the Chief Executive Officer of Cubist Pharmaceuticals, Inc., a biopharmaceutical company, where he also served as Senior Vice President and Chief Financial Officer from November 2002 to March 2013. Prior to that, Mr. McGirr was the President and Chief Operating Officer of hippo inc., a venture-financed internet technology company, where Mr. McGirr also served as a member of its board of directors from 1999 to 2003. Previously, Mr. McGirr was the President of GAB Robins North America, Inc., a risk management company, serving also as Chief Executive Officer from 1997 to 1999. Prior to that, Mr. McGirr was a private equity investor from 1995 to 1996. Earlier in his career, Mr. McGirr served in various positions within the S.G. Warburg Group from 1978 to 1995, ultimately as Chief Financial Officer, Chief Administrative Officer and Managing Director of S.G. Warburg & Co., Inc., a position held from 1992 to 1995. Mr. McGirr is currently a board member of the following publicly listed companies: X4 Pharmaceuticals, Inc. (since September 2017), Insmed Incorporated (since October 2013), Rhythm Pharmaceuticals, Inc. (since November 2015) and previously served on the boards of LifeCell Corporation (from November 2007 to June 2008), Relypsa, Inc. (from November 2012 to September 2016) and Roka Bioscience, Inc. (from October 2013 to January 2018). Mr. McGirr received his B.Sc. in Civil Engineering from the University of Glasgow and his M.B.A. from The Wharton School at the University of Pennsylvania. We believe that Mr. McGirr is qualified to serve on our board of directors because of his experience as an executive officer or director of a number of public and private pharmaceutical companies.

Elisabeth Sandoval has served as a member of our board of directors since March 2019.  Ms. Sandoval currently serves as a consultant to the pharmaceutical industry.  From 2016 to 2019, she served as the Chief Commercial Officer and Executive Vice President of Corporate Strategy for Alder Biopharmaceuticals, a clinical stage company focused on developing novel therapeutic antibodies for the treatment of migraine.  Ms. Sandoval is also responsible for developing and leading the company’s medical affairs, investor relations, corporate communications and business development functions. Before joining Alder, she was Chief Commercial Officer for KYTHERA Biopharmaceuticals, where she led the commercial strategy and execution including the hiring and development of all commercial functions and launch of a first-in-class product prior to KYTHERA’s acquisition by Allergan. Before KYTHERA, Ms. Sandoval was Vice President of Marketing for Bausch and Lomb Surgical, leading all marketing strategy and execution globally.  Prior to this position, Ms. Sandoval was Vice President of Global Marketing at Allergan with responsibility for developing the global commercial strategy for the Medical Aesthetics division and execution of key product launches. She spent 23 years at Allergan in sales and marketing leadership roles in the specialties of dermatology, neurology, and aesthetics. Ms. Sandoval serves on the board of directors for Alastin Skincare, a privately held company. Ms. Sandoval began her career in research and development at Johnson & Johnson’s Ethicon division. She holds an MBA from Pepperdine University and a B.S. in Biology from the University of California, Irvine.

Scott Whitcup, M.D. has served as a member of our board of directors since February 2016. Dr. Whitcup is founder and Chief Executive Officer of Akrivista and Whitecap Biosciences, two companies focused on the development and commercialization of novel therapies in ophthalmology and dermatology. Previously, Dr. Whitcup held various research and development roles from 2000 to 2015 at Allergan, including serving as Executive Vice President, Research and Development and Chief Scientific Officer, where he led the discovery and global development of both pharmaceutical products and medical devices in therapeutic areas including ophthalmology, CNS, urology, dermatology, medical aesthetics and surgical obesity. Before Allergan, Dr. Whitcup was the Clinical Director at the National Eye Institute at the NIH, and Chaired the NIH Medical Executive Committee. Dr. Whitcup holds a B.A. in Neurobiology and Behavior from Cornell University and an M.D. from Cornell University Medical College. Dr. Whitcup has completed a residency in Internal Medicine at UCLA, a residency in Ophthalmology at Harvard Medical School‑Massachusetts Eye & Ear Infirmary and a fellowship in Uveitis and Ocular Immunology at the National Eye Institute, National Institutes of Health. He is a Diplomate of both the American Board of Internal Medicine and the American Board of Ophthalmology, a licensed

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M.D. in California and is on the Clinical Faculty of the Department of Ophthalmology, at the Jules Stein Eye Institute, David Geffen School of Medicine at the University of California at Los Angeles. Dr. Whitcup has published more than 250 scientific articles and co‑authored a leading textbook on uveitis and ocular immunology. Dr. Whitcup is a venture partner at Vivo Capital. Dr. Whitcup currently serves on the board of Scilex Holding Company and Anivive Lifesciences, and previously served on the board of Nightstar Therapeutics, Avanir Pharmaceuticals, and Questcor Pharmaceuticals, publicly traded companies, and Semnur Pharmaceuticals. We believe that Dr. Whitcup is qualified to serve on our board of directors due to his clinical development expertise, medical and scientific expertise and his leadership experience with life sciences companies. 

Meetings of the Board of Directors

The board of directors met eight times during the fiscal year ended December 31, 2019. The audit committee met four times, the compensation committee met four times and the nominating and corporate governance committee met zero times. Each member of the board of directors, attended at least 75% of the aggregate number of meetings of our board of directors. We encourage all of our directors and nominees for director to attend our annual meeting of stockholders; however, attendance is not mandatory.

Corporate Governance Guidelines

The board of directors has documented our governance practices in our corporate governance guidelines to assure that the board will have the necessary authority and practices in place to review and evaluate our business operations as needed and to make decisions that are independent of our management. The guidelines are also intended to align the interests of directors and management with those of our stockholders. The corporate governance guidelines set forth certain practices the board will follow with respect to board composition, board committees, board nomination, director qualifications and evaluation of the board and committees. The corporate governance guidelines and the charter for each committee of the board of directors may be viewed at http://ir.menlotherapeutics.com/index.php/governance/documents-charters.

Leadership Structure of the Board

Our amended and restated bylaws and corporate governance guidelines provide our board of directors with flexibility to designate the position of Chairman of the board of directors, and if so, to combine or separate the positions of Chairman of the board of directors and Chief Executive Officer, or to implement a lead director in accordance with its determination that utilizing a particular structure would be in the best interests of our company.

Our board of directors has concluded that our current leadership structure is appropriate at this time. Our board of directors periodically reviews our leadership structure and may make changes in the future as it deems appropriate.

Role of Board in Risk Oversight Process

Risk assessment and oversight are an integral part of our governance and management processes. Our board of directors encourages management to promote a culture that incorporates risk management into our corporate strategy and day‑to‑day business operations. Management discusses strategic and operational risks at regular management meetings, and conducts specific strategic planning and review sessions during the year that include a focused discussion and analysis of the risks facing us. Throughout the year, senior management reviews these risks with the board of directors at regular board meetings as part of management presentations that focus on particular business functions, operations or strategies, and presents the steps taken by management to mitigate or eliminate such risks.

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Our board of directors does not have a standing risk management committee, but rather administers this oversight function directly through our board of directors as a whole, as well as through various standing committees of our board of directors that address risks inherent in their respective areas of oversight. While our board of directors is responsible for monitoring and assessing strategic risk exposure, our audit committee is responsible for overseeing our major financial risk exposures and the steps our management has taken to monitor and control these exposures. The audit committee also monitors compliance with legal and regulatory requirements and considers and approves or disapproves any related person transactions. Our nominating and corporate governance committee monitors the effectiveness of our corporate governance guidelines. Our compensation committee assesses and monitors whether any of our compensation policies and programs has the potential to encourage excessive risk‑taking.

Committees of the Board of Directors

Our board of directors has the following standing committees: an audit committee, a compensation committee and a nominating and corporate governance committee. Our board of directors may establish other committees to facilitate the management of our business. The composition and functions of each committee are described below.

 

 

Below is a description of each committee of the board of directors.

Audit Committee

Our audit committee oversees our corporate accounting and financial reporting process. Among other matters, the audit committee:

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The current members of our audit committee are Messrs. McGirr, Berns and Ebel, with Mr. McGirr serving as the chairperson of the committee. All members of our audit committee meet the requirements for financial literacy under the applicable rules and regulations of the SEC and the Nasdaq Stock Market LLC. Our board of directors has determined that Mr. McGirr is an audit committee financial expert as defined under the applicable rules of the SEC and has the requisite financial sophistication as defined under the applicable rules and regulations of the Nasdaq Stock Market LLC. Under the rules of the SEC, members of the audit committee must also meet heightened independence standards. However, so long as at least one member of the audit committee satisfies the heightened audit committee independence standards on the date of the effectiveness of the registration statement, a majority of members of the audit committee may be exempt from the heightened audit committee independence standards for 90 days from such date and a minority of members of the audit committee may be exempt from the heightened audit committee independence standards for one year from such date. Our board of directors has determined that Messrs. McGirr, Berns and Ebel are independent under the applicable rules of the SEC and the Nasdaq Stock Market LLC. The audit committee operates under a written charter that satisfies the applicable standards of the SEC and the Nasdaq Stock Market LLC.

 

Compensation Committee

Our compensation committee oversees policies and makes determinations relating to compensation and benefits of our current and prospective officers, directors and employees. The compensation committee periodically evaluates the performance of our company, and where appropriate, our officers, in light of the goals and objectives it has established, and determines and approves, or may recommend to the board of directors to approve, the bonus award, if any, payable to these officers. The compensation committee may establish compensation and make bonus awards to our chief executive officer directly or may make recommendations to the board of directors regarding compensation and bonus awards payable to our chief executive officer. Our compensation committee also reviews director compensation and makes recommendations to the board of directors regarding director compensation. The compensation committee also reviews and approves or makes recommendations to our board of directors regarding the issuance of stock options and other awards under our stock plans. The compensation committee will periodically review and evaluate the performance of the compensation committee and its members, including compliance by the compensation committee with its charter.

The current members of our compensation committee are Ms. Sandoval and Messrs. Ebel and McGirr, with Mr. Ebel serving as the chairperson of the committee. Our board of directors has determined that each of Ms. Sandoval and Messrs. Ebel and McGirr is independent under the applicable rules and regulations of the Nasdaq Stock Market LLC and is a “non-employee director” as defined in Rule 16b-3 promulgated under the Exchange Act. The compensation committee operates under a written charter that satisfies the applicable standards of the SEC and the Nasdaq Stock Market LLC.

Nominating and Corporate Governance Committee

Our nominating and corporate governance committee is responsible for making recommendations to our board of directors regarding candidates for directorships and the size and composition of our board of directors. In addition, the nominating and corporate governance committee is responsible for overseeing our corporate governance policies and reporting and making recommendations to our board of directors concerning governance matters.

The current members of our nominating and corporate governance committee are Dr. Whitcup and Mr. Berns, with Dr. Whitcup serving as the chairperson of the committee. Our board of directors has determined that each of Dr. Whitcup and Mr. Berns is an independent director under the applicable rules and regulations of the Nasdaq Stock Market LLC relating to nominating and corporate governance committee independence. The nominating and corporate governance committee operates under a written charter that satisfies the applicable standards of the SEC and the Nasdaq Stock Market LLC.

Compensation Committee Interlocks and Insider Participation

During the year ended December 31, 2019, our compensation committee consisted of Ms. Sandoval and Messrs. Ebel and McGirr. None of the members of our compensation committee during 2019 nor any of the current members of our compensation committee has at any time been one of our officers or employees. None of our executive officers currently serves, or in the past fiscal year has served, as a member of the board of directors or compensation committee of any entity that has one or more executive officers on our board of directors or compensation committee.

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Board Diversity

Our nominating and corporate governance committee is responsible for reviewing with the board of directors, on an annual basis, the appropriate characteristics, skills and experience required for the board of directors as a whole and its individual members. In evaluating the suitability of individual candidates (both new candidates and current members), the nominating and corporate governance committee, in recommending candidates for election, and the board of directors, in approving (and, in the case of vacancies, appointing) such candidates, may take into account many factors, including but not limited to the following:

Currently, our nominating and corporate governance committee and board of directors evaluate each individual in the context of the board of directors as a whole, with the objective of assembling a group that can best maximize the success of the business and represent stockholder interests through the exercise of sound judgment using its diversity of experience in these various areas.

Stockholder Communications with the Board of Directors

The board of directors will consider any written or electronic communication from our stockholders to the board, a committee of the board or any individual director. Any stockholder who wishes to communicate to the board of directors, a committee of the board or any individual director should submit written or electronic communications to our Secretary at our principal executive offices, which shall include contact information for such stockholder. All communications from stockholders received shall be forwarded by our Secretary to the board of directors, a committee of the board or an individual director, as appropriate, on a periodic basis, but in any event no later than the board of director’s next scheduled meeting. The board of directors, a committee of the board, or individual directors, as appropriate, will consider and review carefully any communications from stockholders forwarded by our Secretary.

Material Changes to Nominee Recommendation Procedures

Following our initial public offering in January 2018, there have been no material changes to the procedures by which stockholders may recommend nominees to our board in 2020.

Family Relationships

There are no family relationships among any of our directors or executive officers.

Code of Business Conduct and Ethics

We have adopted a code of business conduct and ethics that applies to all of our employees, officers and directors, including those officers responsible for financial reporting. Our code of business conduct and ethics is available on our website at www.menlotherapeutics.com. Any amendments to the code, or any waivers of its requirements, will be disclosed on our website. The reference to our web address does not constitute incorporation by reference of the information contained at or available through our website.

Section 16(a) Beneficial Ownership Reporting Compliance

Section 16(a) of the Exchange Act requires our directors, executive officers and beneficial owners of more than 10% of our common stock to file reports of holdings and transactions in our common stock and our other securities with the SEC.  Officers, directors and beneficial owners of more than 10% of our common stock are required by SEC regulations to furnish us with copies of all Section 16(a) forms they file. Our directors, executive officers and beneficial owners of more than 10% of our common stock did not become subject to such Section 16(a) reporting requirements until January 29, 2018.

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To our knowledge, based solely on our review of Forms 3, 4 and 5, and any amendments thereto, furnished to us or written representations that no Form 5 was required, we believe that during the fiscal year ended December 31, 2019, all filing requirements applicable to our executive officers and directors under the Exchange Act were met in a timely manner.

Item 11. Executive Compensation.

The following is a discussion of compensation arrangements of our named executive officers, or NEOs. As an “emerging growth company” as defined in the JOBS Act, we are not required to include a Compensation Discussion and Analysis section and have elected to comply with the scaled disclosure requirements applicable to emerging growth companies.

Our Chief Executive Officer and our two other most highly compensated officers for the year ended December 31, 2019 were:

We refer to these executive officers as our named executive officers, or NEOs.

Summary Compensation Table

The following table shows information regarding the compensation of our named executive officers for services performed in the years ended December 31, 2019 and 2018.

 

 

 

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Outstanding Equity Awards at Fiscal Year End

The following table sets forth all outstanding equity awards held by each of the named executive officers as of December 31, 2019.

 

 

 

Narrative to Summary Compensation Table and Outstanding Equity Awards at Fiscal Year End

We have entered into agreements with each of our named executive officers in connection with his or her employment with us. These agreements set forth the terms and conditions of employment of each NEO, including base salary, initial equity award grants and standard employee benefit plan participation. Our board of directors or the compensation committee reviews each NEO’s base salary and other compensation from time to time to ensure compensation adequately reflects the NEO’s qualifications, experience, role and responsibilities.

2019 Salaries

For fiscal year 2019, Mr. Basta’s annual base salary was $598,000, Ms. Ball’s annual base salary was $416,000, and Dr. Kwon’s annual base salary was $412,000.

Terms and Conditions of 2019 Annual Bonuses

Each NEO’s target bonus opportunity is expressed as a percentage of base salary that can be achieved by meeting corporate objectives at a target level. Each of our NEO’s target bonus opportunity is set in their employment agreements, as amended with us. The 2019 annual bonus for Mr. Basta, Ms. Ball and Dr. Kwon were targeted at 55%, 40% and 40% of their respective base salaries.

For 2019, all of our NEOs were eligible to earn their annual bonuses pursuant to the achievement of certain performance goals. The performance goals for annual bonuses are reviewed and approved annually by the compensation committee of our board of directors and Mr. Basta’s annual bonus was reviewed and approved by the board of directors. Following a review of the corporate goals attained in 2019, the overall bonus funding was approved at 91% of the target for 2019, and

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each of our NEO’s annual bonus was paid at 91% of his or her target bonus amount in December 2019. Thus, for fiscal year 2019, Mr. Basta’s bonus was $305,887, Ms. Ball’s bonus was $154,752 and Dr. Kwon’s bonus was $153,265.

2019 Equity Award Grants

On July 29, 2019, we granted Mr. Basta 238,800 restricted stock units and each of Ms. Ball and Mr. Kwon 80,300 restricted stock units.  The restricted stock unit awards were scheduled to vest in equal installments on the first two anniversaries of the date of grant, subject to the named executive officer’s continued service through the applicable vesting date.  On December 11, 2019, the vesting of the restricted stock units was fully accelerated in connection with the pending Merger in order to mitigate potential negative tax consequences to both our company and the named executive officers.

In accordance with Mr. Basta’s option agreement and employment agreement, as amended, on the date of a “Change in Control” transaction (as defined in the 2011 Stock Incentive and 2018 Omnibus Incentive Plans, or the “2011 and 2018 Plans”), which includes the pending Merger, vesting will accelerate with respect to 100% of the options that Mr. Basta holds immediately prior to the Change in Control transaction.

In accordance with our standard form option agreement and form option grant notice, in connection with a Change in Control, which includes the pending Merger, each option granted to Ms. Ball and Dr. Kwon that is scheduled to vest and, if applicable, become exercisable, on or after the twelve (12) month anniversary of such event (ignoring, for this purpose, any accelerated vesting provisions) shall instead vest and, if applicable, become exercisable on the date of such 12 month anniversary. However, if Ms. Ball or Dr. Kwon is terminated by us without “cause” or resigns for “good reason” (each as defined in the 2011 and 2018 Plans) within the twelve (12) month period following a Change in Control, then, subject to the execution and non-revocation of a general release of claims in favor of our company, all options will vest and become exercisable upon such termination.

Change in Control and Severance Provisions

Steven Basta. Under Mr. Basta’s employment agreement, as amended, in the event Mr. Basta’s employment with us is terminated without “cause” (as defined below) or he resigns from his employment for “good reason” (as defined below), and Mr. Basta executes and does not revoke a general release of claims in favor of us, then Mr. Basta will receive the following: (i) an amount equal to twelve (12) months of base salary, payable in one lump sum; (ii) COBRA premiums paid by us for the twelve (12) month period following his termination and (iii) accelerated vesting with respect to the number of shares underlying any equity incentives or options that are subject to vesting and that would have otherwise vested during the twelve (12) month period following his termination.

In addition, if Mr. Basta is terminated by us without cause or he resigns from his employment for good reason during the three (3) months before and twelve (12) month period following a Change in Control (as defined in the 2018 Omnibus Incentive Plan), Mr. Basta will receive (i)a lump-sum cash payment in cash equal to the sum of (a) eighteen (18) months’ base salary plus (b) one and a half times (1.5x) target annual bonus plus (c) target annual bonus, pro-rated monthly for any partial year and (ii) COBRA premiums paid by us for the eighteen (18) month period following his termination.

The severance payments and benefits described above will commence within 60 days following Mr. Basta’s termination date, provided that Mr. Basta has signed and not revoked a release of claims in favor of our company.

For purposes of Mr. Basta’s employment agreement:

Cause means if it has caused or is reasonably expected to result in material injury to the company: (i) the executive’s gross negligence or willful failure substantially to perform his or her duties and responsibilities to the company or deliberate violation of a company policy, which failure is not corrected within 30 days after the board of directors has given the executive written notice specifying the failure in reasonable detail, and he or she had an opportunity to address the board of directors with, at the executive’s option, counsel present; (ii) the executive’s intentional commission of any act of fraud, embezzlement or dishonesty against the company or any other willful misconduct; (iii) the executive’s improper, unauthorized use or disclosure of any proprietary information or trade secrets of the company or any other party to whom the executive owes an obligation of nondisclosure as a result of his or her relationship with the company; or (iv) the executive’s willful breach of any material obligations under any written agreement or covenant with the company, which failure is not corrected within 30 days after the board of directors has given the executive written notice specifying the failure in reasonable detail, and the executive has had an opportunity to address the board of directors with, at the executive’s option, counsel present.

Good reason means the occurrence at any time of any of the following without the executive’s prior written consent: (i) removal from the current executive officer position held by such executive with respect to the company resulting in a

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material diminution of the executive’s authority, duties or responsibilities (other than a mere change in title following any merger or consolidation of the company with another entity); (ii) the assignment of duties or responsibilities materially inconsistent with those customarily associated with the position of such executive officer or a material diminution of the executive’s position, authority, duties or responsibilities (other than a mere change in title following any merger or consolidation of the company with another entity); (iii) a material reduction in the executive’s base salary; (iv) any willful failure or willful breach by the company of any of the material obligations of the executive’s employment agreement; or (v) a requirement that the executive relocate his principal place of business by more than 50 miles; provided that the executive will not be deemed to have good reason unless (a) the executive first provides the company with written notice of the condition giving rise to good reason within 90 days of its initial occurrence, and (b) the company fails to cure such condition within 30 days after receiving such written notice.

Kristine Ball and Paul Kwon. Under Ms. Ball’s and Dr. Kwon’s employment agreements, as amended, in the event Ms. Ball’s or Dr. Kwon’s employment with us is terminated without “cause” (as defined below) or resigns from employment for “good reason” (as defined below), and Ms. Ball or Dr. Kwon executes and does not revoke a general release of claims in favor of us, then Ms. Ball or Dr. Kwon will receive (i) an amount equal to nine (9) months of base salary payable in one lump sum; and (ii) COBRA premiums paid by our company for nine (9) months.

In addition, upon a termination without cause or a resignation for good reason during the three (3) months before and twelve (12) month period following a Change in Control, Ms. Ball or Dr. Kwon will receive (i) a lump-sum cash payment equal to: (a) twelve (12) months’ base salary plus (b) one times (1x) annual target bonus plus (c) target annual bonus, pro-rated monthly for any partial year and (ii) COBRA premiums paid by our company during the twelve (12) month period following the executive’s termination of employment.

The severance payments and benefits described above will commence within 60 days following the executive’s termination date, provided that the executive has signed and not revoked a release of claims in favor of our company.

For purposes of Ms. Ball’s and Dr. Kwon’s employment agreement:

Cause means (i) the executive’s gross negligence or willful failure substantially to perform his or her duties and responsibilities to the company or deliberate violation of a company policy; (ii) the executive’s intentional commission of any act of fraud, embezzlement or dishonesty against the company or any other willful misconduct that has caused or is reasonably expected to result in material injury to the company; (iii) the executive’s unauthorized use or disclosure of any proprietary information or trade secrets of the company or any other party to whom the executive owes an obligation of nondisclosure as a result of his or her relationship with the company; or (iv) the executive’s willful breach of any obligations under any written agreement or covenant with the company.

Good reason means the occurrence at any time of any of the following without the executive’s prior written consent: (i) a material diminution of the executive’s authority, duties or responsibilities (other than a mere change in title following any merger or consolidation of the company with another entity); (ii) the assignment of duties or responsibilities materially inconsistent with those customarily associated with the position of such executive officer or a material diminution of the executive’s position, authority, duties or responsibilities (other than a mere change in title following any merger or consolidation of the company with another entity); (iii) a material reduction in the executive’s base salary; (iv) any willful failure or willful breach by the company of any of the material obligations of the executive’s employment agreement; or (v) a requirement that the executive relocate executive’s principal place of business by more than 50 miles; provided that the executive will not be deemed to have good reason unless (a) the executive first provides the company with written notice  of the condition giving rise to good reason within 90 days of its initial occurrence, and (b) the company fails to cure such condition within 30 days after receiving such written notice.

Terms and Conditions of 401(k) Plan

We participate in a tax‑qualified retirement plan that provides eligible U.S. employees with an opportunity to save for retirement on a tax advantaged basis. Eligible employees are able to defer eligible compensation subject to applicable annual Internal Revenue Code (the “Code”) limits. Employees’ pre‑tax contributions are allocated to each participant’s individual account and are then invested in selected investment alternatives according to the participants’ directions. Employees are immediately and fully vested in their contributions. The 401(k) plan is intended to be qualified under Section 401(a) of the Code with the 401(k) plan’s related trust intended to be tax exempt under Section 501(a) of the Code. As a tax‑qualified retirement plan, contributions to the 401(k) plan and earnings on those contributions are not taxable to the employees until distributed from the 401(k) plan.

Employee Benefits and Perquisites

All of our full‑time employees, including our NEOs, are eligible to participate in our health and welfare plans, including medical, dental and vision benefits, medical and dependent care flexible spending accounts, short‑term and long‑term

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disability insurance and life insurance. We do not provide our NEOs with perquisites or other personal benefits, other than the retirement, health and welfare benefits that apply uniformly to all of our employees.

Director Compensation

Our board of directors has adopted the following compensation policy that is applicable to all of our non-employee directors upon completion of our initial public offering in January 2018:

 

 

The exercise price per share of each option granted under this policy will be equal to the per share fair market value of our stock on the date of grant. Each such option will have a term of ten years from the date of grant, subject to earlier termination in connection with a termination of the non-employee director’s service with us. In the event of a change of control transaction, any unvested portion of an equity award granted under this policy will fully vest and become exercisable immediately prior to the effective date of such transaction, subject to the non-employee director’s continuous service with us on the effective date of such transaction.  Cash retainers will be paid on a quarterly basis in arrears, pro-rated based on the days served in the applicable fiscal quarter. In addition, none of our non-employee directors shall in any event be permitted to receive cash and equity-based compensation (calculated based on grant date fair value) exceeding, in the aggregate, $500,000 in any calendar year.

Our director compensation policy was adopted by our board of directors in consideration of a number of factors, including its assessment of a director compensation report from Compensia, which our board of directors engaged to prepare a competitive assessment of non-employee director compensation. The Compensia report delivered to our board of directors in December 2017 recommended a director compensation program based on the 50^th percentile of a comparator group.

In March 2019, we granted Ms. Sandoval 33,355 option awards in connection with her appointment as a director. The award has an exercise price of $8.24 and vests over three years from the vesting commencement date of March 19, 2019.

In June 2019, we granted Mr. Burns, Mr. Ebel, Mr. McGirr, and Dr. Whitcup annual option awards with respect to 22,500 shares, respectively, in connection with their continued service as directors. The awards have an exercise price of $6.02 per share and fully vest over one year from the vesting commencement date of June 25, 2019. Additionally, in June 2019, we granted Ms. Sandoval 11,645 shares in connection with her continued service as a director. The award has an exercise price of $6.02 per share and vests over three years from the vesting commencement date of March 19, 2019.

The vesting of each stock option held by our non-employee directors will accelerate in full upon a Change in Control, including the pending Merger.

We also reimburse all of our non-employee directors for all reasonable and customary business expenses in accordance with company policy.

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Director Compensation Table

The following table sets forth information for the fiscal year ended December 31, 2019 regarding the compensation awarded to, earned by or paid to our non‑employee directors:

 

(1) Dr. Cha resigned from our board of directors in March 2019.

(2) Dr. Royston resigned from our board of directors in August 2019.

(3) Ms. Sandoval was appointed to our board of directors in March 2019.

 

As of December 31, 2019, our non-employee directors held the following equity awards:

 

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

The following table sets forth information relating to the beneficial ownership of our common stock as of February 14, 2020, by:

The number of shares beneficially owned by each entity, person, director or executive officer is determined in accordance with the rules of the SEC, and the information is not necessarily indicative of beneficial ownership for any other purpose. Under such rules, beneficial ownership includes any shares over which the individual has sole or shared voting power or investment power as well as any shares that the individual has the right to acquire within 60 days after February 15, 2020 through the exercise of any stock option, warrants or other rights. Except as otherwise indicated, and subject to applicable community property laws, the persons named in the table have sole voting and investment power with respect to all shares of common stock held by that person.

The percentage of shares beneficially owned is computed on the basis of 24,438,631 shares of our common stock outstanding as of February 14, 2020. Shares of our common stock that a person has the right to acquire within 60 days after February 14, 2020 are deemed outstanding for purposes of computing the percentage ownership of the person holding such rights, but are not deemed outstanding for purposes of computing the percentage ownership of any other person, except with respect to the percentage ownership of all directors and executive officers as a group. Unless otherwise indicated below, the address for each beneficial owner listed is c/o Menlo Therapeutics Inc., 200 Cardinal Way, 2nd Floor, Redwood City, California 94063.

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(4)   The information reported is based on a Schedule 13G filed with the SEC on February 14, 2020. BiomedicalValue Fund, L.P. (“BVF”) is the record owner of 551,773 shares of Common Stock (the “BVF Shares”). Great Point Partners, LLC (“Great Point”) is the investment manager of BVF, and by virtue of such status may be deemed to be the beneficial owner of the BVF Shares. Each of Dr. Jeffrey R. Jay, M.D. (“Dr. Jay”), as senior managing member of Great Point, and Mr. David Kroin (“Mr. Kroin”), as special managing member of Great Point, has voting and investment power with respect to the BVF Shares, and therefore may be deemed to be the beneficial owner of the BVF Shares.  Biomedical Offshore Value Fund, Ltd. (“BOVF”) is the record owner of 713,669 shares of common stock (the “BOVF Shares”). Great Point is the investment manager of BOVF, and by virtue of such status may be deemed to be the beneficial owner of the BOVF Shares. Each of Dr. Jay, as senior managing member of Great Point, and Mr. Kroin, as special managing member of Great Point, has voting and investment power with respect to the BOVF Shares, and therefore may be deemed to be the beneficial owner of the BOVF Shares.  GEF-SMA,LP (“GEF-SMA”) is the record owner of 386,571 shares of common stock (the “GEF-SMA Shares”). Great Point is the investment manager of GEF-SMA, and by virtue of such status may be deemed to be the beneficial owner of the GEF-SMA Shares. Each of Dr. Jay, as senior managing member of Great Point, and Mr. Kroin, as special managing member of Great Point, has voting and investment power with respect to the GEF-SMA Shares, and therefore may be deemed to be the beneficial owner of the GEF-SMA Shares.  Notwithstanding the above, Great Point, Dr. Jay and Mr.

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Kroin disclaim beneficial ownership of the BVF Shares, the BOVF Shares and the GEF-SMA Shares described above, except to the extent of their respective pecuniary interests. The address of Great Point Partners, LLC is 165 Mason Street, 3rd Floor, Greenwich, CT 06830.

(9)   Consists of (i) 192,359 shares of common stock, (ii) 252,085 shares of common stock held by The Shelter Trust   under the Basta Revocable Trust (the “Shelter Trust”), (iii) 65,320 shares of common stock held by the Basta Revocable Trust dated August 4, 2017 (the “Basta Trust”), and (iv) 547,768 shares of common stock issuable upon the exercise of stock options within 60 days of February 14, 2020. As the trustee of each of the Shelter Trust and the Basta Trust, Mr. Basta has voting and investment power over the shares of common stock held by each of the Shelter Trust and the Basta Trust.

(10) Consists of (i) 52,534 shares of common stock and (ii) 174,474 shares of common stock issuable upon the exercise of stock options within 60 days of February 14, 2020.

(11) Consists of (i) 52,534 shares of common stock and (ii) 234,212 shares of common stock issuable upon the exercise of stock options within 60 days of February 14, 2020.

(12) Consists of 25,247 shares of common stock issuable upon the exercise of stock options within 60 days of February 14, 2020.

(13) Consists of 25,247 shares of common stock issuable upon the exercise of stock options within 60 days of February 14, 2020.

(14) Consists of (i) 12,355 shares of common stock, and (ii) 25,835 shares of common stock issuable upon the exercise of stock options within 60 days of February 14, 2020.  

(15) Consists of (i) 25,000 shares of common stock and (ii) 106,416 shares of common stock issuable upon the exercise of stock options within 60 days of February 14, 2020.  

(16) Beneficial ownership consists of (i) 668,006 shares of common stock and (ii) 1,139,199 shares of common stock that may be acquired pursuant to the exercise of stock options within 60 days of February 14, 2020.  

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Securities Authorized for Issuance Under Equity Compensation Plans

The following table contains information about our equity compensation plans as of December 31, 2019. As of December 31, 2019, we had two equity compensation plans, our 2018 Omnibus Plan and 2018 Employee Stock Purchase Plan, which have been approved by our board of directors and our stockholders.

 

Equity Compensation Plan Information

 

 

 

 

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Item 13. Certain Relationships and Related Transactions, and Director Independence.

Certain Related Party Transactions

The following is a description of transactions during our last fiscal year to which we have been a party, in which the amount involved exceeds $120,000, and in which any of our directors, executive officers or beneficial owners of more than 5% of our capital stock, or an affiliate or immediate family member thereof, had or will have a direct or indirect material interest.

 

Relationship with Former Board Member

 

David Collier, M.D., a former member of our board of directors, entered into a consulting agreement with us in 2016, pursuant to which Dr. Collier provides certain advisory and support services in exchange for options to purchase 31,488 shares of our common stock, with an exercise price of $1.83 per share, subject to certain vesting requirements.

 

Director and Executive Officer Compensation

Please see “Director Compensation” and “Executive Compensation” for information regarding the compensation of our directors and executive officers.

Employment Agreements

We have entered into employment agreements with our executive officers. For more information regarding these agreements, see “Executive Compensation—Narrative to Summary Compensation Table and Outstanding Equity Awards at Fiscal Year End.”

Indemnification Agreements and Directors’ and Officers’ Liability Insurance

We have entered into or intend to enter into indemnification agreements with each of our directors and executive officers. These agreements require us to, among other things, indemnify each director and executive officer to the fullest extent permitted by Delaware law, including indemnification of expenses such as attorneys’ fees, judgments, penalties fines and settlement amounts incurred by the director or executive officer in any action or proceeding, including any action or proceeding by or in right of us, arising out of the person’s services as a director or executive officer. We have obtained an insurance policy that insures our directors and officers against certain liabilities, including liabilities arising under applicable securities laws.

Investors’ Rights Agreements

We entered into a second amended and restated investors’ rights agreement with the purchasers of our outstanding preferred stock (which converted to common stock in our IPO), including entities with which certain of our directors are affiliated. As of December 31, 2019, the holders of approximately 5.5 million shares of our common stock are entitled to rights with respect to the registration of their shares under the Securities Act. The investor rights agreement also provided for a right of first offer in favor of certain holders of preferred stock with regard to certain issuances of our securities. The right of first offer terminated upon completion of our January 2018 IPO.

Independence of Board of Directors and its Committees

Under the rules of the Nasdaq Stock Market LLC, independent directors must comprise a majority of a listed company’s board of directors within a specified period of the closing of our initial public offering. In addition, the rules of Nasdaq require that, subject to specified exceptions, each member of a listed company’s audit, compensation and nominating and corporate governance committees be independent. Under the rules of Nasdaq, a director will only qualify as an “independent director” if, in the opinion of that company’s board of directors, that person does not have a relationship that would interfere with the exercise of independent judgment in carrying out the responsibilities of a director.

Audit committee members must also satisfy the independence criteria set forth in Rule 10A-3 under the Securities Exchange Act of 1934, as amended. In order to be considered independent for purposes of Rule 10A-3, a member of an audit committee of a listed company may not, other than in his or her capacity as a member of the audit committee, the board of directors or any other board committee: (1) accept, directly or indirectly, any consulting, advisory or other compensatory fee from the listed company or any of its subsidiaries; or (2) be an affiliated person of the listed company or any of its subsidiaries. We currently satisfy the audit committee independence requirements of Rule 10A-3. Additionally, compensation committee members must not have a relationship with us that is material to the director’s ability to be independent from management in connection with the duties of a compensation committee member.

Our board of directors has undertaken a review of the independence of each director and considered whether each director has a material relationship with us that could compromise his ability to exercise independent judgment in carrying out his responsibilities. As a result of this review, our board of directors determined that all of our directors, except for Mr. Basta,

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are “independent directors” as defined under the applicable rules and regulations of the SEC, and the listing requirements and rules of Nasdaq.

Policies and Procedures for Related Party Transactions

Our board of directors has adopted a written related person transaction policy effective in January 2018, setting forth the policies and procedures for the review and approval or ratification of related person transactions. This policy covers, with certain exceptions set forth in Item 404 of Regulation S‑K under the Securities Act, any transaction, arrangement or relationship, or any series of similar transactions, arrangements or relationships in which we were or are to be a participant, where the amount involved exceeds $120,000 and a related person had or will have a direct or indirect material interest, including without limitation purchases of goods or services by or from the related person or entities in which the related person has a material interest, indebtedness, guarantees of indebtedness and employment by us of a related person. In reviewing and approving any such transactions, our audit committee will be tasked to consider all relevant facts and circumstances, including but not limited to whether the transaction is on terms comparable to those that could be obtained in an arm’s length transaction with an unrelated third party and the extent of the related person’s interest in the transaction. All of the transactions described in this section occurred prior to the adoption of this policy.

Item 14. Principal Accounting Fees and Services.

Substantially all MHM’s personnel, who work under the control of MHM shareholders, are employees of wholly-owned subsidiaries of CBIZ, Inc., which provides personnel and various services to MHM in an alternative practice structure. The following table summarizes the fees of Mayer Hoffman McCann P.C., our independent registered public accounting firm, billed us for each of the years ended December 31, 2019 and 2018.

 

All fees described above were pre-approved by the Audit Committee.

PRE-APPROVAL POLICIES AND PROCEDURES

The Audit Committee has adopted a policy and procedures for the pre-approval of audit and non-audit services rendered by the Company’s independent registered public accounting firm, Mayer Hoffman McCann P.C. The policy generally pre-approves specified services in the defined categories of audit services, audit-related services and tax services up to specified amounts. Pre-approval may also be given as part of the Audit Committee’s approval of the scope of the engagement of the independent auditor or on an individual, explicit, case-by-case basis before the independent auditor is engaged to provide each service. The pre-approval of services may be delegated to one or more of the Audit Committee’s members, but the decision must be reported to the full Audit Committee at its next scheduled meeting. This policy is set forth in the charter of the Audit Committee and is available at http://ir.menlotherapeutics.com/index.php/governance/documents-charters.

The Audit Committee has determined that the rendering of services other than audit services by Mayer Hoffman McCann P.C. is compatible with maintaining the principal accountant’s independence.

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Item 15. Exhibits and Financial Statement Schedules.

(a) The following documents are filed as part of this Annual Report on Form 10-K:

See Index to Financial Statements at Item 8 herein.

All schedules are omitted because they are not applicable, or the required information is shown in the financial statements or notes thereto.

Exhibit Index

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Item 16. Form 10-K Summary.

 

Registrants may voluntarily include a summary of information required by Form 10-K under Item 16. We have elected not to include such summary.

 

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Signatures

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Annual Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized.

 

POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Steven Basta and Kristine Ball, his or her true and lawful attorney-in-fact and agent, with full power of substitution, for him or her and in his or her name, place and stead, in any and all capacities, to sign any and all amendments to this annual report on Form 10-K, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorney-in-fact and agent, full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorney-in-fact and agent, or his substitutes or substitute, may lawfully do or cause to be done by virtue hereof.

IN WITNESS WHEREOF, each of the undersigned has executed this Power of Attorney as of the date indicated opposite his/her name.

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this Annual Report on Form 10-K has been signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated.

 

 

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