S-1 1 d106401ds1.htm S-1 S-1
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As filed with the Securities and Exchange Commission on August 24, 2016

 

Registration No. 333-             

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

Novan, Inc.

(Exact name of registrant as specified in its charter)

 

 

Delaware   2834   20-4427682

(State or other jurisdiction of

incorporation or organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification No.)

4222 Emperor Boulevard, Suite 200

Durham, North Carolina 27703

(919) 485-8080

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

 

 

Nathan Stasko, Ph.D.

President and Chief Executive Officer

Novan, Inc.

4222 Emperor Boulevard, Suite 200

Durham, North Carolina 27703

(919) 485-8080

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 

 

Copies to:

 

Charles K. Ruck

Wesley C. Holmes

Latham & Watkins LLP

885 Third Avenue

New York, New York 10022

Telephone: (212) 906-1200

 

Divakar Gupta

Brent B. Siler

Cooley LLP

1114 Avenue of the Americas

New York, New York 10036

Telephone: (212) 479-6000

 

 

Approximate date of commencement of proposed sale to the public: As soon as practicable after this Registration Statement is declared effective.

If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  ¨

If this form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

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

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   x  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

 

 

CALCULATION OF REGISTRATION FEE

 

 

Title of Each Class of Securities To Be Registered  

Proposed Maximum

Aggregate Offering Price(1)

   Amount of
Registration Fee(2)

Common Stock, $0.0001 par value per share

  $60,000,000    $6,042

 

 

(1) Estimated solely for the purpose of calculating the registration fee pursuant to Rule 457(o) under the Securities Act of 1933, as amended.
(2) Calculated pursuant to Rule 457(o) based on an estimate of the proposed maximum aggregate offering price.

 

 

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.

 

 

 


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The information in this preliminary prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.

 

 

Subject to Completion.    Dated August 24, 2016

PRELIMINARY PROSPECTUS

 

 

             Shares

 

 

LOGO

Common Stock

This is the initial public offering of our common stock. We are offering          shares of our common stock.

We expect the public offering price to be between $         and $         per share. Currently, no public market exists for the shares. We have applied to list our common stock on The NASDAQ Global Market under the symbol “NOVN”.

We are an “emerging growth company” under the applicable Securities and Exchange Commission rules and will be subject to reduced public company reporting requirements for this prospectus and future filings. See “Prospectus Summary—Implications of Being an Emerging Growth Company.”

Our business and investment in our common stock involves risks that are described in the “Risk Factors” section beginning on page 11 of this prospectus.

 

 

 

    Per Share     Total  

Initial public offering price

  $                   $                

Underwriting discounts and commissions(1)

  $        $     

Proceeds, before expenses, to Novan, Inc.

  $        $     

 

(1) We refer you to “Underwriting” beginning on page 153 for additional information regarding total underwriter compensation.

The underwriters may also exercise their option to purchase up to an additional              shares from us, at the initial public offering price, less the underwriting discounts and commissions, for 30 days after the date of this prospectus to cover overallotments.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

The underwriters expect to deliver the shares against payment in New York, New York on or about                     , 2016.

 

 

Piper Jaffray

 

 

 

JMP Securities   Wedbush PacGrow

 

The date of this prospectus is                     , 2016.


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TABLE OF CONTENTS

 

PROSPECTUS SUMMARY

    1   

RISK FACTORS

    11   

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

    48   

MARKET, INDUSTRY AND OTHER DATA

    49   

USE OF PROCEEDS

    50   

DIVIDEND POLICY

    51   

CAPITALIZATION

    52   

DILUTION

    54   

SELECTED CONSOLIDATED FINANCIAL DATA

    57   

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

    59   

BUSINESS

    76   

MANAGEMENT

    123   

EXECUTIVE COMPENSATION

    128   

CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS

    141   

PRINCIPAL STOCKHOLDERS

    145   

DESCRIPTION OF CAPITAL STOCK

    147   

SHARES ELIGIBLE FOR FUTURE SALE

    150   

MATERIAL U.S. FEDERAL INCOME TAX CONSEQUENCES TO NON-U.S. HOLDERS

    152   

UNDERWRITING

    156   

LEGAL MATTERS

    163   

EXPERTS

    163   

WHERE YOU CAN FIND MORE INFORMATION

    163   

INDEX TO FINANCIAL STATEMENTS

    F-1   

 

 

We have not, and the underwriters have not, authorized anyone to provide any information or to make any representations other than those contained in this prospectus or in any free writing prospectus prepared by or on behalf of us or to which we have referred you. We take no responsibility for, and can provide no assurance as to the reliability of, any other information that others may give you. This prospectus is an offer to sell only the shares of common stock offered hereby, but only under circumstances and in jurisdictions where it is lawful to do so. The information contained in this prospectus or in any applicable free writing prospectus is current only as of its date, regardless of its time of delivery or any sale of shares of our common stock. Our business, financial condition, results of operations and prospects may have changed since that date.

TRADEMARKS

Novan® is a registered trademark of our company in the United States. We have pending trademark applications for Nitricil, Micronox and Pura-T in the United States. This prospectus also includes trademarks, trade names and service marks that are the property of other organizations. Solely for convenience, our trademarks and trade names referred to in this prospectus appear without any “™” or “®” symbol, but those references are not intended to indicate, in any way, that we will not assert, to the fullest extent under applicable law, our rights or the rights of any applicable licensor, to these trademarks and trade names.

INVESTORS OUTSIDE THE UNITED STATES

Neither we nor any of the underwriters have taken any action that would permit this offering or possession or distribution of this prospectus in any jurisdiction where action for that purpose is required, other than in the United States. Persons who have come into possession of this prospectus in a jurisdiction outside the United States are required to inform themselves about and to observe any restrictions relating to this offering and the distribution of this prospectus.


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PROSPECTUS SUMMARY

The following summary highlights information contained elsewhere in this prospectus. This summary is not complete and may not contain all the information you should consider before investing in our common stock. You should read this entire prospectus carefully, especially the risks of investing in our common stock discussed under the heading “Risk Factors,” and our financial statements and related notes included at the end of this prospectus before making an investment decision.

References to “Novan,” “the Company,” “we,” “us” and “our” are to Novan, Inc.

Overview

We are a late-stage pharmaceutical company focused on redefining the standard of care in dermatology through the development and commercialization of innovative therapies using our nitric oxide platform. Nitric oxide plays a vital role in the natural immune system response against microbial pathogens and is a critical regulator of inflammation. Our ability to harness nitric oxide and its multiple mechanisms of action has enabled us to create a platform with the potential to generate differentiated, first-in-class product candidates. The two key components of our nitric oxide platform are our proprietary Nitricil technology, which drives the creation of new chemical entities, or NCEs, and our topical formulation science, both of which we use to modulate, or “tune,” our product candidates for specific indications. We are using our platform to transform a useful, naturally occurring molecule into a therapeutic pipeline for a host of skin diseases.

We are rapidly advancing programs in five dermatological conditions with significant unmet medical need. These are some of the most prevalent diseases in dermatology and together represent a large market opportunity with a patient population surpassing 150 million Americans and 1.5 billion individuals globally.

Our lead product candidate is SB204, a cosmetically elegant topical gel that targets multiple mechanisms of action for the treatment of acne vulgaris, the most common skin disease in the United States. We commenced two identically designed Phase 3 pivotal clinical trials in the first quarter of 2016 and expect to report top-line results from these pivotal trials in the first quarter of 2017. Assuming successful completion of a long-term safety study in the second half of 2017, we are targeting submission of a new drug application, or NDA, for SB204 by year-end 2017. Our other product candidates include SB206, SB208 and SB414, which are targeted toward the treatment of either a specific microorganism or inflammatory components of a disease pathology. SB206 is a first-in-class, topical anti-viral gel in Phase 2 clinical development for the treatment of viral skin infections such as external genital and perianal warts caused by human papillomavirus, or HPV. We initiated our Phase 2 clinical trial for SB206 in 2015, and we expect to announce top-line results in the second half of 2016. SB208 is a topical broad-spectrum anti-fungal product candidate for the treatment of fungal infections of the skin and nails. We commenced Phase 2 clinical development of SB208 for the treatment of infections caused by dermatophytes such as Trichophyton rubrum, or T. rubrum, in July 2016. SB414, a topical cream in preclinical development for the treatment of inflammatory skin diseases such as psoriasis and atopic dermatitis, rounds out our current pipeline.

We believe that our ability to conveniently deploy nitric oxide on demand in topical formulations allows us the potential to significantly improve patient outcomes in a variety of skin diseases and positions us to be a commercially successful leader in the dermatology market.

 



 

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Our Dermatology-Focused Nitric Oxide Platform

Nitric oxide is one of the most researched molecules in human physiology and has been extensively studied in many areas of medicine, including in microbial diseases and in the modulation of inflammation. As a fundamental component in host immune response against invading organisms, cells of the immune system naturally generate nitric oxide using the enzyme nitric oxide synthase and the amino acid precursor L-arginine. Nitric oxide is released in a targeted manner to kill microbial pathogens, including bacteria, fungi and viruses. Nitric oxide and its metabolites drive cell death within bacteria and fungi by targeting metal centers or amino acids on proteins critical to sustaining microbial viability. In virally infected cells, nitric oxide inhibits viral replication by binding directly to key enzymes or by inducing apoptosis, or programmed cell death, in these cells where tumor suppressors have been degraded or disabled. Beyond nitric oxide’s essential role in pathogen control, a large number of cells produce and respond to nitric oxide for several other immunoregulatory functions. The anti-inflammatory and immunosuppressive effects of nitric oxide occur in part through the inhibition of T cell proliferation and leukocyte recruitment.

However, the scarcity of nitric oxide-based therapeutic products is due to the challenges associated with controlling the release of a gas, the poor stability and low storage capacity of nitric oxide-loaded molecules, the inability to target specific tissues and the toxicity of several small molecules used previously as backbones to store nitric oxide. We believe the following key components of our nitric oxide platform fuel the creation of differentiated product candidates and address each of these limitations:

(1)    Our Nitricil technology enables us to engineer tunable NCEs that allow for the stable chemical storage of large amounts of nitric oxide in solid form by loading it on an inert macromolecule, or polymer. The advantages of our proprietary Nitricil technology include tunability, stability, high storage capacity, targeted delivery and what we believe is an attractive safety profile. Our ability to select from several nitric oxide-loaded starting materials has driven our library of over 200 Nitricil compositions, each of which possesses a unique nitric oxide release profile.

(2)    Our formulation science enables us to further tune the release of nitric oxide when applied to the skin by using proprietary combinations of inactive ingredients. This additional level of control enables us to use one NCE for multiple indications by altering the nitric oxide pharmacology with the composition of the topical formulation. This component of our nitric oxide platform creates an additional barrier to entry, which we believe may create a prolonged period of market exclusivity for each of our product candidates. Additionally, our formulation science allows us to customize the drug delivery method for the relevant anatomical location of a skin disease while considering physician and patient preferences for aesthetically pleasing and convenient products.

We have chosen to focus on dermatology because nitric oxide’s multiple mechanisms of action converge in the largest organ of the body, the skin. All of the major cell types that comprise the three layers of the skin are capable of producing nitric oxide at different rates, and these cells play an important part in organizing the skin’s unique ability to repair itself and maintain barrier function. Our platform allows us the ability to tune the release profile of nitric oxide and trigger its wide range of beneficial effects when host systems fail or are overwhelmed by invading microorganisms.

We believe that our nitric oxide platform is well suited to disrupt the large and growing dermatology market, reported to be $28 billion in the United States in 2014, according to IMS Health, Inc., or IMS. Despite the size of this market, innovation in medical dermatology has been largely stagnant for decades. For example, the widespread use of antibiotics and retinoids to treat acne vulgaris has been unchanged for over 30 years and, in our view, has failed to balance efficacy, tolerability and growing

 



 

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concerns over antibiotic resistance in a single product. We believe our nitric oxide platform will address the limitations of the current treatment landscape and therefore position us to redefine the standard of care in dermatology.

Our Product Candidates

SB204 for the Treatment of Acne Vulgaris (Phase 3) — We are developing our lead product candidate, SB204, as a once-daily, fast-acting, topical first-line monotherapy for the treatment of acne vulgaris. In the first quarter of 2016, we commenced two identically designed Phase 3 pivotal clinical trials of SB204 in which we expect to enroll a total of 2,600 patients with acne vulgaris, and we expect top-line results in the first quarter of 2017. Acne vulgaris is the most common skin disease in the United States, affecting approximately 40 to 50 million Americans annually, according to the American Academy of Dermatology. We believe the current treatment landscape significantly underserves patient needs due to the difficulty of balancing efficacy, systemic safety and cutaneous tolerability. Prior to initiating our Phase 3 trials, our 630-patient clinical program for SB204 included one first-in-human trial, six Phase 1 clinical trials and two Phase 2 clinical trials involving patients suffering from acne vulgaris, in each of which SB204 was well tolerated. In each of our Phase 2 clinical trials, we observed statistically significant reductions in both inflammatory and non-inflammatory lesion counts after 12 weeks of treatment. We designed the protocol for our Phase 3 clinical trials based on feedback we received from the U.S. Food and Drug Administration, or FDA, during our end-of-Phase 2 meeting in September 2015. Assuming successful completion of our Phase 3 clinical trials and our long-term safety study, we are targeting submission of our NDA for SB204 to the FDA by the end of 2017.

SB206, a Topical Anti-viral for the Treatment of External Genital and Perianal Warts (Phase 2) — Our second most advanced product candidate, SB206, represents a new approach to the treatment of HPV skin infections. In our preclinical studies, we observed complete inhibition of papilloma growth in vivo and inhibition of HPV viral replication in vitro. We have initially chosen to evaluate the anti-viral mechanism of action in a Phase 2 randomized, double-blind, vehicle-controlled clinical trial in 120 patients with genital warts caused by HPV and expect top-line results in the second half of 2016. All warts, including genital warts, are caused by HPV. We believe that SB206 has the potential to provide substantial improvements over currently approved topical therapies for warts, including shorter treatment duration, improved efficacy due to the direct anti-viral effect of nitric oxide, better local tolerability and decreased incidence of wart recurrence.

SB208, a Topical Anti-fungal for the Treatment of Onychomycosis (Phase 2) — We are developing SB208 as a topical anti-fungal for the treatment of fungal infections of the skin and nails. We commenced Phase 2 clinical development of SB208 for the treatment of infections caused by dermatophytes such as T. rubrum in July 2016. T. rubrum is a key pathogen in the development of athlete’s foot and onychomycosis. We believe SB208 will deliver high concentrations of nitric oxide that rapidly penetrate targeted tissues to potentially improve upon current efficacy rates observed with topical therapies while maintaining an attractive safety profile.

SB414, a Topical Anti-inflammatory for the Treatment of Inflammatory Skin Diseases (Preclinical) — Our pipeline also includes SB414, a topical cream product candidate, for which we are currently conducting preclinical studies for the treatment of inflammatory skin diseases, like psoriasis and atopic dermatitis. SB414 utilizes a slower nitric oxide-releasing cream formulation for which we have observed potent inflammatory cytokine inhibition in preclinical models. We plan to commence toxicology studies for SB414 in 2016 in support of the submission of an investigational new drug application, or IND, to the FDA, and are targeting initiation of clinical development in the second half of 2017.

 



 

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Our Strategy

Our strategy is to develop and commercialize novel nitric oxide-based therapies that redefine the standard of care in dermatology. We are focused on creating topical dermatological therapies in indications with underserved patient populations and well-defined clinical and regulatory development pathways. In order to pursue our strategy, we plan to:

 

  n   Complete development of our Phase 3 product candidate, SB204, and achieve regulatory approval in the United States.

 

  n   Achieve proof-of-concept for our other clinical-stage product candidates, SB206 and SB208, and advance them into late-stage development.

 

  n   Expand our existing pipeline by efficiently developing SB414 and other topical nitric oxide-based product candidates for new dermatological indications.

 

  n   Establish our own sales and marketing organization to commercialize our products in the United States.

We maintain exclusive, worldwide commercial rights for all product candidates currently in our pipeline. Our intent is to build a dermatology-focused sales organization, with approximately 75 representatives in the field, to sell our product candidates that receive regulatory approval in the United States. Our sales force will initially target high-volume prescribing dermatologists and other healthcare providers. Our commercialization strategy will leverage our NCEs with differentiated mechanisms of action to enhance reimbursement potential and facilitate broad patient access. We are also evaluating strategic partnerships to commercialize our dermatology products in select international markets.

We believe that our management team’s significant experience in nitric oxide science, drug development and commercialization of dermatological products positions us to execute on our vision to be a commercially successful leader in the field of dermatology.

Risks Associated with Our Business

Our business is subject to a number of risks of which you should be aware before making a decision to invest in our common stock. These risks are discussed more fully in the section titled “Risk Factors” and include, among others:

 

  n   We specialize in nitric oxide-based product candidates and our current intellectual property rights are limited to the field of dermatology. We may not be successful in redeploying our resources if our nitric oxide platform in dermatology fails to meet our expectations.

 

  n   Clinical drug development involves a lengthy and expensive process with an uncertain outcome, and results of earlier studies and trials may not be predictive of future trial results.

 

  n   Our product candidates may pose safety issues, cause adverse events, have side effects or have other properties that could delay or prevent their regulatory approval, limit the commercial profile of an approved label or result in significant negative consequences following marketing approval, if any.

 

  n   Even if we obtain marketing approval for any product candidates, the products may become subject to unfavorable third-party coverage or reimbursement policies.

 

  n   Our product candidates, if approved, will face significant competition, and our failure to effectively compete may prevent us from achieving significant market penetration.

 



 

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  n   We rely or intend to rely on third parties to conduct some of our preclinical and all of our clinical trials and to manufacture our clinical drug supplies and any approved product candidate. 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 any of our product candidates or our commercialization efforts may be stopped, delayed or made less profitable.

 

  n   If we are unable to obtain and maintain patent protection for our product candidates, or if the scope of the patent protection obtained is not sufficiently broad, our competitors could develop and commercialize technology and products similar or identical to ours, and our ability to successfully commercialize our technology and product candidates may be impaired.

 

  n   We will need substantial additional funding and as of June 30, 2016, we had an accumulated deficit of $92.5 million. If we are unable to raise capital when needed, we would be forced to delay, reduce, terminate or eliminate our product development programs, or our commercialization efforts.

 

  n   As a result of our operating losses and negative cash flows from operations, the report of our independent registered public accounting firm on our December 31, 2015 financial statements included an explanatory paragraph indicating that there is substantial doubt about our ability to continue as a going concern.

Implications of Being an Emerging Growth Company

We are an “emerging growth company,” as defined in the Jumpstart Our Business Startups Act of 2012, or the JOBS Act, and are eligible to take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies. These include:

 

  n   reduced obligations with respect to financial data, including presenting only two years of audited financial statements and only two years of selected financial data in the registration statement on Form S-1 of which this prospectus is a part;

 

  n   reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements;

 

  n   an exception from compliance with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act; and

 

  n   exemptions from the requirements of holding a non-binding advisory vote on executive compensation and the requirement to obtain stockholder approval of any golden parachute payments not previously approved.

We may take advantage of these exemptions for up to five years or such earlier time that we are no longer an emerging growth company. We would cease to be an emerging growth company if we have more than $1.0 billion in annual revenue, we are deemed to be a large accelerated filer under rules of the Securities and Exchange Commission, or SEC, or we issue more than $1.0 billion of non-convertible debt over a three-year period. We may choose to take advantage of some or all of the available exemptions. We have taken advantage of certain reduced reporting requirements in this prospectus. Accordingly, the information contained herein may be different than the information you receive from other public companies in which you hold stock.

In addition, Section 107 of the JOBS Act provides that an emerging growth company can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act of

 



 

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1933, or Securities Act, for complying with new or revised accounting standards. In other words, an emerging growth company can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. We have irrevocably elected not to avail ourselves of this election and, therefore, we will be subject to the same new or revised accounting standards as other public companies that are not emerging companies.

Corporate Information

Novan, Inc. was incorporated in Delaware in 2006. On December 16, 2015, we formed KNOW Bio, LLC as a wholly owned subsidiary for the purpose of giving effect to the separation of non-dermatological assets from our company. On December 30, 2015, we distributed all of the outstanding member interests of KNOW Bio pro rata to our stockholders. Our principal executive offices are located at 4222 Emperor Boulevard, Suite 200, Durham, NC 27703. Our telephone number is (919) 485-8080. Our corporate website is www.novan.com. The information contained on or that can be accessed through our website is not incorporated by reference into this prospectus, and you should not consider information on our website to be part of this prospectus or in deciding to purchase our common stock.

 



 

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THE OFFERING

 

Issuer

Novan, Inc.

 

Common stock offered by us

            shares (or              shares if the underwriters exercise in full their option to purchase additional shares)

 

Common stock to be outstanding
immediately after this offering

        shares (or          shares if the underwriters exercise in full their option to purchase additional shares)

 

Underwriters’ option to purchase additional
shares

         shares

 

Use of proceeds

We estimate that our net proceeds from our issuance and sale of              shares of our common stock in this offering will be approximately $         million (or approximately $         million if the underwriters exercise in full their option to purchase additional shares), based on an assumed initial public offering price of $         per share, which is the midpoint of the price range set forth on the cover page of this prospectus, and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us.

 

  We currently intend to use the net proceeds from this offering, together with existing cash, as follows: (i) approximately $         to fund the development of SB204 through NDA submission; (ii) approximately $         to fund platform expansion with Phase 2 trials for SB206 and SB208; and (iii) the balance to fund internal research and development expenses associated with existing product candidates, including SB414, and future product candidates, and for working capital and general corporate purposes.

 

Risk factors

See “Risk Factors” in this prospectus for a discussion of factors that you should consider carefully before deciding to invest in shares of our common stock.

 

Proposed NASDAQ Global Market Symbol

“NOVN”

 

Dividend Policy

We currently intend to retain all available funds and any future earnings to support operations and to finance the growth and development of our business. Our future ability to pay cash dividends on our capital stock may be limited by the terms of any future debt or preferred securities or future credit facility.

 



 

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The number of shares of our common stock to be outstanding after this offering is based on 2,707,628 shares of our common stock outstanding as of June 30, 2016 and 10,760,961 additional shares of our common stock issuable upon the conversion of all outstanding shares of our preferred stock and our non-voting common stock, which will occur automatically upon the closing of this offering, and excludes:

 

  n   734,496 shares of common stock issuable upon the exercise of options outstanding as of June 30, 2016, having a weighted average exercise price of $7.68 per share; and

 

  n   1,000,000 shares of common stock reserved for future issuance under our 2016 Incentive Award Plan, or 2016 Plan, which will become effective upon the effectiveness of the registration statement of which this prospectus is a part.

Unless otherwise indicated, all information in this prospectus assumes or gives effect to:

 

  n   the automatic conversion of all outstanding shares of our preferred stock into an aggregate of 10,531,698 shares of common stock, which will occur upon the closing of this offering;

 

  n   the automatic conversion of all outstanding shares of our non-voting common stock into an aggregate of 229,263 shares of common stock, which will occur upon the closing of this offering;

 

  n   no exercise of outstanding options after June 30, 2016;

 

  n   the filing and effectiveness of our amended and restated certificate of incorporation; and

 

  n   no exercise of the underwriters’ option to purchase additional shares to cover overallotments, if any.

 



 

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Summary Financial Data

The following tables set forth a summary of our historical financial data as of, and for the periods ended on, the dates indicated. The statement of operations data for the years ended December 31, 2014 and 2015 are derived from our audited consolidated financial statements included elsewhere in this prospectus. The statement of operations data for the six months ended June 30, 2015 and 2016, and the balance sheet data as of June 30, 2016, are derived from our unaudited interim financial statements included elsewhere in this prospectus. We have prepared the unaudited consolidated interim financial statements on the same basis as the audited financial statements and have included, in our opinion, all adjustments, consisting only of normal recurring adjustments, that we consider necessary for a fair statement of the financial information set forth in those statements. You should read this data together with our audited consolidated financial statements and related notes appearing elsewhere in this prospectus and the information under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Our historical results are not necessarily indicative of our future results and our interim results are not necessarily indicative of results to be expected for the full year ending December 31, 2016, or any other period.

 

    Year Ended December 31,     Six Months Ended
June 30,
 
    2014      2015     2015     2016  
    (in thousands, except share and per share data)  

Statement of operations data:

        

Government research contracts and grants revenue

  $ 112       $      $      $   
 

 

 

    

 

 

   

 

 

   

 

 

 

Operating expenses:

        

Research and development

    6,770         16,569        6,698        22,373   

General and administrative

    5,170         9,265        3,409        6,834   
 

 

 

    

 

 

   

 

 

   

 

 

 

Total operating expenses

    11,940         25,834        10,107        29,207   
 

 

 

    

 

 

   

 

 

   

 

 

 

Operating loss

    (11,828      (25,834     (10,107     (29,207
 

 

 

    

 

 

   

 

 

   

 

 

 

Other income (expense):

        

Interest income

    58         48        2        34   

Interest expense

    (701      (1     (1       

Change in fair value of warrant liability

    (641                      

Other income (expense), net

    9         1        (1     9   
 

 

 

    

 

 

   

 

 

   

 

 

 

Total other income (expense)

    (1,275      48               43   
 

 

 

    

 

 

   

 

 

   

 

 

 

Loss from continuing operations

    (13,103      (25,786     (10,107     (29,164

Income (loss) from discontinued operations

    1,715         (2,274     711          
 

 

 

    

 

 

   

 

 

   

 

 

 

Net loss and comprehensive loss

  $ (11,388    $ (28,060   $ (10,818   $ (29,164
 

 

 

    

 

 

   

 

 

   

 

 

 

Income (loss) per share, basic and diluted:

        

Continuing operations

  $ (4.96    $ (9.47   $ (3.75   $ (9.93

Discontinued operations

    0.65         (0.83     (0.27       
 

 

 

    

 

 

   

 

 

   

 

 

 

Net loss per share, basic and diluted (1)

  $ (4.31    $ (10.30   $ (4.02   $ (9.93
 

 

 

    

 

 

   

 

 

   

 

 

 

Weighted-average common shares used in computing net loss per share, basic and diluted (1)

    2,643,912         2,722,943        2,692,909        2,936,483   
 

 

 

    

 

 

   

 

 

   

 

 

 

Pro forma loss per share, basic and diluted:

        

Continuing operations (unaudited)

     $ (2.23     $ (2.17

Discontinued operations (unaudited)

       (0.20         
    

 

 

     

 

 

 

Pro forma net loss per share, basic and diluted (unaudited) (2)

     $ (2.43     $ (2.17
    

 

 

     

 

 

 

Weighted-average common shares used to compute pro forma net loss per share, basic and diluted (unaudited) (2)

       11,550,492          13,410,313   
    

 

 

     

 

 

 

 



 

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(1) See note 1 in the notes to our consolidated financial statements appearing elsewhere in this prospectus for an explanation of the method used to calculate the historical basic and diluted net loss per share.
(2) The unaudited pro forma weighted average common shares used in computing pro forma net loss per share (basic and diluted) has been prepared to give effect to the automatic conversion of all outstanding shares of preferred stock into 10,531,698 shares of common stock.

 

    As of June 30, 2016  
    Actual      Pro Forma(1)      Pro Forma
As Adjusted(2)(3)
 
           (in thousands)         

Balance sheet data:

       

Cash and cash equivalents

  $ 19,602       $ 19,602      

Total assets

  $ 32,734       $ 32,734      

Total liabilities

  $ 16,768       $ 16,768      

Accumulated deficit

  $ (92,498    $ (92,498   

Total stockholders’ (deficit) equity

  $ (88,832    $ 15,966      

 

(1) The pro forma balance sheet data gives effect to (a) the automatic conversion of all outstanding shares of our preferred stock into 10,531,698 shares of common stock upon the closing of this offering.
(2) In addition to the pro forma adjustments set forth in footnote 1, the pro forma as adjusted data gives further effect to the sale by us of          shares of common stock in this offering at an assumed initial public offering price of $         per share, the midpoint of the price range set forth on the cover page of this prospectus, after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us.
(3) The pro forma as adjusted information is illustrative only, and will depend on the actual initial public offering price, number of shares offered and other terms of this offering determined at pricing. A $1.00 increase or decrease in the assumed initial public offering price of $         per share, the midpoint of the price range set forth on the cover page of this prospectus, would increase or decrease each of pro forma as adjusted cash and cash equivalents, total assets and total stockholders’ equity by $         million, assuming the number of shares we are offering, as set forth on the cover page of this prospectus, remains the same, after deducting underwriting discounts and commissions and estimated offering expenses payable by us. We may also increase or decrease the number of shares we are offering. An increase or decrease of 1,000,000 in the number of shares we are offering, as set forth on the cover page of this prospectus, would increase or decrease each of pro forma as adjusted cash and cash equivalents, total assets and total stockholders’ equity by approximately $         million, assuming the assumed initial public offering price per share remains the same.

 



 

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RISK FACTORS

Investing in our common stock involves a high degree of risk. These risks include, but are not limited to, those described below, each of which may be relevant to an investment decision. You should carefully consider the risks described below, together with all of the other information in this prospectus, including our financial statements and related notes, before investing in our common stock. The realization of any of these risks could have a significant adverse effect on our reputation, business, including our financial condition, results of operations and growth, which we refer to collectively in this section as our business, and ability to accomplish our strategic objectives. In that event, the trading price of our common stock could decline, and you may lose part or all of your investment.

Risks Related to the Development, Regulatory Approval and Commercialization of our Current and Future Product Candidates

Drug development involves a lengthy and expensive process with uncertain outcomes, and results from earlier studies and trials may not be predictive of future trial results.

Clinical testing is expensive and can take many years to complete, and its outcome is inherently uncertain. Failure or delay can occur at any time during the clinical trial process. Success in preclinical testing and early clinical trials does not ensure that later clinical trials will be successful. A number of companies in the pharmaceutical and biotechnology industries have suffered significant setbacks in clinical trials, even after promising results in earlier preclinical studies or clinical trials. These setbacks have been caused by, among other things, preclinical findings made while clinical trials were underway and safety or efficacy observations made in clinical trials, including previously unreported adverse events. The results of preclinical studies and early clinical trials of our product candidates may not be predictive of the results of later-stage clinical trials. Product candidates in later stages of clinical trials may fail to show the required safety profile or meet the efficacy endpoints despite having progressed through preclinical studies and initial clinical trials. Notwithstanding any potential promising results in earlier testing, we cannot be certain that we will not face similar setbacks. Even if our clinical trials are completed, the results may not be sufficient to obtain regulatory approval for our product candidates.

We have completed Phase 2 studies of SB204 and initiated our Phase 3 trials in the first quarter of 2016. We are also currently conducting Phase 2 trials of SB206 and SB208. We may experience delays in completing and initiating these ongoing and planned trials and we cannot be certain that the trials or any other future clinical trials for our product candidates will begin on time, need to be redesigned, enroll an adequate number of patients on time or be completed on schedule, if at all. Clinical trials can be delayed or terminated for a variety of reasons, including delays or failures related to:

 

  n   the FDA disagreeing as to the design or implementation of our clinical trials;

 

  n   reaching agreement on acceptable terms with prospective contract research organizations, or CROs, and clinical trial sites, the terms of which can be subject to extensive negotiation and may vary significantly among different CROs and trial sites;

 

  n   obtaining institutional review board, or IRB, approval at each site;

 

  n   the safety profiles of our product candidates;

 

  n   recruiting suitable patients to participate in a trial;

 

  n   having patients complete a trial or return for post-treatment follow-up;

 

  n   clinical sites deviating from trial protocol;

 

  n   addressing patient safety concerns that arise during the course of a trial;

 

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  n   adding a sufficient number of clinical trial sites; or

 

  n   manufacturing sufficient quantities of product candidate for use in clinical trials.

We could also encounter delays if a clinical trial is suspended or terminated by us, by the IRBs of the institutions in which such trials are being conducted, by the Data Safety Monitoring Board, or DSMB, for such trial or by the FDA or other regulatory authorities. Such authorities may suspend or terminate a clinical trial due to a number of factors, including failure to conduct the clinical trial in accordance with regulatory requirements or our clinical protocols, inspection of the clinical trial operations or trial site by the FDA or other regulatory authorities resulting in the imposition of a clinical hold, unforeseen safety issues or adverse events, failure to demonstrate a benefit from using a drug, changes in governmental regulations or administrative actions or lack of adequate funding to continue the clinical trial.

If we experience delays in the completion, or termination, of any clinical trial of our product candidates, the commercial prospects of our product candidates may be harmed, and our ability to generate product revenues from any of these product candidates will be delayed or not realized at all. Any delays in completing our clinical trials will increase our costs, slow down our product candidate development and approval process and jeopardize our ability to commence product sales and generate revenues. Any of these occurrences may significantly 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 our product candidates.

In addition, we are conducting preclinical studies for SB414. We plan to commence toxicology studies in 2016 in support of an IND submission, and we expect to initiate clinical development in the second half of 2017. Our preclinical studies may not prove successful in demonstrating proof-of concept, or may show adverse toxicological findings, and even if successful may not necessarily predict that subsequent clinical trials will show the requisite safety and efficacy of our product candidates.

We have never conducted a Phase 3 clinical trial before, and may be unable to successfully do so for any of our product candidates.

The conduct of a Phase 3 clinical trial is a complex process that differs from clinical trials conducted in earlier phases. While some of our employees have conducted Phase 3 clinical trials in the past while employed at different companies, we, as a company, have not conducted a Phase 3 clinical trial before, and as a result, may require more time and incur greater costs than we anticipated. We commenced two identically designed Phase 3 pivotal clinical trials of our lead product candidate, SB204, for the treatment of acne vulgaris in the first quarter of 2016. Failure to complete, or delays experienced in, our clinical trials, or failure to commence any planned clinical trials would prevent us from, or delay us in, obtaining regulatory approval of and commercializing our product candidates.

If we encounter difficulties enrolling patients in our clinical trials, our clinical development activities could be delayed or otherwise adversely affected.

The timely completion of clinical trials in accordance with their protocols depends on, among other things, our ability to enroll a sufficient number of patients who remain in the trial until its conclusion. We may experience difficulties in patient enrollment in our clinical trials for a variety of reasons. The enrollment of patients depends on many factors, including:

 

  n   the patient eligibility criteria defined in the protocol;

 

  n   the size of the patient population required for analysis of the trial’s primary endpoints;

 

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  n   the proximity of patients to trial sites;

 

  n   the design of the trial;

 

  n   our ability to recruit clinical trial investigators with the appropriate competencies and experience;

 

  n   clinicians’ and patients’ perceptions as to the potential advantages of the product candidate being studied in relation to other available therapies, including any new drugs that may be approved for the indications we are investigating;

 

  n   our ability to obtain patient consents; and

 

  n   the risk that patients enrolled in clinical trials will drop out of the trials before completion.

In addition, our clinical trials will compete for the recruitment of patients with other clinical trials for product candidates that are in the same therapeutic areas as our product candidates, and this competition will reduce the number and types of patients available to us, because some patients who might have opted to enroll in our trials may instead opt to enroll in a trial being conducted by one of our competitors.

Delays in patient enrollment may result in increased costs, which would adversely impact our statement of operations and cash flows, or may affect the timing or outcome of the planned clinical trials, which could prevent completion of these trials and adversely affect our ability to advance the development of our product candidates and hurt our competitive position.

We may expend our limited resources to pursue a particular product candidate or indication and fail to capitalize on product candidates or indications that may be more profitable or for which there is a greater likelihood of success.

Because we have limited financial and managerial resources, we intend to focus on developing product candidates for specific indications that we identify as most likely to succeed, in terms of their potential both to gain regulatory approval and to achieve commercialization. As a result, we may forego or delay pursuit of opportunities with other product candidates or in other indications with greater commercial potential.

Our resource allocation decisions may cause us to fail to capitalize on viable commercial products or profitable market opportunities. Our spending on current and future research and development programs and product candidates for specific indications may not yield any commercially viable product candidates. If we do not accurately evaluate the commercial potential or target market for a particular product candidate, we may relinquish valuable rights to that product candidate 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 to the product candidate.

Our product candidates may pose safety issues, cause adverse events or have other properties that could delay or prevent their regulatory approval, limit the commercial profile of an approved label, or result in significant negative consequences following marketing approval, if any.

We, any partner with whom we may collaborate in the future or the FDA may suspend, delay, require modifications to or terminate our clinical trials at any time, for various reasons, including the discovery of serious or unexpected toxicities or other safety issues experienced by trial participants.

In addition, adverse events caused by our product candidates could cause us or regulatory authorities to interrupt, delay or halt clinical trials and could result in a more restrictive label or the delay

 

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or denial of regulatory approval by the FDA or comparable foreign regulatory authorities. Results of our clinical trials could reveal a high and unacceptable severity and prevalence of adverse events or unexpected characteristics. To date, patients treated with our product candidates have experienced drug-related cutaneous tolerability observations, including dryness, scaling, burning, erythema, itching, pain or irritation, and adverse events, including irritation and contact dermatitis.

If safety issues or unacceptable adverse events arise in the development of our product candidates, we, the FDA, the IRBs at the institutions in which our trials are conducted, or the DSMB could suspend or terminate our clinical trials or the FDA or comparable foreign regulatory authorities could order us to cease clinical trials or deny approval of our product candidates for any or all targeted indications. Treatment-related adverse events could also affect patient recruitment or the ability of enrolled patients to complete the trial or result in potential product liability claims. In addition, these adverse events may not be appropriately recognized or managed by the treating medical staff.

Any of the foregoing events could prevent us from achieving or maintaining market acceptance of the particular product candidate, if approved, and may result in the loss of significant revenues to us, which would materially and adversely affect our results of operations and business.

The regulatory approval processes of the FDA are lengthy, time-consuming and inherently unpredictable, and if we are ultimately unable to obtain regulatory approval for our product candidates, our business will be substantially harmed.

The time required to obtain approval by the FDA is unpredictable but typically takes many years following the commencement of clinical trials and depends upon numerous factors, including the substantial discretion of the regulatory authorities. In addition, approval policies, regulations, or the type and amount of clinical data necessary to gain approval may change during the course of a product candidate’s clinical development and may vary among jurisdictions. We have not obtained regulatory approval for any product candidate and it is possible that none of our existing product candidates or any product candidates we may seek to develop in the future will ever obtain regulatory approval. Neither we nor any future collaborator is permitted to market any of our product candidates in the United States until we receive regulatory approval of an NDA from the FDA.

Prior to obtaining approval to commercialize a product candidate in the United States or abroad, we or our collaborators must demonstrate with substantial evidence from well-controlled clinical trials, and to the satisfaction of the FDA, that such product candidates are safe and effective for their intended uses. Results from preclinical studies and clinical trials can be interpreted in different ways. Even if we believe the preclinical or clinical data for our product candidates are promising, such data may not be sufficient to support approval by the FDA and other regulatory authorities. The FDA may also require us to conduct additional preclinical studies or clinical trials for our product candidates either prior to or post-approval, or it may object to elements of our clinical development program.

The FDA can delay, limit or deny approval of our product candidates or require us to conduct additional preclinical or clinical testing or abandon a program for many reasons, including:

 

  n   the FDA’s disagreement with the design or implementation of our clinical trials;

 

  n   negative or ambiguous results from our clinical trials or results that may not meet the level of statistical significance required by the FDA for approval;

 

  n   serious and unexpected drug-related adverse events experienced by participants in our clinical trials or by individuals using drugs similar to our product candidates;

 

  n   our inability to demonstrate to the satisfaction of the FDA that our product candidates are safe and effective for the proposed indication;

 

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  n   the FDA’s disagreement with the interpretation of data from preclinical studies or clinical trials;

 

  n   our inability to demonstrate that the clinical and other benefits of our product candidates outweigh any safety or other perceived risks;

 

  n   the FDA’s requirement for additional preclinical studies or clinical trials;

 

  n   the FDA’s disagreement regarding the formulation, labeling or the specifications of our product candidates;

 

  n   the FDA’s agency’s failure to approve the manufacturing processes or facilities of third-party manufacturers with which we contract; or

 

  n   the potential for approval policies or regulations of the FDA to significantly change in a manner rendering our clinical data insufficient for approval.

Of the large number of drugs in development, only a small percentage successfully complete the FDA approval process and become commercialized. The lengthy approval process as well as the unpredictability of outcomes from future clinical trials may result in our failing to obtain regulatory approval to market our product candidates.

Even if we eventually complete clinical testing and receive approval of an NDA or foreign marketing application for our product candidates, the FDA may grant approval contingent on the performance of costly additional clinical trials, including Phase 4 clinical trials, or the implementation of a Risk Evaluation and Mitigation Strategy, or REMS, which may be required to ensure safe use of the drug after approval. The FDA also may approve a product candidate for a more limited indication or patient population than we originally requested, and the FDA may not approve the labeling that we believe is necessary or desirable for the successful commercialization of a product candidate. Any delay in obtaining, or inability to obtain, applicable regulatory approval would delay or prevent commercialization of that product candidate.

Regulatory approval of our product candidates by foreign regulatory authorities may be delayed or denied. We may be subject to pricing controls imposed by foreign governments and regulatory authorities.

We may seek regulatory approval of our product candidates from foreign regulatory authorities in the future. Such regulatory authorities may impose additional regulations and guidelines that differ in form and substance from those imposed by their counterparts in the United States and with which we are more familiar. Accordingly, the regulatory approval of our product candidates in those foreign jurisdictions could be delayed, limited or denied altogether. This could limit the scope of or prevent the commercialization of our products in the future and adversely affect our financial performance.

Further, in some countries, the pricing of pharmaceutical prescriptions is subject to governmental control. In these countries, pricing negotiations with governmental authorities can take considerable time after the receipt of marketing approval for a product candidate. In addition, there can be considerable pressure by governments and other stakeholders on prices and reimbursement levels, including as part of cost containment measures. Political, economic and regulatory developments may further complicate pricing negotiations, and pricing negotiations may continue after coverage and reimbursement have been obtained. Reference pricing used by various countries and parallel distribution or arbitrage between low-priced and high-priced countries can further reduce prices. To obtain reimbursement or pricing approval in some countries, we may be required to conduct a clinical trial that compares the cost-effectiveness of our product candidate to other available therapies, which is time-consuming and costly. If coverage and reimbursement of our product candidates are unavailable or limited in scope or amount, or if pricing is set at unsatisfactory levels, our business could be harmed.

 

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Even if our current product candidates or any future product candidates obtain regulatory approval, they may fail to achieve the broad degree of physician and patient adoption and use necessary for commercial success.

The commercial success of any of our current or future product candidates, if approved, will depend significantly on the broad adoption and use of the resulting product by physicians and patients for approved indications. Our product candidates may not be commercially successful. The degree and rate of physician and patient adoption of our current or future product candidates, if approved, will depend on a number of factors, including:

 

  n   the clinical indications for which the product is approved and patient demand for approved products that treat those indications;

 

  n   the effectiveness of our product as compared to other available therapies;

 

  n   the availability of coverage and adequate reimbursement from managed care plans and other healthcare payors for any of our product candidates that may be approved;

 

  n   the cost of treatment with our product candidates in relation to alternative treatments and willingness to pay for the product, if approved, on the part of patients;

 

  n   acceptance by physicians, major operators of clinics and patients of the product as a safe and effective treatment;

 

  n   physician and patient willingness to adopt a new therapy over other available therapies to treat approved indications;

 

  n   overcoming any biases physicians or patients may have toward particular therapies for the treatment of approved indications;

 

  n   patient satisfaction with the results and administration of our product candidates and overall treatment experience;

 

  n   the willingness of patients to pay for certain of our product candidates relative to other discretionary items, especially during economically challenging times;

 

  n   the revenue and profitability that our product candidates may offer a physician as compared to alternative therapies;

 

  n   the prevalence and severity of adverse events;

 

  n   limitations or warnings contained in the FDA-approved labeling for our product candidates;

 

  n   any FDA requirement to undertake a REMS;

 

  n   the effectiveness of our sales, marketing and distribution efforts;

 

  n   adverse publicity about our product candidates or favorable publicity about competitive products; and

 

  n   potential product liability claims.

If any of our current or future product candidates are approved for use but fail to achieve the broad degree of physician and patient adoption necessary for commercial success, our operating results and financial condition will be adversely affected, which may delay, prevent or limit our ability to generate revenue and continue our business.

 

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Even if we make a submission under a special protocol assessment, or SPA, from the FDA, there is no guarantee that we will obtain agreement from the FDA on the SPA. Even if we do obtain the FDA’s agreement, an SPA would not guarantee approval of any of our product candidates or any other particular outcome from regulatory review.

We currently do not have an SPA in place with respect to any of our product candidates. We have previously made such a submission for an SPA to the FDA in connection with the design of our Phase 3 clinical trials for SB204. We received feedback from the FDA on our Phase 3 trial design that we believed was sufficient to move forward on the Phase 3 development program without further pursuing an SPA. We recognize that the feedback obtained in connection with the SPA discussions does not constitute a formal SPA or a binding declaration from the FDA that it agrees with the Phase 3 clinical trials’ design, clinical endpoints or statistical analysis plan. We may, in the future, decide to make a submission for an SPA for any of our current or future product candidates.

The FDA’s SPA process is designed to facilitate the FDA’s review and approval of drugs by allowing the FDA to evaluate the proposed design and size of clinical trials that are intended to form the primary basis for determining a drug product’s efficacy. Upon specific request by a clinical trial sponsor, the FDA will evaluate the protocol and respond to a sponsor’s questions regarding, among other things, primary efficacy endpoints, trial conduct and data analysis, within 45 days of receipt of the request. The FDA ultimately assesses whether the protocol design and planned analysis of the trial are acceptable to support regulatory approval of the product candidate with respect to the effectiveness of the indication studied. All agreements and disagreements between the FDA and the sponsor regarding an SPA must be clearly documented in an SPA letter or the minutes of a meeting between the sponsor and the FDA.

Even if the FDA agrees to the SPA, an SPA agreement does not guarantee approval of a product candidate. Even if the FDA agrees to the design, execution, and analysis proposed in protocols reviewed under the SPA process, the FDA may revoke or alter its agreement in certain circumstances. In particular, an SPA agreement is not binding on the FDA if public health concerns emerge that were unrecognized at the time of the SPA agreement, other new scientific concerns regarding product safety or efficacy arise, the sponsor company fails to comply with the agreed upon trial protocols, or the relevant data, assumptions or information provided by the sponsor in a request for the SPA change or are found to be false or omit relevant facts. In addition, even after an SPA agreement is finalized, the SPA agreement may be modified, and such modification will be deemed binding on the FDA review division, except under the circumstances described above, if the FDA and the sponsor agree in writing to modify the protocol and such modification is intended to improve the study. The FDA retains significant latitude and discretion in interpreting the terms of the SPA agreement and the data and results from any study that is the subject of the SPA agreement.

Moreover, if the FDA revokes or alters its agreement under the SPA, or interprets the data collected from the clinical trial differently than we do, the FDA may not deem the data sufficient to support an application for regulatory approval.

Our product candidates may cause side effects which could delay or prevent their commercialization.

If any of our product candidates receives marketing approval, and we or other companies developing other nitric oxide-based therapies, including KNOW Bio, LLC, which has the right to develop our current nitric oxide-based technology in non-dermatological indications, later identify undesirable side effects caused by such products, a number of potentially significant negative consequences could result, including:

 

  n   regulatory authorities may withdraw their approval of the product;

 

  n   we may be required to recall a product or change the way such product is administered to patients;

 

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  n   additional restrictions may be imposed on the marketing of the particular product or the manufacturing processes for the product or any component thereof;

 

  n   regulatory authorities may require the addition of labeling statements, such as a ‘‘black box’’ warning or a contraindication;

 

  n   we may be required to implement a REMS or create a Medication Guide outlining the risks of such adverse events for distribution to patients;

 

  n   we could be sued and held liable for harm caused to patients;

 

  n   the product may become less competitive; and

 

  n   our reputation may suffer.

We expect to educate and train medical personnel so they know how to use our product candidates to understand their potential side effect profiles. Inadequate training in recognizing or managing the potential side effects of our product candidates could result in patient injury.

If we are unable to establish sales, marketing and distribution capabilities for our product candidates or any future product candidate that receives regulatory approval, we may not be successful in commercializing those product candidates, if approved.

We do not currently have a sales, marketing or distribution infrastructure in place. To achieve commercial success for any product candidate for which we may obtain marketing approval, we will need to establish a sales, marketing and distribution framework. In the future, we expect to build a focused sales, marketing and distribution infrastructure to market any of our product candidates in the United States. There are risks involved with establishing our own sales, marketing and distribution capabilities. For example, recruiting and training a sales force is expensive and time-consuming and could delay market uptake. If the commercial launch of a product candidate for which we recruit a sales force and establish marketing capabilities is delayed or does not occur for any reason, we would have prematurely or unnecessarily incurred these commercialization expenses. This may be costly, and our investment would be lost if we cannot retain or reposition our sales and marketing personnel.

Factors that may inhibit our efforts to commercialize our products on our own include:

 

  n   our inability to recruit, train and retain adequate numbers of effective sales and marketing personnel;

 

  n   the inability of sales personnel to obtain access to physicians or persuade adequate numbers of physicians to prescribe any future products;

 

  n   the lack of complementary products to be offered by sales personnel, which may put us at a competitive disadvantage relative to companies with more extensive product lines; and

 

  n   unforeseen costs and expenses associated with creating an independent sales and marketing organization.

If we are unable to establish our own sales, marketing and distribution capabilities and enter into arrangements with third parties to perform these services, this could, in turn, decrease our revenue and our profitability. In addition, we may not be successful in entering into arrangements with third parties to sell, market and distribute our product candidates or may be unable to do so on terms that are favorable to us. We may not have adequate control over such third parties, and any of them may fail to devote the necessary resources and attention to sell and market our products effectively. If we do not establish sales, marketing and distribution capabilities successfully, either on our own or in collaboration with third parties, we will not be successful in commercializing our product candidates.

 

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Additionally, we are currently evaluating strategic partnerships to commercialize our dermatology products in select international markets. We may not be sufficiently familiar or have the requisite resources to penetrate international markets where some of our competitors have already achieved broad recognition and have established commercialization strategies in place. Moreover, we may not succeed in targeting healthcare providers, including physicians, outside the dermatology prescribing base, who may not be familiar with our product candidates.

Our product candidates, if approved, will face significant competition and our failure to effectively compete may prevent us from achieving significant market penetration.

The pharmaceutical industry is characterized by rapidly advancing technologies, intense competition and a strong emphasis on developing proprietary therapeutics. Numerous companies are engaged in the development, patenting, manufacturing and marketing of healthcare products competitive with those that we are developing. We face competition from a number of sources, such as pharmaceutical companies, generic drug companies, biotechnology companies and academic and research institutions, many of which have greater financial resources, marketing capabilities, sales forces, manufacturing capabilities, research and development capabilities, clinical trial expertise, intellectual property portfolios, experience in obtaining patents and regulatory approvals for product candidates and other resources than we do. Some of the companies that offer competing products also have a broad range of other product offerings, large direct sales forces and long-term customer relationships with our target physicians, which could inhibit our market penetration efforts. In addition, certain of our product candidates, if approved, may compete with other dermatological products, including over-the-counter treatments, for a share of some patients’ discretionary budgets and for physicians’ attention within their clinical practices.

Many pharmaceutical companies currently offer products, and continue to develop additional alternative product candidates and technologies, for indications similar to those targeted by our product candidates, including Galderma S.A., Allergan, Inc. and Valeant Pharmaceuticals International, Inc. The markets for dermatological therapies are competitive and are characterized by significant technological development and new product introduction. We anticipate that, if we obtain regulatory approval of our product candidates, we will face significant competition from other approved therapies. If approved, our product candidates may also compete with unregulated, unapproved and off-label treatments. To compete successfully in this market, we will have to demonstrate that the relative cost, safety and efficacy of our approved products, if any, provide an attractive alternative to existing and other new therapies. Such competition could lead to reduced market share for our product candidates and contribute to downward pressure on the pricing of our product candidates.

Due to less stringent regulatory requirements in certain foreign countries, there are many more dermatological products and procedures available for use in those international markets than are approved for use in the United States. In certain international markets, there are also fewer limitations on the claims that our competitors can make about the effectiveness of their products and the manner in which they can market them. As a result, we expect to face more competition in these markets than in the United States.

Even if we obtain marketing approval for any product candidates, the products may become subject to unfavorable third-party coverage or reimbursement policies, which would harm our business.

The success of our product candidates, if approved, depends on the availability of adequate coverage and reimbursement from government authorities and third-party payors, such as private health insurers and health maintenance organizations. Patients who are provided medical treatment for their conditions generally rely on third-party payors to reimburse all or part of the costs associated with their treatment. Adequate coverage and reimbursement from governmental healthcare programs, such as Medicare and Medicaid, and commercial payors is critical to product acceptance.

 

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Government authorities and third-party payors, such as private health insurers and health maintenance organizations, decide which drugs and treatments they will cover and the amount of reimbursement that will be provided. Coverage decisions may depend on clinical and economic standards that disfavor new products when more established or lower cost therapeutic alternatives are already available or subsequently become available. Third-party payors may refuse to include a particular branded product in their formularies, or lists of medications for which third-party payors provide coverage and reimbursement, or otherwise restrict patient access through formulary controls or otherwise to a branded product when a less costly generic equivalent or other alternative is available. Coverage may be more limited than the purposes for which a product is approved by the FDA or similar regulatory authorities outside the United States.

Assuming that we obtain coverage for a given product, the resulting reimbursement rates might not be adequate to cover our costs, including research, development, manufacture, sale and distribution, or achieve or sustain profitability, or may require co-payments that patients find unacceptably high. 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 product candidates. 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 product candidates. Increasingly, third-party payors are requiring that pharmaceutical companies provide them with predetermined discounts from list prices and are challenging the prices charged for products. There is significant uncertainty related to insurance coverage and reimbursement of newly approved products. It is difficult to predict at this time what third-party payors will decide with respect to the coverage and reimbursement for our product candidates

In the United States, no uniform policy of coverage and reimbursement for products exists among third-party payors. Therefore, coverage and reimbursement for a product can differ significantly from payor to payor. As a result, obtaining and maintaining coverage and reimbursement for a product from a government or other third-party payor is a time-consuming and costly process that could require us to provide supporting scientific, clinical and cost-effectiveness data for the use of our products to each payor separately, with no assurance that adequate coverage and reimbursement will be applied consistently or obtained in the first instance.

Governmental and third-party payors in the United States and abroad are developing increasingly sophisticated methods of controlling healthcare costs. Further, we believe that future coverage and reimbursement will likely be subject to increased restrictions both in the United States and in international markets. Third-party coverage and reimbursement for our product candidates for which we may receive regulatory approval may not be available, limited, or adequate in either the United States or international markets.

We may face product liability exposure, and if successful claims are brought against us, we may incur substantial liability if our insurance coverage for those claims is inadequate.

We face an inherent risk of product liability as a result of the clinical testing of our product candidates and will face an even greater risk if we commercialize any products. This risk exists even if a product is approved for commercial sale by the FDA and manufactured in facilities licensed and regulated by the FDA or an applicable foreign regulatory authority. Our product candidates are designed to affect important bodily functions and processes. Any adverse events, manufacturing defects, misuse or abuse associated with our product candidates could result in injury to a patient or even death. We cannot offer any assurance that we will not face product liability suits in the future, nor can we assure you that our insurance coverage will be sufficient to cover our liability under any such cases.

In addition, a liability claim may be brought against us even if our product candidates merely appear to have caused an injury. Product liability claims may be brought against us by consumers,

 

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healthcare providers, pharmaceutical companies or others selling or otherwise coming into contact with our product candidates, among others. If we cannot successfully defend ourselves against product liability claims we will incur substantial liabilities and reputational harm. In addition, regardless of merit or eventual outcome, product liability claims may result in:

 

  n   withdrawal of clinical trial participants;

 

 

  n   decreased enrollment rates of clinical trial participants;

 

  n   termination of clinical trial sites or entire trial programs;

 

  n   the inability to commercialize our product candidates;

 

  n   decreased demand for our product candidates;

 

  n   impairment of our business reputation;

 

  n   product recall or withdrawal from the market or labeling, marketing or promotional restrictions;

 

  n   substantial costs of any related litigation or similar disputes;

 

  n   distraction of management’s attention and other resources from our primary business;

 

  n   substantial monetary awards to patients or other claimants against us that may not be covered by insurance; or

 

  n   loss of revenue.

We have obtained product liability insurance coverage, with an aggregate limit of $5.0 million, for clinical trials. Large judgments have been awarded in class action or individual lawsuits based on drugs that had unanticipated adverse events. Our insurance coverage may not be sufficient to cover all of our product liability related expenses or losses and may not cover us for any expenses or losses we may suffer. Moreover, insurance coverage is becoming increasingly expensive, and, in the future, we may not be able to maintain insurance coverage at a reasonable cost, in sufficient amounts or upon adequate terms to protect us against losses due to product liability. We will need to increase our product liability coverage if any of our product candidates receive regulatory approval, which will be costly, and we may be unable to obtain this increased product liability insurance on commercially reasonable terms, or at all. A successful product liability claim or series of claims brought against us could cause our stock price to decline and, if judgments exceed our insurance coverage, could decrease our cash, negatively impact our statement of operations and could harm our financial condition.

If and when we market our product candidates, our relationships with healthcare providers, customers and third-party payors, as well as our general business operations, may be subject to applicable anti-kickback, fraud and abuse and other healthcare laws and regulations, and failure to comply with such regulations could expose us to penalties including criminal sanctions, civil penalties, exclusion from government healthcare programs, contractual damages, reputational harm and diminished profits and future earnings.

Healthcare providers, customers and third-party payors will play a primary role in the recommendation and prescription of any product candidates for which we may obtain marketing approval. Our future arrangements with third-party payors, healthcare providers and customers and our general operations may expose us to broadly applicable fraud and abuse and other healthcare laws and regulations that may constrain the business or financial arrangements and relationships through which we market, sell and distribute any product candidates for which we obtain marketing approval. Restrictions under applicable federal and state healthcare laws and regulations may include the following:

 

  n  

the federal Anti-Kickback Statute, which prohibits, among other things, persons and entities from knowingly and willfully soliciting, offering, receiving or providing remuneration, directly or

 

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indirectly, in cash or in kind, to induce or reward, or in return for, either the referral of an individual for, or the purchase, order or recommendation of, any good or service, for which payment may be made, in whole or in part, under a federal healthcare program such as Medicare and Medicaid. A person or entity does not need to have actual knowledge of the federal Anti-Kickback Statute or specific intent to violate it in order to have committed a violation.

 

  n   the federal false claims and civil monetary penalties laws, including the civil False Claims Act, which impose criminal and civil penalties, including through civil whistleblower or qui tam actions, against individuals or entities for knowingly presenting, or causing to be presented, to the federal government, claims for payment that are false or fraudulent or knowingly making a false statement to avoid, decrease or conceal an obligation to pay money to the federal government; in addition, the government may assert that a claim including items and services resulting from a violation of the U.S. federal Anti-Kickback Statute constitutes a false of fraudulent claim for purposes of the False Claims Act;

 

  n   the federal Health Insurance Portability and Accountability Act of 1996, or HIPAA, which imposes criminal and civil liability for, among other things, executing or attempting to execute a scheme to defraud any healthcare benefit program or making false statements relating to healthcare matters. Similar to the 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;

 

  n   HIPAA, as amended by the Health Information Technology for Economic and Clinical Health Act, or HITECH, and their implementing regulations, which also imposes obligations, including mandatory contractual terms, on certain types of people and entities with respect to safeguarding the privacy, security and transmission of individually identifiable health information;

 

  n   the federal Physician Payments Sunshine Act, which requires manufacturers of drugs, devices, biologics and medical supplies for which payment is available under Medicare, Medicaid or the Children’s Health Insurance Program (with certain exceptions) to report annually to the government information related to certain payments or other ‘‘transfers of value’’ made to physicians (defined to include doctors, dentists, optometrists, podiatrists and chiropractors) and teaching hospitals, and requires applicable manufacturers to report annually to the government ownership and investment interests held by the physicians described above and their immediate family members and payments or other ‘‘transfers of value’’ to such physician owners; and

 

  n   analogous state and foreign laws and regulations, such as state anti-kickback and false claims laws, which may apply to sales or marketing arrangements and claims involving healthcare items or services reimbursed by non-governmental third-party payors, including private insurers; state laws that require pharmaceutical companies to comply with the pharmaceutical industry’s voluntary compliance guidelines and the relevant compliance guidance promulgated by the federal government; state laws that require drug manufacturers to report information related to payments and other transfers of value to physicians and other healthcare providers or marketing expenditures; and state and foreign laws governing the privacy and security of health information in some circumstances, many of which differ from each other in significant ways and often are not preempted by HIPAA, thus complicating compliance efforts.

Efforts to ensure that our internal operations and business arrangements with third parties comply with applicable healthcare laws and regulations will involve substantial costs. It is possible that governmental authorities will conclude that our business practices may not comply with current or future statutes, regulations or case law involving applicable fraud and abuse or other healthcare laws

 

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and regulations. The risk of our being found in violation of these laws is increased by the fact that many of them have not been fully interpreted by the regulatory authorities or the courts, and their provisions are open to a variety of interpretations. Because of the breadth of these laws and the narrowness of the statutory exceptions and safe harbors available under such laws, it is possible that some of our business activities, including our relationships with physicians and other healthcare providers, some of whom will recommend, purchase or prescribe our products, could be subject to challenge under one or more of such laws.

If our operations are found to be in violation of any of these laws or any other governmental laws and regulations that may apply to us, we may be subject to significant civil, criminal and administrative penalties, damages, fines, imprisonment, exclusion of products from government funded healthcare programs, such as Medicare and Medicaid, disgorgement, contractual damages, reputational harm, diminished profits and the curtailment or restructuring of our operations. If any of the physicians or other healthcare providers or entities with whom we expect to do business is found to be not in compliance with applicable laws, they may be subject to criminal, civil or administrative sanctions, including exclusions from government funded healthcare programs, which would adversely impact our statement of operations and cash flows.

Risks Related to Manufacturing and our Reliance on Third Parties

We rely on third parties to conduct some of our preclinical studies and all of 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 any of our product candidates.

We currently do not have the ability to independently conduct preclinical studies that comply with the regulatory requirements known as good laboratory practice, or GLP, requirements. We also do not currently have the ability to independently conduct any clinical trials. The FDA and regulatory authorities in other jurisdictions require us to comply with regulations and standards, commonly referred to as good clinical practice, or GCP, requirements for conducting, monitoring, recording and reporting the results of clinical trials, in order 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. We rely on medical institutions, clinical investigators, contract laboratories and other third parties, such as contract research organizations, or CROs, to conduct GLP-compliant preclinical studies and GCP-compliant clinical trials on our product candidates properly and on time. While we will have agreements governing their activities, we control only certain aspects of their activities and have limited influence over their actual performance. The third parties with whom we contract for execution of our GLP preclinical studies and our GCP clinical trials play a significant role in the conduct of these studies and trials and the subsequent collection and analysis of data. These third parties are not our employees and, except for restrictions imposed by our contracts with such third parties, we have limited ability to control the amount or timing of resources that they devote to our programs. Although we rely on these third parties to conduct our GLP-compliant preclinical studies and GCP-compliant clinical trials, we remain responsible for ensuring that each of our GLP preclinical studies and clinical trials is conducted in accordance with its investigational plan and protocol and applicable laws and regulations, and our reliance on the CROs does not relieve us of our regulatory responsibilities. In addition, if any of our CROs terminate their involvement with us for any reason, we may not be able to enter into similar arrangements with alternative CROs within a short period of time, or do so on commercially reasonable terms.

Many of the third parties with whom we contract may also have relationships with other commercial entities, including our competitors, for whom they may also be conducting clinical trials or other drug development activities that could harm our competitive position. In addition, since the number of

 

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qualified clinical investigators is limited, we expect to conduct some of our clinical trials at the same clinical trial sites that some of our competitors use, which will reduce the number of patients who are available for our clinical trials in such clinical trial site. If the third parties conducting our GLP preclinical studies or 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 their failure to adhere to our clinical trial protocols or to GCPs, or for any other reason, we may need to enter into new arrangements with alternative third parties. This could be difficult, costly or impossible, and our preclinical studies or clinical trials may need to be extended, delayed, terminated or repeated. As a result we may not be able to obtain regulatory approval in a timely fashion, or at all, for the applicable product candidate, our financial results and the commercial prospects for our product candidates would be harmed, our costs could increase, and our ability to generate revenues could be delayed.

In addition, principal investigators for our clinical trials may serve as scientific advisors or consultants to us from time to time and may receive cash or equity compensation in connection with such services. If these relationships and any related compensation result in perceived or actual conflicts of interest, or the FDA concludes that the financial relationship may have affected the interpretation of the trial, the integrity of the data generated at the applicable clinical trial site may be questioned and the utility of the clinical trial itself may be jeopardized, which could result in the delay or rejection by the FDA of any NDA we submit. Any such delay or rejection could prevent us from commercializing our future product candidates.

We rely on third parties to manufacture our clinical drug supplies and we intend to rely on third parties to produce commercial supplies of any approved product candidate, and our commercialization of any of our product candidates could be stopped, delayed or made less profitable if those third parties fail to obtain approval of the FDA or comparable regulatory authorities, fail to provide us with sufficient quantities of drug product or fail to do so at acceptable quality levels or prices.

We do not currently have nor do we plan to acquire the infrastructure or capability internally to completely manufacture our clinical drug supplies for use in the conduct of our clinical trials, and we lack the resources and the capability to manufacture any of our product candidates on a clinical or commercial scale. While we currently manufacture the active drug substance in our own facilities, we rely on third parties to manufacture the finished drug product. The facilities used by our contract manufacturers to manufacture our product candidates must be approved by the FDA pursuant to inspections that will be conducted after we submit our NDA to the FDA. We do not control the manufacturing process of, and are completely dependent on, our contract manufacturing partners for compliance with the regulatory requirements, known as current good manufacturing practice, or cGMP, requirements for manufacture of drug products. If our contract manufacturers cannot successfully manufacture material that conforms to our specifications and the strict regulatory requirements of the FDA or others, they will not be able to secure or maintain regulatory approval for their manufacturing facilities. In addition, we have no control over the ability of our contract manufacturers to maintain adequate quality control, quality assurance and qualified personnel. If the FDA or a comparable foreign regulatory authority does not approve these facilities for the manufacture of our product candidates or if it withdraws any such approval in the future, we may need to find alternative manufacturing facilities, which would significantly impact our ability to develop, obtain regulatory approval for or market our product candidates, if approved.

We rely on third-party manufacturers to purchase from third-party suppliers the materials necessary to produce our product candidates for our clinical trials. There are a limited number of suppliers for raw materials, including nitric oxide, that we use to manufacture our drugs and there may be a need to assess alternate suppliers to prevent a possible disruption of the manufacture of the materials, importantly nitric oxide, necessary to produce our product candidates for our clinical trials, and if approved, ultimately for commercial sale. We do not have any control over the process or timing of the

 

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acquisition of these raw materials by our manufacturers. Moreover, we currently do not have any agreements for the commercial production of these raw materials, including nitric oxide. Although we generally do not begin a clinical trial unless we believe we have a sufficient supply of a product candidate to complete the clinical trial, any significant delay in the supply of a product candidate, or the raw material components thereof, for an ongoing clinical trial due to the need to replace a third-party manufacturer could considerably delay completion of our clinical trials, product testing and potential regulatory approval of our product candidates. If our manufacturers or we are unable to purchase these raw materials, including nitric oxide after regulatory approval has been obtained for our product candidates, the commercial launch of our product candidates would be delayed or there would be a shortage in supply, which would impair our ability to generate revenues from the sale of our product candidates.

We expect to continue to depend on third-party contract manufacturers for the foreseeable future. We have not entered into long-term agreements with our current contract manufacturers or with any alternate suppliers, and though we intend to do so prior to commercial launch in order to ensure that we maintain adequate supplies of finished drug product, we may be unable to enter into such an agreement or do so on commercially reasonable terms. We currently obtain our supplies of finished drug product through individual purchase orders.

Our employees, independent contractors, principal investigators, CROs, consultants, commercial partners and vendors may engage in misconduct or other improper activities, including noncompliance with regulatory standards and requirements, which could expose us to liability and hurt our reputation.

We are exposed to the risk that our employees, independent contractors, principal investigators, CROs, consultants, commercial partners and vendors may engage in fraudulent conduct or other illegal activity. Misconduct by these parties could include intentional, reckless or negligent conduct or disclosure of unauthorized activities to us that violates: (i) FDA laws and regulations, including those laws that require the reporting of true, complete and accurate information to the FDA, (ii) manufacturing standards, (iii) federal and state data privacy, security, fraud and abuse and other healthcare laws, or (iv) laws that require the true, complete and accurate reporting of financial information or data. Activities subject to these laws also involve the improper use or misrepresentation of information obtained in the course of clinical trials, creating fraudulent data in our preclinical studies or clinical trials or illegal misappropriation of drug product, which could result in regulatory sanctions and cause serious harm to our reputation. It is not always possible to identify and deter misconduct by employees and other third parties, and the precautions we take to detect and prevent this activity may not be effective in controlling unknown or unmanaged risks or losses or in protecting us from governmental investigations or other actions or lawsuits stemming from a failure to be in compliance with such laws or regulations. Additionally, we are subject to the risk that a person or government could allege such fraud or other misconduct, even if none occurred. If any such actions are instituted against us, and we are not successful in defending ourselves or asserting our rights, those actions could have a significant impact on our business and financial results, including, without limitation, the imposition of significant civil, criminal and administrative penalties, damages, monetary fines, possible exclusion from participation in Medicare, Medicaid and other federal healthcare programs, reputational harm, diminished profits and future earnings, and curtailment of our operations.

Risks Related to Our Operations

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

The manufacturing activities of our third-party suppliers and manufacturers involve the controlled storage, use and disposal of hazardous materials owned by us, including the components of our

 

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product candidates such as nitric oxide 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 suppliers’ or manufacturers’ facilities pending use and disposal. We and our suppliers and manufacturers cannot completely eliminate the risk of contamination, which could cause an interruption of our commercialization efforts, research and development efforts and business operations, injury to our service providers and others and 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 suppliers and 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 financial resources.

We specialize solely in developing nitric oxide-based dermatology therapeutics, and if we do not successfully achieve regulatory approval for any of our product candidates or successfully commercialize them, we may not be able to continue as a business.

All of our clinical development efforts to date have focused on the development of nitric oxide-based topical therapies. There can be no assurance that the intended or anticipated results from the use of nitric oxide-based therapies will be reaped, and that we will successfully bring our product candidates to market. Because all of our current product candidates are based on nitric oxide and our Nitricil technology, the failure of our Nitricil technology to be safe or efficacious generally will have adverse implications for our entire product candidate pipeline. If, for any reason, our intended use of nitric oxide does not materialize, we may not be able to redeploy our resources to alternative components or raw materials, efficiently or at all.

New stockholders in this offering will not have an interest in the non-dermatological assets transferred to KNOW Bio, LLC in connection with the Separation Transaction.

In December 2015, we formed KNOW Bio, LLC, a wholly owned subsidiary of our company, or KNOW Bio, for the purpose of giving effect to the legal separation of non-dermatological assets, mainly consisting of intellectual property rights, from our company. We made a cash contribution to KNOW Bio to provide it with working capital, and we distributed all of the outstanding member interests of KNOW Bio pro rata to our stockholders. We refer to the foregoing transactions collectively as the Separation Transaction. As a result of the Separation Transaction, new stockholders in this offering will not have an interest in the non-dermatological assets that were separated from our company. An investment in our common stock is not an investment in KNOW Bio.

We expect to experience significant growth which may adversely disrupt our operations.

As of June 30, 2016, we had 62 full-time employees and one part-time employee. As our development progresses, we expect to experience significant growth in the number of our employees and the scope of our operations, particularly in the area of product development and, if any of our product candidates receives marketing approval, sales, marketing and distribution. To manage our anticipated future growth, we must continue to implement and improve our managerial, operational and financial systems, expand our facilities and continue to recruit and train additional qualified personnel. Due to our limited financial resources and the limited experience of our management team in managing a company with such anticipated growth, we may not be able to effectively manage the expansion of our operations or recruit and train additional qualified personnel. The expansion of our operations may lead to significant costs and may divert our management and business development resources. Any inability to manage growth could delay the execution of our business plans or disrupt our operations.

 

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Our business and operations would suffer in the event of computer system failures, cyber-attacks or deficiencies in our cyber-security.

Despite the implementation of security measures, our internal computer systems, and those of 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. 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 or planned clinical trials could result in delays in our regulatory approval efforts and significantly increase our costs to recover or reproduce the data. To the extent that any disruption or security breach was to result in a loss of or damage to our data or applications, or inappropriate disclosure of confidential or proprietary information, we could incur material legal claims and liability, and damage to our reputation, and the further development of our product candidates could be delayed.

Risks Related to Government Regulation

Even if we receive regulatory approval of our product candidates, 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 our product candidates.

Any regulatory approvals that we receive for our product candidates may be subject to limitations on the approved indicated uses for which the product may be marketed or the conditions of approval, or contain requirements for potentially costly post-market testing and surveillance to monitor the safety and efficacy of the product candidate. The FDA may also require a REMS as a condition of approval of our product candidates, which could include requirements for a medication guide, physician communication plans or additional elements to ensure safe use, such as restricted distribution methods, patient registries and other risk minimization tools. In addition, if the FDA or a comparable foreign regulatory authority approves our product candidates, the manufacturing processes, labeling, packaging, distribution, adverse event reporting, storage, advertising, promotion, import, export and recordkeeping 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 our product candidates, 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:

 

  n   restrictions on the marketing or manufacturing of our product candidates, withdrawal of the product from the market, or voluntary or mandatory product recalls;

 

  n   fines, warning letters or holds on clinical trials;

 

  n   refusal by the FDA to approve pending applications or supplements to approved applications filed by us or suspension or revocation of approvals;

 

  n   product seizure or detention, or refusal to permit the import or export of our product candidates; and

 

  n   injunctions or the imposition of civil or criminal penalties.

 

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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 our product candidates. 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 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.

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

In the United States and some foreign 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 prevent or delay marketing approval of our product candidates, restrict or regulate post-approval activities and affect our ability to profitably sell any product candidates for which we obtain marketing approval.

For example, in the United States, in 2010, President Obama signed into law the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act, or collectively the ACA, a sweeping law intended 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 the healthcare and health insurance industries, impose new taxes and fees on the health industry and impose additional health policy reforms. Among the provisions of the ACA of importance to our potential product candidates are the following:

 

  n   an annual, nondeductible fee payable by any entity that manufactures or imports specified branded prescription drugs and biologic agents;

 

  n   an increase in the statutory minimum rebates a manufacturer must pay under the Medicaid Drug Rebate Program;

 

  n   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;

 

  n   a new Medicare Part D coverage gap discount program, in which manufacturers must agree to offer 50% point-of-sale discounts off negotiated prices of applicable brand drugs to eligible beneficiaries under their coverage gap period, as a condition for the manufacturer’s outpatient drugs to be covered under Medicare Part D;

 

  n   extension of manufacturers’ Medicaid rebate liability to individuals enrolled in Medicaid managed care organizations;

 

  n   expansion of eligibility criteria for Medicaid programs;

 

  n   expansion of the entities eligible for discounts under the Public Health Service pharmaceutical pricing program;

 

  n   a new requirement to annually report drug samples that manufacturers and distributors provide to physicians; and

 

  n   a new Patient-Centered Outcomes Research Institute to oversee, identify priorities in, and conduct comparative clinical effectiveness research, along with funding for such research.

There have been judicial and Congressional challenges to certain aspects of the ACA, and we expect there will be additional challenges and amendments to the ACA in the future. At this time, the full effect that the ACA would have on our business remains unclear.

 

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In addition, other legislative changes have been proposed and adopted in the U.S. since the ACA was enacted. These changes included aggregate reductions to Medicare payments to providers of up to 2% per fiscal year, which went into effect in April 2013 and, due to the Bipartisan Budget Act of 2015, will remain in effect through 2025 unless additional action is taken by Congress. In January 2013, President Obama signed into law 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. These new laws may result in additional reductions in Medicare and other healthcare funding. In addition, recently there has been heightened governmental scrutiny over the manner in which manufacturers set prices for their commercial products.

We expect that the ACA, as well as other healthcare reform measures that may be adopted in the future, may result in additional reductions in Medicare and other healthcare funding, more rigorous coverage criteria, new payment methodologies and in additional downward pressure on the price that we receive for any approved product. Any reduction in reimbursement from Medicare or other government programs may result in a similar reduction in payments from private payors. The implementation of cost containment measures or other healthcare reforms may prevent us from being able to generate revenue, attain profitability, or commercialize our product candidates, if approved.

Legislative and regulatory proposals have been made to expand post-approval requirements and restrict sales and promotional activities for pharmaceutical products. We cannot be sure whether additional legislative changes will be enacted, or whether the FDA regulations, guidance or interpretations will be changed, or what the impact of such changes on the marketing approvals of our product candidates, if any, may be. In addition, increased scrutiny by the U.S. Congress of the FDA’s approval process may significantly delay or prevent marketing approval, as well as subject us to more stringent product labeling and post-marketing testing and other requirements.

We are subject to governmental economic sanctions and export and import controls that could impair our ability to compete in international markets or subject us to liability if we are not in compliance with applicable laws.

As a U.S. company, we are subject to U.S. import and export controls and economic sanctions laws and regulations, and we are required to import and export our product candidates, technology and services in compliance with those laws and regulations, including the U.S. Export Administration Regulations, the International Traffic in Arms Regulations, and economic embargo and trade sanction programs administered by the Treasury Department’s Office of Foreign Assets Control.

U.S. economic sanctions and export control laws and regulations prohibit the shipment of certain products and services to countries, governments and persons targeted by U.S. sanctions. While we are currently taking precautions to prevent doing any business, directly or indirectly, with countries, governments and persons targeted by U.S. sanctions and to ensure that our product candidates, if approved, are not exported or used by countries, governments and persons targeted by U.S. sanctions, such measures may be circumvented.

Furthermore, if we export our product candidates, if approved, the exports may require authorizations, including a license, a license exception or other appropriate government authorization. Complying with export control and sanctions regulations for a particular sale may be time-consuming and may result in the delay or loss of sales opportunities. Failure to comply with export control and sanctions regulations for a particular sale may expose us to government investigations and penalties.

If we are found to be in violation of U.S. sanctions or import or export control laws, it could result in civil and criminal, monetary and non-monetary penalties, including possible incarceration for those individuals responsible for the violations, the loss of export or import privileges and reputational harm.

 

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We are subject to anti-corruption and anti-money laundering laws with respect to our operations and non-compliance with such laws can subject us to criminal or civil liability and harm our business.

We are subject to the U.S. Foreign Corrupt Practices Act of 1977, as amended, or the FCPA, the U.S. domestic bribery statute contained in 18 U.S.C. § 201, the U.S. Travel Act, the USA PATRIOT Act and possibly other anti-bribery and anti-money laundering laws in countries in which we may conduct activities. Anti-corruption laws are interpreted broadly and prohibit companies and their employees and third-party intermediaries from authorizing, offering or providing, directly or indirectly, improper payments or benefits to recipients in the public or private sector. As we commercialize our product candidates and eventually commence international sales and business, we may engage with collaborators and third-party intermediaries to sell our products abroad and to obtain necessary permits, licenses and other regulatory approvals. We or our third-party intermediaries may have direct or indirect interactions with officials and employees of government agencies or state-owned or affiliated entities. We may be held liable for the corrupt or other illegal activities of these third-party intermediaries, our employees, representatives, contractors, partners and agents, even if we do not explicitly authorize such activities.

Noncompliance with anti-corruption and anti-money laundering laws could subject us to whistleblower complaints, investigations, sanctions, settlements, prosecution, other enforcement actions, disgorgement of profits, significant fines, damages, other civil and criminal penalties or injunctions, suspension or debarment from contracting with certain persons, the loss of export privileges, reputational harm, adverse media coverage and other collateral consequences. Responding to any action will likely result in a materially significant diversion of management’s attention and resources and significant defense costs and other professional fees.

Risks Related to Our Intellectual Property

If we are unable to obtain and maintain patent protection for our product candidates, or if the scope of the patent protection obtained is not sufficiently broad, our competitors could develop and commercialize technology and products similar or identical to ours, and our ability to successfully commercialize our technology and product candidates may be impaired.

We rely upon a combination of patents, trade secret protection, and confidentiality agreements to protect the intellectual property related to our product candidates. Our success depends in large part on our ability to obtain and maintain patent protection in the United States and other countries with respect to our product candidates. We seek to protect our proprietary position by filing patent applications in the United States and abroad related to our product candidates.

The patent prosecution process is expensive and time-consuming, however, and we may not be able to file and prosecute all necessary or desirable patent applications at a reasonable cost or in a timely manner. It is also possible that we will fail to identify patentable aspects of our technology platform or product candidates before it is too late to obtain patent protection. We may not have the right to control the preparation, filing and prosecution of patent applications, or to maintain the rights to patents licensed to or from third parties. In particular, certain patents and patent applications covering our core technology platform are exclusively licensed from the University of North Carolina, or UNC, and under our license agreement with UNC, we rely on UNC to prosecute and maintain such patents and applications. Therefore, these patents and applications, and any other patents and applications that we may license from or to third parties, may not be prosecuted and enforced in a manner consistent with the best interests of our business.

If the patent applications we hold or have in-licensed with respect to our product candidates fail to issue, if their breadth or strength of protection is threatened, or if they fail to provide meaningful

 

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exclusivity for our current or any future product candidates, it could have a materially adverse effect on our business. Even if our owned and licensed patent applications issue as patents, they may not issue in a form that will provide us with any meaningful protection, prevent competitors from competing with us or otherwise provide us with any competitive advantage. Our competitors may be able to circumvent our owned and licensed patents by developing similar or alternative technologies or products in a non-infringing manner.

The patent position of biotechnology and pharmaceutical companies generally is highly uncertain, involves complex legal and factual questions and has in recent years been the subject of much litigation. In addition, the laws of foreign countries may not protect our rights to the same extent as the laws of the United States or vice versa. For example, European patent law restricts the patentability of methods of treatment of the human body more than United States law does. Publications of discoveries in the scientific literature often lag behind the actual discoveries, and patent applications in the United States and other jurisdictions are typically not published until 18 months after filing, or in some cases not at all. Therefore, we cannot know with certainty whether we were the first to make the inventions claimed in our owned and licensed patents or pending patent applications, or that we were the first to file for patent protection of such inventions. As a result, the issuance, scope, validity, enforceability and commercial value of our patent rights are highly uncertain. Our pending and future patent applications may not result in patents being issued that protect our technology or products, in whole or in part, or which effectively prevent others from commercializing competitive technologies and products. Changes in either the patent laws or interpretation of the patent laws in the United States and other countries may diminish the value of our owned and licensed patents or narrow the scope of our patent protection while patent reform legislation could increase the uncertainties and costs surrounding the prosecution of our patent applications and the enforcement or defense of our issued patents.

Recent patent reform legislation could increase the uncertainties and costs surrounding the prosecution of our patent applications and the enforcement or defense of our issued patents. On September 16, 2011, the Leahy-Smith America Invents Act, or the Leahy-Smith Act, was signed into law. The Leahy-Smith Act includes a number of significant changes to United States patent law. These include provisions that affect the way patent applications are prosecuted and may also affect patent litigation. The United States Patent Office recently developed new regulations and procedures to govern administration of the Leahy-Smith Act, and many of the substantive changes to patent law associated with the Leahy-Smith Act, and in particular, the first to file provisions, only became effective on March 16, 2013. Accordingly, it is not clear what, if any, impact the Leahy-Smith Act will have on the operation of our business. However, the Leahy-Smith Act and its implementation could increase the uncertainties and costs surrounding the prosecution of our patent applications and the enforcement or defense of our issued patents, all of which could have an adverse effect on our business and financial condition. For example, the first to file system under the Leahy-Smith Act may incentivize companies like us in the biopharmaceutical industry to file patent applications as soon as possible, and filing applications as soon as possible runs the risk that the application will not have the supporting data to claim the broadest protection possible in the United States.

Moreover, we may be subject to a third-party preissuance submission of prior art to the U.S. Patent and Trademark Office, or USPTO, or become involved in opposition, derivation, reexamination, inter partes review, post-grant review or interference proceedings challenging our patent rights or the patent rights of others. An adverse determination in any such submission, proceeding or litigation could reduce the scope of, or invalidate, our patent rights, allow third parties to commercialize our technology or products and compete directly with us, without payment to us, or result in our inability to manufacture or commercialize products without infringing third-party patent rights. In addition, if the breadth or strength of protection provided by our owned and licensed patents and patent applications is threatened, it could dissuade companies from collaborating with us to license, develop or commercialize current or future product candidates.

 

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In addition, the issuance of a patent is not conclusive as to its inventorship, scope, validity or enforceability, and our owned and licensed patents may be challenged in the courts or patent offices in the United States and abroad. Such challenges may result in loss of exclusivity or freedom to operate or in patent claims being narrowed, invalidated or held unenforceable, in whole or in part, which could limit our ability to stop others from using or commercializing similar or identical technology and products, or limit the duration of the patent protection of our technology and products. Given the amount of time required for the development, testing and regulatory review of new product candidates, patents protecting such candidates might expire before or shortly after such candidates are commercialized. As a result, our patent portfolio may not provide us with sufficient rights to exclude others from commercializing products similar or identical to ours.

Finally, certain of our activities and our licensors’ activities have been funded, and may in the future be funded, by the U.S. federal government. When new technologies are developed with U.S. federal government funding, the government obtains certain rights in any resulting patents, including a nonexclusive license authorizing the government to use the invention for non-commercial purposes. These rights may permit the government to disclose our confidential information to third parties and to exercise “march-in” rights to use or allow third parties to use our patented technology. The government can exercise its march-in rights if it determines that action is necessary because we fail to achieve practical application of the U.S. government-funded technology, because action is necessary to alleviate health or safety needs, to meet requirements of federal regulations or to give preference to U.S. industry. In addition, U.S. government-funded inventions must be reported to the government, U.S. government funding must be disclosed in any resulting patent applications, and our rights in such inventions may be subject to certain requirements to manufacture products in the United States.

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.

Periodic maintenance fees on any issued patent are due to be paid to the USPTO and other foreign patent agencies in several stages over the lifetime of the patent. The USPTO and various foreign national or international patent agencies require compliance with a number of procedural, documentary, fee payment and other similar provisions during the patent application process. While an inadvertent lapse can in many cases be cured by payment of a late fee or by other means in accordance with the applicable rules, there are situations in which noncompliance can result in abandonment or lapse of the patent or patent application, resulting in partial or complete loss of patent rights in the relevant jurisdiction. Non-compliance events that could result in abandonment or lapse of patent rights include, but are not limited to, failure to timely file national and regional stage patent applications based on our international patent application, failure to respond to official actions within prescribed time limits, non-payment of fees and failure to properly legalize and submit formal documents. If we or our licensors fail to maintain the patents and patent applications covering our technology platform or product candidates, our competitors might be able to enter the market, which would have an adverse effect on our business.

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

The United States has recently enacted and implemented 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 actions by the U.S. Congress, the federal courts, and the USPTO, the laws

 

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and regulations governing patents could change in unpredictable ways that would weaken our ability to obtain new patents or to enforce patents that we have licensed or that we might obtain in the future.

We may be involved in lawsuits to protect or enforce our owned and licensed patents, which could be expensive, time-consuming and unsuccessful. Further, our issued patents could be found invalid or unenforceable if challenged in court.

If we were to initiate legal proceedings against a third-party to enforce a patent directed to our product candidates, or one of our future product candidates, the defendant could counterclaim that our patent is invalid or unenforceable. In patent litigation in the United States, defendant counterclaims alleging invalidity 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, non-enablement or insufficient written description. 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. Third parties may also raise similar claims before the USPTO, even outside the context of litigation. The outcome following legal assertions of invalidity and unenforceability is unpredictable. With respect to the validity question, 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 or unenforceability, we would lose at least part, and perhaps all, of the patent protection on our product candidates. Such a loss of patent protection would harm our business.

Interference proceedings provoked by third parties or brought by us or declared by the USPTO may be necessary to determine the priority of inventions with respect to our owned and licensed patents or patent applications. An unfavorable outcome could require us to cease using the related technology or to attempt to license rights to it from the prevailing party. Our business could be harmed if the prevailing party does not offer us a license on commercially reasonable terms, or at all.

Furthermore, because of the substantial amount of discovery required in connection with intellectual property litigation, there is a risk that some of our confidential information could be compromised by disclosure during this type of litigation.

Most of our competitors are larger than we are and have substantially greater resources than we do. They are, therefore, likely to be able to sustain the costs of complex patent or other intellectual property rights litigation longer than we could. Accordingly, despite our efforts, we may not be able to prevent third parties from infringing upon or misappropriating our intellectual property. Litigation could result in substantial costs and diversion of management resources, which could harm our business. In addition, the uncertainties associated with litigation could compromise our ability to raise the funds necessary to continue our clinical trials, continue our internal research programs, or in-license needed technology or other product candidates. There could also be public announcements of the results of the hearing, motions, or other interim proceedings or developments. If securities analysts or investors perceive those results to be negative, it could cause the price of shares of our common stock to decline.

We may not be able to protect our intellectual property rights throughout the world, which could impair our business.

Filing, prosecuting and defending patents on our product candidates in all countries throughout the world would be prohibitively expensive, and our intellectual property rights in some countries outside the United States can be less extensive than those in the United States. In addition, the laws of some foreign countries do not protect intellectual property rights to the same extent as federal and state laws in the United States. Consequently, we may not be able to prevent third parties from practicing our invention in such countries. Competitors may use our technologies in jurisdictions where we have not

 

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obtained patent protection to develop their own products and may export otherwise infringing products to territories where we have patent protection, but enforcement rights are not as strong as those in the United States. These products may compete with our product candidates and our owned and licensed patents or other intellectual property rights may not be effective or sufficient to prevent them from competing.

Many companies have encountered significant problems in protecting and defending intellectual property rights in foreign jurisdictions. The legal systems of some countries do not favor the enforcement of patents and other intellectual property protection, which could make it difficult for us to stop the infringement of our owned and licensed patents generally. Proceedings to enforce our patent rights in foreign jurisdictions could result in substantial costs and divert our efforts and attention from other aspects of our business, could put our patents at risk of being invalidated or interpreted narrowly and our owned and licensed patent applications at risk of not issuing and could provoke third parties to assert claims against us. We may not prevail in any lawsuits that we initiate, and the damages or other remedies awarded, if any, may not be commercially meaningful.

Many countries, including European Union countries, India, Japan and China, have compulsory licensing laws under which a patent owner may be compelled under specified circumstances to grant licenses to third parties. In those countries, we may have limited remedies if patents are infringed or if we are compelled to grant a license to a third party, which could materially diminish the value of those patents. This could limit our potential revenue opportunities. Accordingly, our efforts to enforce our intellectual property rights around the world may be inadequate to obtain a significant commercial advantage from the intellectual property that we develop or license.

We may not be able to obtain licenses to third-party intellectual property. Third parties may initiate legal proceedings alleging infringement of their intellectual property rights.

A third party may hold intellectual property, including patent rights that are important or necessary to the development or commercialization of our product candidates. However, we may not be able to obtain such licenses on commercially reasonable terms, or at all. In addition, our existing licenses may be terminated or may not be renewed, which could hurt our business.

In addition, our commercial success depends upon our ability to develop, manufacture, market and sell our product candidates and use our proprietary technologies without infringing the proprietary rights of third parties. There is considerable intellectual property litigation in the biotechnology and pharmaceutical industries. We may become party to, or threatened with, future adversarial proceedings or litigation regarding intellectual property rights with respect to our products and technology, including interference or derivation proceedings before the USPTO. Numerous U.S. and foreign issued patents and pending patent applications owned by third parties exist in the fields in which we are developing our product candidates. As the biotechnology and pharmaceutical industries expand and more patents are issued, and as we gain greater visibility and market exposure as a public company, the risk increases that our product candidates or other business activities may be subject to claims of infringement of the patent and other proprietary rights of third parties. Third parties may assert infringement claims against us based on existing patents or patents that may be granted in the future. We have conducted searches for information in support of patent protection and otherwise evaluating the patent landscape for nitric oxide releasing materials and products, and, based on these searches and evaluations to date, we do not believe that there are valid patents which contain granted claims that could be asserted with respect to our nitric oxide-based product candidates.

Parties making claims against us may obtain injunctive or other equitable relief, which could effectively block our ability to further develop and commercialize one or more of our product candidates or force us to cease some of our business operations. Defense of these claims, regardless of their

 

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merit, would involve substantial litigation expense and would be a substantial diversion of employee resources from our business. If we are found to infringe a third party’s intellectual property rights, we could be required to redesign our infringing products or obtain a license from such third party to continue developing and marketing our products and technology. However, we may not be able to obtain any required license on commercially reasonable terms or at all. Even if we were able to obtain a license, it could be non-exclusive, thereby giving our competitors access to the same technologies licensed to us. Moreover, we could be forced, including by court order, to cease commercializing the infringing technology or product. In addition, we could be found liable for monetary damages, including treble damages and attorneys’ fees if we are found to have willfully infringed a patent. Claims that we have misappropriated the confidential information or trade secrets of third parties could have a similar negative impact on our business.

We may be subject to claims by third parties asserting that we or our employees have misappropriated their intellectual property, or claiming ownership of what we regard as our own intellectual property.

Many of our employees were previously employed at other biotechnology or pharmaceutical companies or universities. Although we try to ensure that our employees do not use the proprietary information or know-how of others in their work for us, we may be subject to claims that these employees or we have used or disclosed intellectual property, including trade secrets or other proprietary information, of any such employee’s former employer. Litigation may be necessary to defend against these claims.

In addition, while it is our policy to require our employees and contractors who may be involved in the 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 develops intellectual property that we regard as our own. Our and their 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.

If we fail in prosecuting or defending any such claims, in addition to paying monetary damages, we may lose valuable intellectual property rights or personnel. Even if we are successful in prosecuting or defending against such claims, litigation could result in substantial costs and be a distraction to management.

If we fail to comply with our obligations under any license, collaboration or other agreements, it could have a material adverse effect on our commercialization efforts for our product candidates.

Our current license with UNC imposes, and any future licenses we enter into may impose, various development, commercialization, milestone, royalty, diligence, sublicensing, insurance, patent prosecution and enforcement, and other obligations on us. If we breach any of these obligations, or use the intellectual property licensed to us in an unauthorized manner, we may be required to pay damages and the licensor may have the right to terminate the license, which could result in us being unable to develop, manufacture and sell products that are covered by the licensed technology or enable a competitor to gain access to the licensed technology.

If we are unable to protect the confidentiality of our trade secrets, our business and competitive position would be harmed.

In addition to seeking patents for our product candidates, we also rely on trade secrets, including unpatented know-how, technology and other proprietary information, to maintain our competitive position.

 

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We seek to protect our trade secrets, in part, by entering into non-disclosure and confidentiality agreements with parties who have access to them, such as our employees (including through specific provisions in employment contracts), corporate collaborators, outside scientific collaborators, contract manufacturers, consultants, advisors and other third parties. We also enter into confidentiality and invention or patent assignment agreements with our employees and consultants. Despite these efforts, any of these parties may breach the agreements and disclose our proprietary information, including our trade secrets, and we may not be able to obtain adequate remedies for such breaches. Enforcing a claim that a party illegally disclosed or misappropriated a trade secret is difficult, expensive and time-consuming, and the outcome is unpredictable. In addition, some courts inside and outside the United States are less willing or unwilling to protect trade secrets. If any of our trade secrets were to be lawfully obtained or independently developed by a competitor, we would have no right to prevent them, or those to whom they communicate it, from using that technology or information to compete with us. If any of our trade secrets were to be disclosed to or independently developed by a competitor, our competitive position would be materially impaired.

Our reliance on third parties requires us to share our trade secrets, which increases the possibility that a competitor will discover them or that our trade secrets will be misappropriated or disclosed.

Because we expect to rely on third parties to manufacture SB204 and any future product candidates, we must, at times, share trade secrets with them. These agreements typically limit the rights of the third parties to use or disclose our confidential information, including our trade secrets. Despite the contractual provisions employed when working with third parties, the need to share trade secrets and other confidential information increases the risk that such trade secrets become known by our competitors, are inadvertently incorporated into the technology of others, or are disclosed or used in violation of these agreements. Given that our proprietary position is based, in part, on our know-how and trade secrets, a competitor’s discovery of our trade secrets or other unauthorized use or disclosure would impair our competitive position and may adversely impact our business.

Any trademarks we have obtained or may obtain may be infringed or successfully challenged, materially harming to our business.

We expect to rely on trademarks as one means to distinguish any of our product candidates that are approved for marketing from the products of our competitors. Once we select new trademarks and apply to register them, our trademark applications may not be approved. Third parties may oppose or attempt to cancel our trademark applications or trademarks, or otherwise challenge our use of the trademarks. In the event that our trademarks are successfully challenged, we could be forced to rebrand our products, which could result in loss of brand recognition and could require us to devote resources to advertising and marketing new brands. Further, our competitors may infringe our trademarks, including with respect to our Nitricil technology and we may not have adequate resources to enforce our trademarks.

Outside of the United States we cannot be certain that any country’s patent or trademark office will not implement new rules that could seriously affect how we draft, file, prosecute and maintain patents, trademarks and patent and trademark applications.

We cannot be certain that the patent or trademark offices of countries outside the United States will not implement new rules that increase costs for drafting, filing, prosecuting and maintaining patents, trademarks and patent and trademark applications or that any such new rules will not restrict our ability to file for patent protection. For example, we may elect not to seek patent protection in some jurisdictions or for some product candidates in order to save costs. We may be forced to abandon or return the rights to specific patents due to a lack of financial resources.

 

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Intellectual property rights do not necessarily address all potential threats to our competitive advantage.

The degree of future protection afforded by our intellectual property rights is uncertain because intellectual property rights have limitations, and may not adequately protect our business, or permit us to maintain our competitive advantage, for reasons including but not limited to the following:

 

  n   others may be able to make formulations or compositions that are the same as or similar to certain of our product candidates but that are not covered by the claims of the patents that we own or license;

 

  n   others may independently develop similar or alternative technologies or duplicate any of our technologies without infringing our trade secret or similar rights;

 

  n   issued patents that we own or license may not provide us with any competitive advantages, or may be held invalid or unenforceable as a result of legal challenges;

 

  n   our competitors might conduct research and development activities in the United States and other countries that provide a safe harbor from patent infringement claims for certain research and development activities, as well as in countries where we do not have patent rights, and then use the information learned from such activities to develop competitive products for sale in our major commercial markets; and

 

  n   we may not develop additional proprietary technologies that are patentable.

Risks Related to our Financial Results

We have incurred significant losses since our inception. We expect to incur losses for at least the next several years and may never achieve or maintain profitability.

Since inception, we have incurred significant operating losses. Our net loss was $11.4 million for the year ended December 31, 2014, $28.1 million for the year ended December 31, 2015 and $29.2 million for the six months ended June 30, 2016. As of June 30, 2016, we had an accumulated deficit of $92.5 million. As a result of our operating losses and negative cash flows from operations, the report of our independent registered public accounting firm on our December 31, 2015 financial statements included an explanatory paragraph indicating that there is substantial doubt about our ability to continue as a going concern. To date, we have financed our operations primarily through private placements of our common and preferred stock, convertible debt financings, government contracts, and government and other third-party grants. We have devoted substantially all of our efforts to research and development, including clinical trials. We have not completed development of any product candidates. We expect to continue to incur significant expenses and increasing operating losses for at least the next several years. We anticipate that our expenses will increase substantially if and as we:

 

  n   conduct the Phase 3 clinical trials of SB204 for the treatment of acne vulgaris;

 

  n   initiate clinical trials of our additional product candidates;

 

  n   seek regulatory approvals for our product candidates that successfully complete clinical trials;

 

  n   qualify contract manufacturing organizations for the manufacture of drug product for the commercial launch of our product candidates;

 

  n   establish a sales, marketing and distribution infrastructure to commercialize products for which we may obtain regulatory approval;

 

  n   maintain, expand and protect our intellectual property portfolio;

 

  n   continue our research and development efforts;

 

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  n   hire additional clinical, quality control, scientific and management personnel;

 

  n   add operational, financial and management information systems and personnel, including personnel to support our product development and planned commercialization efforts; and

 

  n   incur additional legal, accounting and other expenses in operating as a public company.

To become and remain profitable, we must develop and eventually commercialize a product or products with significant market potential. This development and commercialization will require us to be successful in a range of challenging activities, including successfully completing clinical trials of our product candidates, obtaining regulatory approval for these product candidates, and marketing and selling those products for which we may obtain regulatory approval. We are only in the preliminary stages of some of these activities. We may never succeed in these activities and may never generate revenues that are significant or large enough to achieve profitability.

Even if we do achieve profitability, we may not be able to sustain or increase profitability on a quarterly or annual basis. Our failure to become and remain profitable would decrease the value of the company and could impair our ability to raise capital, expand our business, maintain our research and development efforts or continue our operations. A decline in the value of our company could also cause you to lose all or part of your investment.

Our ability to utilize our net operating loss, or NOL, carryforwards may be limited.

As of December 31, 2015, we had NOL carryforwards available to reduce future taxable income, if any, for federal and state income tax purposes of $48.1 million and $50.6 million, respectively. If not utilized, the federal and state NOL carryforwards will begin expiring in 2028 and 2023 for federal and state tax purposes, respectively. Our ability to utilize NOL carryforward amounts to reduce taxable income in future years may be limited for various reasons, including if future taxable income is insufficient to recognize the full benefit of such NOL carryforward amounts prior to their expiration. Additionally, our ability to fully utilize these U.S. tax assets can also be adversely affected by “ownership changes” within the meaning of Section 382 of the Internal Revenue Code of 1986, as amended, or the Code, in a three-year period. Any ownership change is generally defined as a greater than 50% increase in equity ownership by “5% stockholders,” as that term is defined for purposes of Section 382 of the Code in any three year period. We may experience ownership changes in connection with this offering or otherwise in the future as a result of shifts in our stock ownership. As a result, if we earn net taxable income, our ability to use our pre-change NOL carryforwards to offset U.S. federal taxable income may be subject to limitations, which could potentially result in increased future tax liability to us. In addition, at the state level, there may be periods during which the use of NOL carryforwards is suspended or otherwise limited, which could accelerate or permanently increase state taxes owed.

We will need substantial additional funding. If we are unable to raise capital when needed, we would be forced to delay, reduce, terminate or eliminate our product development programs, or our commercialization efforts.

We expect our expenses to increase in connection with our ongoing activities, including conducting our Phase 3 clinical trials of SB204 and additional clinical trials of SB206, and seeking regulatory approval for our product candidates. In addition, if we obtain regulatory approval of any of our product candidates, we expect to incur significant commercialization expenses for product sales, marketing, manufacturing and distribution. Furthermore, upon the closing of this offering, we expect to incur additional costs associated with operating as a public company. Accordingly, we will need to obtain substantial additional funding in connection with our continuing operations. If we are unable to raise capital when needed or on attractive terms, we would be forced to delay, reduce, terminate or eliminate our product development programs, or our commercialization efforts.

 

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As of June 30, 2016, we had cash and cash equivalents of $19.6 million and working capital of $10.9 million. We expect that the net proceeds from this offering, together with our existing cash and cash equivalents and short-term investments, will enable us to fund our operating expenses and capital expenditure requirements into 2017, including funding the Phase 3 clinical trials of SB204, the ongoing Phase 2 clinical trial of SB206 and first Phase 2 clinical trial study for SB208.

We will need to obtain significant financing, in addition to the net proceeds of this offering, prior to the commercialization of SB204 to fund any commercialization efforts in anticipation of regulatory approval of SB204.

Our future capital requirements will depend on many factors, including:

 

  n   clinical trials for SB204, SB206 and SB208;

 

  n   the scope, progress, results and costs of preclinical development, laboratory testing and clinical trials for our other product candidates;

 

  n   costs, timing and outcome of regulatory review of our product candidates;

 

  n   costs of commercialization activities, including product sales, marketing, manufacturing and distribution, for any of our product candidates for which we receive regulatory approval;

 

  n   revenue, if any, received from commercial sales of our product candidates, should any of our product candidates be approved by the FDA or a similar regulatory authority outside the United States;

 

  n   costs of preparing, filing and prosecuting patent applications, maintaining and enforcing our intellectual property rights and defending intellectual property-related claims;

 

  n   the extent to which we acquire or invest in other businesses, products and technologies;

 

  n   our ability to obtain government or other third-party funding for the development of our product candidates; and

 

  n   our ability to establish collaborations on favorable terms, if at all, particularly arrangements to develop, market and distribute our product candidates outside North America.

Conducting preclinical testing and clinical trials is a time-consuming, expensive and uncertain process that takes years to complete, and we may never generate the necessary data or results required to obtain regulatory approval and achieve product sales. In addition, our product candidates, if approved, may not achieve commercial success. Our commercial revenues, if any, will be derived from sales of products that we do not expect to be commercially available for several years, if at all. Accordingly, we will need to continue to rely on additional financing to achieve our business objectives. Additional financing may not be available to us on acceptable terms, or at all.

Raising additional capital may cause dilution to our existing stockholders, restrict our operations or require us to relinquish rights to our technologies or product candidates.

Until such time, if ever, as we can generate substantial product revenues, we expect to finance our cash needs through a combination of equity offerings, debt financings, government contracts, government and other third-party grants or other third-party funding, marketing and distribution arrangements and other collaborations, strategic alliances and licensing arrangements. We will require substantial funding in addition to the net proceeds of this offering to complete the planned leasing, fund our commercialization efforts and fund our operating expenses and other activities. To the extent that we raise additional capital through the sale of equity or convertible debt securities, your ownership interest will be diluted, and the terms of these securities may include liquidation or other preferences

 

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that adversely affect your rights as a stockholder. Debt financing, if available, may involve agreements that include covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making capital expenditures or declaring dividends.

We currently intend to collaborate with third parties for the development and commercialization of our product candidates. If we raise additional funds through government or other third-party funding, marketing and distribution arrangements or other collaborations, strategic alliances or licensing arrangements with third parties, we may have to relinquish valuable rights to our technologies, future revenue streams, research programs or product candidates or to grant licenses on terms that may not be favorable to us.

The report of our independent registered public accounting firm on our 2015 consolidated financial statements contains an explanatory paragraph regarding going concern, and we will need additional financing to execute our business plan, to fund our operations and to continue as a going concern.

Since inception, we have experienced recurring operating losses and negative cash flows and we expect to continue to generate operating losses and consume significant cash resources in the foreseeable future. These conditions raise substantial doubt about our ability to continue as a going concern without additional financing. As a result, our independent registered public accounting firm included an explanatory paragraph in its report on our 2015 consolidated financial statements with respect to this uncertainty. Substantial doubt about our ability to continue as a going concern may materially and adversely affect the price per share of our common stock and we may have a more difficult time obtaining financing.

We have prepared our consolidated financial statements on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities and commitments in the normal course of business. Our 2015 consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.

We have a limited operating history and no history of commercializing drugs, which may make it difficult for you to evaluate the success of our business to date and to assess our future viability.

We commenced operations in 2006, and our operations to date have been largely focused on raising capital and developing SB204 and SB206 for the treatments of acne vulgaris and HPV, respectively. We have not yet demonstrated our ability to successfully complete later-stage clinical trials, obtain regulatory approvals, manufacture a drug on a commercial scale, or arrange for a third-party to do so on our behalf, or conduct sales and marketing activities necessary for successful commercialization. Consequently, any predictions you make about our future success or viability may not be as accurate as they could be if we had a longer operating history or a history of successfully developing and commercializing drugs.

We may encounter unforeseen expenses, difficulties, complications, delays and other known or unknown factors in achieving our business objectives. We will need to transition at some point from a company with a development focus to a company capable of supporting commercial activities. We may not be successful in such a transition.

We may be adversely affected by natural disasters and other catastrophic events, and by man-made problems such as terrorism, that could disrupt our business operations and our business continuity and disaster recovery plans may not adequately protect us from a serious disaster.

Our corporate headquarters are located in Durham, North Carolina, near major hurricane and tornado zones. If a disaster, power outage or other event occurred that prevented us from using all or a

 

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significant portion of our headquarters, that damaged critical infrastructure, such as enterprise financial systems, manufacturing resource planning or 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. Our manufacturers’ and suppliers’ facilities are located in multiple locations, where other natural disasters or similar events, such as blizzards, tornadoes, fires, explosions or large-scale accidents or power outages, could severely disrupt their operations. In addition, acts of terrorism and other geo-political unrest could cause disruptions in our business or the businesses of our collaborators, manufacturers or the economy as a whole. All of the aforementioned risks may be further increased if we do not implement a disaster recovery plan or our collaborators’ or manufacturers’ disaster recovery plans prove to be inadequate. Any of the above could result in delays in the regulatory approval, manufacture, distribution or commercialization of our product candidates.

Risks Related to Our Common Stock and this Offering

After this offering, our executive officers, directors and principal stockholders, if they choose to act together, will continue to have the ability to control all matters submitted to stockholders for approval.

Upon the closing of this offering, our executive officers, directors and stockholders who owned more than 5% of our outstanding common stock before this offering and their respective affiliates will, in the aggregate, hold shares representing approximately     % of our outstanding voting common stock. As a result, if these stockholders were to choose to act together, they would be able to control or significantly influence all matters submitted to our stockholders for approval, as well as our management and affairs. For example, these persons, if they choose to act together, would control or significantly influence the election of directors and approval of any merger, consolidation or sale of all or substantially all of our assets. This concentration of ownership control may:

 

  n   delay, defer or prevent a change in control;

 

  n   entrench our management and the board of directors; or

 

  n   impede a merger, consolidation, takeover or other business combination involving us that other stockholders may desire.

The significant concentration of stock ownership may negatively impact the price of our common stock due to investors’ perception that conflicts of interest may exist or arise.

If you purchase shares of common stock in this offering, you will suffer immediate and substantial dilution of your investment.

The initial public offering price of our common stock will be substantially higher than the net tangible book value per share of our common stock. Therefore, if you purchase shares of our common stock in this offering, you will pay a price per share that substantially exceeds our net tangible book value per share after this offering. To the extent shares subsequently are issued under outstanding stock options, you will incur further dilution. Based on an assumed initial public offering price of $          per share, which is the midpoint of the price range set forth on the cover page of this prospectus, you will experience immediate dilution of $          per share, representing the difference between our pro forma net tangible book value per share, after giving effect to this offering, and the assumed initial public offering price. In addition, purchasers of common stock in this offering will have contributed approximately     % of the aggregate price paid by all purchasers of our stock but will own only approximately     % of our common stock outstanding after this offering. For further information on this calculation, see “Dilution.”

 

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Provisions in our amended and restated certificate of incorporation and amended and restated bylaws under Delaware law could make an acquisition of our company, which may be beneficial to our stockholders, more difficult and may prevent attempts by our stockholders to replace or remove our current management.

Provisions in our amended and restated certificate of incorporation and our amended and restated bylaws that will become effective upon the closing of this offering may discourage, delay or prevent a merger, acquisition or other change in control of our company that stockholders may consider favorable, including transactions in which you might otherwise receive a premium for your shares. These provisions could also limit the price that investors might be willing to pay in the future for shares of our common stock, thereby depressing the market price of our common stock. In addition, because our board of directors is responsible for appointing the members of our management team, these provisions may frustrate or prevent any attempts by our stockholders to replace or remove our current management by making it more difficult for stockholders to replace members of our board of directors. Among other things, these provisions include those establishing:

 

  n   a classified board of directors with three-year staggered terms, which may delay the ability of stockholders to change the membership of a majority of our board of directors;

 

  n   no cumulative voting in the election of directors, which limits the ability of minority stockholders to elect director candidates;

 

  n   the exclusive right of our board of directors to elect a director to fill a vacancy created by the expansion of the board of directors or the resignation, death or removal of a director, which prevents stockholders from filling vacancies on our board of directors;

 

  n   the ability of our board of directors to authorize the issuance of shares of preferred stock and to determine the terms of those shares, including preferences and voting rights, without stockholder approval, which could be used to significantly dilute the ownership of a hostile acquirer;

 

  n   the ability of our board of directors to alter our amended and restated bylaws without obtaining stockholder approval;

 

  n   the required approval of the holders of at least two-thirds of the shares entitled to vote at an election of directors to adopt, amend or repeal our amended and restated bylaws or repeal the provisions of our amended and restated certificate of incorporation regarding the election and removal of directors;

 

  n   a prohibition on stockholder action by written consent, which forces stockholder action to be taken at an annual or special meeting of our stockholders;

 

  n   the requirement that a special meeting of stockholders may be called only by the chief executive officer, the chairman, the president or the board of directors, which may delay the ability of our stockholders to force consideration of a proposal or to take action, including the removal of directors;

 

  n   advance notice procedures that stockholders must comply with in order to nominate candidates to our board of directors or to propose matters to be acted upon at a stockholders’ meeting, which may discourage or deter a potential acquirer from conducting a solicitation of proxies to elect the acquirer’s own slate of directors or otherwise attempting to obtain control of us; and

 

  n   the requirement that the Court of Chancery of the State of Delaware be the sole and exclusive forum for derivative actions and other corporate claims unless we consent to an alternative forum in writing, which may limit a stockholder’s ability to bring a claim in a judicial forum that it finds favorable for disputes with us or any of our directors, officers or other employees and discourage lawsuits with respect to such claims.

 

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Moreover, because we are incorporated in Delaware, we are governed by the provisions of Section 203 of the General Corporation Law of the State of Delaware, which prohibits a person who owns in excess of 15% of our outstanding voting stock from merging or combining with us for a period of three years after the date of the transaction in which the person acquired in excess of 15% of our outstanding voting stock, unless the merger or combination is approved in a prescribed manner.

An active trading market for our common stock may not develop.

Prior to this offering, there has been no public market for our common stock. The initial public offering price for our common stock will be determined through negotiations with the underwriters. Although we have applied to have our common stock approved for listing on The NASDAQ Global Market, an active trading market for our shares may never develop or be sustained following this offering. If an active market for our common stock does not develop, it may be difficult for you to sell shares you purchase in this offering at or above the initial public offering price or at all. The lack of an active market may also reduce the fair market value of your shares. An inactive market may also impair our ability to raise capital to continue to fund operations by selling shares and may impair our ability to acquire other companies or technologies by using our shares as consideration.

The price of our common stock may be volatile and fluctuate significantly, which could result in substantial losses for purchasers of our common stock in this offering.

Our stock price is likely to be volatile. The stock market in general has experienced extreme volatility that has often been unrelated to the operating performance of particular companies. As a result of this volatility, you may not be able to sell your common stock at or above the initial public offering price. The market price for our common stock may be influenced by many factors, including:

 

  n   actual or anticipated fluctuations in our financial condition and operating results;

 

  n   actual or anticipated changes in our growth rate relative to our competitors;

 

  n   competition from existing products or new products that may emerge;

 

  n   development of new technologies that may address our markets and may make our technology less attractive;

 

  n   changes in physician, hospital or healthcare provider practices that may make our product candidates less attractive;

 

  n   announcements by us, our partners or our competitors of significant acquisitions, strategic partnerships, joint ventures, collaborations or capital commitments;

 

  n   developments or disputes concerning proprietary rights, including patents, litigation matters and our ability to obtain patent protection for our technologies;

 

  n   the recruitment or departure of key personnel;

 

  n   failure to meet or exceed financial estimates and projections of the investment community or that we provide to the public;

 

  n   actual or anticipated changes in estimates as to financial results, development timelines or recommendations by securities analysts;

 

  n   variations in our financial results or those of companies that are perceived to be similar to us;

 

  n   changes to reimbursement levels by commercial third-party payors and government payors, including Medicare, and negative announcements relating to reimbursement levels;

 

  n   general economic, industry and market conditions; and

 

  n   the other factors described in this “Risk Factors” section.

 

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In addition, the stock market in general and emerging growth companies in particular, have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of these companies. A certain degree of stock price volatility can be attributed to being a newly public company. These broad market and industry fluctuations may negatively impact the price or liquidity of our common stock, regardless of our operating performance.

We have broad discretion in the use of the net proceeds from this offering and may not use them effectively.

Our management will have broad discretion in the application of the net proceeds from this offering and could spend the proceeds in ways that do not improve our results of operations or enhance the value of our common stock. Our use of these proceeds may differ substantially from our current plans. The failure by our management to apply these funds effectively could result in financial losses that could have a material adverse effect on our business and cause the price of our common stock to decline. Pending their use, we may invest the net proceeds from this offering in a manner that does not produce income or that loses value.

Future sales of shares by existing stockholders could cause our stock price to decline.

If our existing stockholders sell, or indicate an intent to sell, substantial amounts of our common stock in the public market after the 180-day contractual lock-up and other legal restrictions on resale discussed in this prospectus lapse, the trading price of our common stock could decline significantly and could decline below the initial public offering price. Upon the completion of this offering, we will have             outstanding shares of common stock, assuming no exercise of outstanding options. Of these shares,          shares of common stock, plus any shares sold pursuant to the underwriters’ option to purchase additional shares, will be immediately freely tradable, without restriction, in the public market.

After the lock-up agreements pertaining to this offering expire, an additional             shares will be eligible for sale in the public market. In addition, upon issuance, the 734,496 shares subject to outstanding options under our stock option plans will become eligible for sale in the public market in the future, subject to certain legal and contractual limitations.

We are an “emerging growth company,” and the reduced disclosure requirements applicable to emerging growth companies may make our common stock less attractive to investors.

We are an “emerging growth company,” as defined in the JOBS Act, and may remain an emerging growth company until the earliest of (1) the end of the fiscal year in which the market value of our common stock that is held by non-affiliates exceeds $700.0 million as of the end of the second fiscal quarter, (2) the end of the fiscal year in which we have total annual gross revenue of $1.0 billion or more during such fiscal year, (3) the date on which we issue more than $1.0 billion in non-convertible debt in a three-year period or (4) December 31, 2021, the end of the fiscal year following the fifth anniversary of the completion of this offering. For so long as we remain an emerging growth company, we are permitted and intend to rely on exemptions from certain disclosure requirements that are applicable to other public companies that are not emerging growth companies. These exemptions include:

 

  n   being permitted to provide only two years of audited financial statements, in addition to any required unaudited interim financial statements, with correspondingly reduced “Management’s Discussion and Analysis of Financial Condition and Results of Operations” disclosure;

 

  n   not being required to comply with the auditor attestation requirements in the assessment of our internal control over financial reporting;

 

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  n   not being required to comply with any requirement that may be adopted by the Public Company Accounting Oversight Board regarding mandatory audit firm rotation or a supplement to the auditor’s report providing additional information about the audit and the financial statements;

 

  n   reduced disclosure obligations regarding executive compensation; and

 

  n   exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved.

We have taken advantage of reduced reporting requirements in this prospectus. In particular, in this prospectus, we have provided only two years of audited financial statements and have not included all of the executive compensation related information that would be required if we were not an emerging growth company. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our stock price may be reduced or more volatile. In addition, the JOBS Act provides that an emerging growth company can take advantage of an extended transition period for complying with new or revised accounting standards. This allows an emerging growth company to delay the adoption of these accounting standards until they would otherwise apply to private companies. We have irrevocably elected not to avail ourselves of this exemption and, therefore, we will be subject to the same new or revised accounting as other public companies that are not emerging growth companies.

We will incur increased costs as a result of operating as a public company, and our management will be required to devote substantial time to new compliance initiatives and corporate governance practices.

As a public company, and particularly after we are no longer an emerging growth company, we will incur significant legal, accounting and other expenses that we did not incur as a private company. The Sarbanes-Oxley Act, the Dodd-Frank Wall Street Reform and Consumer Protection Act, the listing requirements of The NASDAQ Global Market and other applicable securities rules and regulations impose various requirements on public companies, including establishment and maintenance of effective disclosure and financial controls and corporate governance practices. Our management and other personnel will need to devote a substantial amount of time to these compliance initiatives. Moreover, these rules and regulations will increase our legal and financial compliance costs and will make some activities more time-consuming and costly. For example, these rules and regulations may make it more difficult and more expensive for us to obtain director and officer liability insurance, which in turn could make it more difficult for us to attract and retain qualified members of our board of directors.

We are evaluating these rules and regulations, and cannot predict or estimate the amount of additional costs we may incur or the timing of such costs. These rules and regulations are often subject to varying interpretations, in many cases due to their lack of specificity and, as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies. This could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices.

Our management team has limited experience managing a public company.

Most members of our management team have limited experience managing a publicly traded company, interacting with public company investors and complying with the increasingly complex laws pertaining to public companies. Our management team may not successfully or efficiently manage our transition to being a public company subject to significant regulatory oversight and reporting obligations under the federal securities laws and the continuous scrutiny of securities

 

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analysts and investors. These new obligations and constituents will require significant attention from our senior management and could divert their attention away from the day-to-day management of our business.

If securities or industry analysts do not publish research or reports about our business, or if they issue an adverse or misleading opinion regarding our stock, our stock price and trading volume could decline.

The trading market for our common stock will be influenced by the research and reports that industry or securities analysts publish about us or our business. We do not currently have and may never obtain research coverage by securities and industry analysts. If no or few securities or industry analysts commence coverage of us, the trading price for our stock would be negatively impacted. In the event we obtain securities or industry analyst coverage, if any of the analysts who cover us issue an adverse or misleading opinion regarding us, our business model, our intellectual property or our stock performance, or if our regulatory clearance timelines, clinical trial results or operating results fail to meet the expectations of analysts, our stock price would likely decline. If one or more of these analysts ceases coverage of us or fail to publish reports on us regularly, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline.

Because we do not anticipate paying any cash dividends on our capital stock in the foreseeable future, capital appreciation, if any, will be your sole source of gain.

We have never declared or paid cash dividends on our capital stock. We currently intend to retain all of our future earnings, if any, to finance the growth and development of our business. Any future debt agreements may preclude us from paying dividends. As a result, capital appreciation, if any, of our common stock will be your sole source of gain for the foreseeable future.

We could be subject to securities class action litigation.

In the past, securities class action litigation has often been brought against a company following a decline in the market price of its securities. If we face such litigation, it could result in substantial costs and a diversion of management’s attention and resources.

If we fail to maintain proper and effective internal controls, our ability to produce accurate financial statements on a timely basis could be impaired which could adversely impact the market price of our stock.

After the closing of this offering, we will be subject to the reporting requirements of the Exchange Act, the Sarbanes-Oxley Act and the rules and regulations of the stock market on which our common stock is listed. The Sarbanes-Oxley Act requires, among other things, that we maintain effective disclosure controls and procedures and internal control over financial reporting. Commencing with our fiscal year ending December 31, 2017, 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 for that year, as required by Section 404 of the Sarbanes-Oxley Act. This will require that we incur substantial additional professional fees and internal costs to expand our accounting and finance functions and that we expend significant management efforts.

Prior to this offering, we have never been required to test our internal control within a specified period, and, as a result, we may experience difficulty in meeting these reporting requirements in a timely manner.

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

 

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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 SEC or other regulatory authorities.

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This prospectus contains forward-looking statements concerning our business, operations and financial performance and condition, as well as our plans, objectives and expectations for our business operations and financial performance and condition. The forward-looking statements are contained principally in the sections of this prospectus entitled “Prospectus Summary,” “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business” but are also contained elsewhere in this prospectus. Any statements contained herein that are not statements of historical facts may be deemed to be forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as “aim,” “anticipate,” “assume,” “believe,” “contemplate,” “continue,” “could,” “due,” “estimate,” “expect,” “goal,” “intend,” “may,” “objective,” “plan,” “positioned,” “potential,” “predict,” “project,” “seek,” “should,” “target,” “will,” “would” and other similar expressions that are predictions of or indicate future events and future trends, or the negative of these terms or other comparable terminology, although not all forward-looking statements contain these words. In addition, statements such as “we believe” and similar statements reflect our beliefs and opinions on the relevant subject. The forward-looking statements and opinions contained in this prospectus are based upon information available to us as of the date of this prospectus and, while we believe such information forms a reasonable basis for such statements, such information may be limited or incomplete, and our statements should not be read to indicate that we have conducted an exhaustive inquiry into, or review of, all potentially available relevant information. These forward-looking statements include statements about:

 

  n   our plans to develop and commercialize our product candidates;

 

  n   the timing of initiation of our planned clinical trials;

 

  n   the timing of the availability of data from our clinical trials;

 

  n   the timing of our planned NDA filing for SB204 and our IND filings for other programs;

 

  n   the clinical utility, potential benefits and market acceptance of our product candidates;

 

  n   our commercialization, marketing and manufacturing capabilities and strategy;

 

  n   our intellectual property position; and

 

  n   our estimates regarding future revenue, expenses, capital requirements and needs for additional financing.

Forward-looking statements are based on management’s current expectations, estimates, forecasts and projections about our business and the industry in which we operate, and management’s beliefs and assumptions are not guarantees of future performance or development and involve known and unknown risks, uncertainties and other factors that are in some cases beyond our control. As a result, any or all of our forward-looking statements in this prospectus may turn out to be inaccurate. Furthermore, if the forward-looking statements prove to be inaccurate, the inaccuracy may be material. Our forward-looking statements do not reflect the potential impact of any future acquisitions, mergers, dispositions, collaborations, joint ventures or investments that we may make or enter into. In light of the significant uncertainties in these forward-looking statements, you should not regard these statements as a representation or warranty by us or any other person that we will achieve our objectives and plans in any specified time frame, or at all. Factors that may cause actual results to differ materially from current expectations include, among other things, those described in “Risk Factors” and elsewhere in this prospectus. Potential investors are urged to consider these factors carefully in evaluating these forward-looking statements. These forward-looking statements speak only as of the date of this prospectus. Except as required by law, we assume no obligation to update or revise these forward-looking statements for any reason, even if new information becomes available in the future. You should, however, review the factors and risks and other information we describe in the reports we will file from time to time with the SEC after the date of this prospectus.

 

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MARKET, INDUSTRY AND OTHER DATA

This prospectus contains estimates, projections and other information concerning our industry, our business and the markets for our products, including data regarding the estimated size of those markets, the perceptions and preferences of patients and physicians regarding certain drug therapies and other patient data, as well as market research, estimates and forecasts prepared by our management. We obtained the industry, market and other data throughout this prospectus from our own internal estimates and research, as well as from industry publications and research, surveys and studies conducted by third-parties, including governmental agencies.

Information that is based on estimates, forecasts, projections, market research or similar methodologies is inherently subject to assumptions, limitations and uncertainties. Actual events or circumstances may differ materially from events and circumstances that are assumed in this information, and you are cautioned not to give undue weight to such data.

 

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USE OF PROCEEDS

We estimate the net proceeds from this offering will be approximately $         million, or $         million if the underwriters exercise their option to purchase additional shares in full, assuming an initial public offering price of $         per share, the midpoint of the price range set forth on the cover page of this prospectus, after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us.

Each $1.00 increase or decrease in the assumed initial public offering price of $         per share, the midpoint of the price range set forth on the cover page of this prospectus, would increase or decrease the net proceeds to us from the offering by approximately $         million, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same, and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us. We may also increase or decrease the number of shares we are offering. Each increase or decrease of 1,000,000 shares in the number of shares offered by us, as set forth on the cover page of this prospectus, would increase or decrease the net proceeds to us from this offering by approximately $         million, assuming that the assumed initial public offering price per share remains the same, after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us.

We currently expect to use the net proceeds from this offering, together with existing cash, as follows:

(i) approximately $         to fund the development of SB204 through NDA submission;

(ii) approximately $         to fund platform expansion with Phase 2 trials for SB206 and SB208; and

(iii) the balance to fund internal research and development expenses associated with SB414 and future product candidates and for working capital and general corporate purposes.

Our expected use of net proceeds from this offering represents our current intentions based upon our present plans and business condition. As of the date of this prospectus, we cannot predict with certainty all of the particular uses for the net proceeds from this offering or the actual amounts that we will spend on the uses set forth above. The amounts and timing of our actual expenditures and extent of clinical development will depend on numerous factors, including the rate of adoption of our products, the progress, cost and results of product development and clinical research and trials, the expenses we incur in our sales and marketing efforts, the scope of research and development efforts and other factors described under “Risk Factors” in this prospectus, as well as the amount of cash used in our operations. We may find it necessary or advisable to use the net proceeds from this offering for other purposes, and our management will have broad discretion in the application of the net proceeds.

Pending the uses described above, we plan to invest the net proceeds from this offering in short-and intermediate-term, interest-bearing obligations, investment-grade instruments, certificates of deposit or direct or guaranteed obligations of the U.S. government.

 

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DIVIDEND POLICY

On December 16, 2015, we formed a wholly-owned entity, KNOW Bio, LLC, and contributed certain non-dermatological assets, as well as exclusive licenses and sublicenses to develop and commercialize products for non-dermatological indications, $0.1 million of equipment and $5.2 million in cash for additional funding. Our board of directors declared a dividend and distributed 100% of this entity’s equity interest to our Stockholders of record as of December 29, 2015. The $5.2 million of cash included in the transaction was recorded as a cash dividend, as further explained in Note 2 to our financial statements appearing elsewhere in this prospectus.

We have never declared or paid any other cash dividends on our capital stock, and we do not currently intend to pay any cash dividends on our capital stock in the foreseeable future. We currently intend to retain all available funds and any future earnings, if any, to support operations and to finance the growth and development of our business. Our future ability to pay cash dividends on our capital stock may be limited by the terms of any future debt or preferred securities or future credit facility. Investors should not purchase our common stock with the expectation of receiving cash dividends.

 

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CAPITALIZATION

The following table sets forth our cash and cash equivalents and capitalization as of June 30, 2016:

 

  n   on an actual basis;

 

  n   on a pro forma basis to reflect: (a) the automatic conversion of all outstanding shares of our preferred stock into 10,531,698 shares of common stock upon the closing of this offering, (b) the conversion of all outstanding shares of our non-voting common stock into 229,263 shares of common stock upon the closing of this offering, and (c) the filing and effectiveness of our amended and restated certificate of incorporation immediately prior to the closing of this offering; and

 

  n   on a pro forma as adjusted basis to give further effect to the issuance and sale of          shares of common stock offered in this offering at an assumed initial public offering price of $         per share, the midpoint of the price range set forth on the cover page of this prospectus, and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us.

You should read this information together with the information set forth under the headings “Selected Financial Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our financial statements included at the end of this prospectus.

 

    As of June 30, 2016  
    Actual     Pro Forma     Pro Forma
As Adjusted
 
          (in thousands)        

Cash and cash equivalents

  $ 19,602      $ 19,602      $               
 

 

 

   

 

 

   

 

 

 

Redeemable convertible preferred stock

  $ 104,798      $ -      $     
 

 

 

   

 

 

   

 

 

 

Stockholders’ (deficit) equity:

     

Common stock, $0.0001 par value; 22,000,000 shares authorized, 2,707,628 issued and outstanding, actual;          shares authorized, pro forma and pro forma as adjusted;          shares issued and outstanding, pro forma;          shares issued and outstanding, pro forma as adjusted

    0        1     

Non-voting common stock, $0.0001 par value; 229,263 shares authorized, issued and outstanding, actual; no shares authorized, issued or outstanding, pro forma and pro forma as adjusted

    0            

Preferred stock, par value $0.0001 par value per share; no shares authorized, issued or outstanding, actual,          shares authorized, no shares issued or outstanding, pro forma and pro forma as adjusted

               
 

 

 

   

 

 

   

 

 

 

Additional paid-in capital

    3,821        108,618     

Treasury stock at cost; 11,400 shares

    (155     (155  

Accumulated deficit

    (92,498     (92,498  
 

 

 

   

 

 

   

 

 

 

Total stockholders’ (deficit) equity

    (88,832     15,966     
 

 

 

   

 

 

   

 

 

 

Total capitalization

  $ 15,966      $ 15,966      $               
 

 

 

   

 

 

   

 

 

 

 

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Each $1.00 increase or decrease in the assumed initial public offering of $         per share, the midpoint of the price range set forth on the cover page of this prospectus, would increase or decrease each of cash and cash equivalents, additional paid-in capital, total stockholders’ equity and total capitalization on a pro forma as adjusted basis by approximately $         million, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same, and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us. We may also increase or decrease the number of shares we are offering. Each increase or decrease of 1,000,000 shares in the number of shares offered by us would increase or decrease each of cash and cash equivalents, additional paid-in capital, total stockholders’ equity and total capitalization on a pro forma adjusted basis by approximately $         million, assuming that the assumed initial public offering price per share remains the same, and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us.

The number of shares of our common stock shown as outstanding on an actual, pro forma and pro forma as adjusted basis in the discussion and tables above is based on 2,707,628 shares of our common stock outstanding as of June 30, 2016 and excludes:

 

  n   734,496 shares of common stock issuable upon the exercise of outstanding options as of June 30, 2016, having a weighted average exercise price of $7.68 per share; and

 

  n   1,000,000 shares of common stock reserved for future issuance under the 2016 Plan, which will become effective upon the effectiveness of the registration statement of which this prospectus is a part.

 

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DILUTION

If you invest in our common stock in this offering, your ownership interest will be immediately diluted to the extent of the difference between the assumed initial public offering price per share of our common stock share and the pro forma as adjusted net tangible book value per share of our common stock immediately after this offering.

As of June 30, 2016, we had a historical net tangible book value (deficit) of ($88.8) million, or ($30.25) per share of common stock. Our historical net tangible book value per share represents our total tangible assets less our total liabilities and preferred stock, divided by the number of shares of our common stock outstanding as of June 30, 2016, including our non-voting common stock.

As of June 30, 2016, our pro forma net tangible book value would have been $16.0 million, or $1.19 per share, based on shares of our common stock outstanding as of June 30, 2016. Our pro forma net tangible book value (deficit) per share represents our total tangible assets less our total liabilities, divided by the number of shares of our common stock outstanding as of June 30, 2016, after giving effect to the automatic conversion of all outstanding shares of our preferred stock into common stock upon the closing of this offering.

After giving further effect to the sale of              shares of our common stock in this offering at an assumed initial public offering price of $         per share, which is the midpoint of the price range set forth on the cover page of this prospectus, after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us, our pro forma as adjusted net tangible book value as of June 30, 2016 would have been $         million, or $         per share. This amount represents an immediate increase in pro forma net tangible book value of $         per share to our existing stockholders and an immediate dilution in pro forma net tangible book value of $         per share to new investors purchasing shares of our common stock in this offering. We determine dilution by subtracting the pro forma as adjusted net tangible book value per share after this offering from the initial public offering price per share paid by new investors.

The following table illustrates this dilution:

 

Assumed initial public offering price per share

    $     

Historical net tangible book value (deficit) per share as of June 30, 2016

  $ (30.25  

Increase in net tangible book value per share attributable to conversion of preferred stock

    31.44     
 

 

 

   

Pro forma net tangible book value per share as of June 30, 2016

    1.19     

Increase in pro forma net tangible book value per share attributable to new investors in this offering

   
 

 

 

   

Pro forma as adjusted net tangible book value per share after this offering

   
   

 

 

 

Dilution per share to new investors participating in this offering

    $             
   

 

 

 

The dilution information discussed above is illustrative only and will depend on the actual initial public offering price and other terms of this offering determined at pricing. Each $1.00 increase or decrease in the assumed initial public offering price of $ per share, the midpoint of the price range set forth on the cover page of this prospectus, would increase or decrease the pro forma as adjusted net tangible book value by $          per share and the dilution per share to new investors in this offering by $          per share, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same, after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us. An increase or decrease of 1,000,000 shares in the number of shares offered by us, as set forth on the cover page of this prospectus, would increase or

 

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decrease the pro forma as adjusted net tangible book value per share by $          and $                 , respectively, and increase or decrease the dilution per share to new investors participating in this offering by $          and $                 , respectively, assuming no change in the assumed initial public offering price per share after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us.

If the underwriters exercise their option to purchase additional shares in this offering in full, the pro forma as adjusted net tangible book value would increase to $          per share, representing an immediate increase to existing stockholders of $          per share and an immediate dilution to new investors participating in this offering of $          per share.

The table below summarizes, as of June 30, 2016, on the pro forma as adjusted basis described above, the number of shares of our common stock purchased from us, the total consideration paid to us, and the average price per share paid to us by our existing stockholders and to be paid by new investors participating in this offering at an assumed initial public offering price of $          per share, the midpoint of the price range set forth on the cover page of this prospectus, before deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us.

 

    Shares Purchased     Total Consideration     Average Price
Per Share
 
    Number      Percent     Amount      Percent    

Existing stockholders

                      $                                     $                

New investors

           
 

 

 

    

 

 

   

 

 

    

 

 

   

Total

              $                 
 

 

 

    

 

 

   

 

 

    

 

 

   

Each $1.00 increase or decrease in the assumed initial public offering price of $          per share, which is the midpoint of the price range set forth on the cover page of this prospectus, would increase or decrease total consideration paid by new investors by $          million and, in the case of an increase, would increase the percentage of total consideration paid by new investors by          percentage points and, in the case of a decrease, would decrease the percentage of total consideration paid by new investors by          percentage points, assuming the number of shares we are offering, as set forth on the cover page of this prospectus, remains the same, after deducting underwriting discounts and commissions and estimated offering expenses payable by us. We may also increase or decrease the number of shares we are offering. An increase or decrease of 1,000,000 shares in the number of shares offered by us as set forth on the cover page of this prospectus would increase or decrease total consideration paid by new investors by $          million and, in the case of an increase, would increase the percentage of total consideration paid by new investors by          percentage points and, in the case of a decrease, would decrease the percentage of total consideration paid by new investors by          percentage points, assuming that the assumed initial public offering price per share remains the same, after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us.

The number of shares of our common stock reflected in the discussion and tables above is based on 2,936,891 shares of our common stock outstanding as of June 30, 2016, including non-voting common stock, after giving effect to the automatic conversion of all outstanding shares of our preferred stock into 10,531,698 shares of common stock upon the closing of this offering, and excludes:

 

  n   734,496 shares of common stock issuable upon the exercise of outstanding options as of June 30, 2016, having a weighted average exercise price of $7.68 per share; and

 

  n   1,000,000 shares of common stock reserved for future issuance under the 2016 Plan, which will become effective upon the effectiveness of the registration statement of which this prospectus is a part.

 

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Furthermore, we may choose to raise additional capital through the sale of equity or convertible debt securities due to market conditions or strategic considerations even if we believe we have sufficient funds for our current or future operating plans. To the extent that any of our options or warrants described above are exercised, new options are issued and exercised under our equity incentive plans or we issue additional shares of common stock or other equity or convertible debt securities in the future, there will be further dilution to investors participating in this offering.

 

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SELECTED CONSOLIDATED FINANCIAL DATA

You should read the following selected consolidated financial data together with our audited and unaudited financial statements, the related notes appearing elsewhere in this prospectus and the information under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The selected financial data included in this section are not intended to replace the financial statements and the related notes included at the end of this prospectus. We have derived the selected statement of operations data for the years ended December 31, 2014 and 2015, and the balance sheet data as of December 31, 2014 and 2015, from our audited financial statements appearing elsewhere in this prospectus. The statement of operations data for the six months ended June 30, 2015 and 2016, and the balance sheet data as of June 30, 2016, are derived from our unaudited consolidated interim financial statements included at the end of this prospectus. We have prepared the unaudited consolidated interim financial statements on the same basis as the audited consolidated financial statements and have included, in our opinion, all adjustments, consisting only of normal recurring adjustments, that we consider necessary for a fair statement of the financial information set forth in those statements. Our historical results are not necessarily indicative of our future results and our interim results are not necessarily indicative of results to be expected for the full year ending December 31, 2016, or any other period.

 

    Year Ended December 31,     Six Months Ended June 30,  
    2014     2015     2015     2016  
   

(in thousands except share and per share data)

 

Statement of operations data:

       

Government research contracts and grants revenue

  $ 112      $      $      $   
 

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

       

Research and development

    6,770        16,569        6,698        22,373   

General and administrative

    5,170        9,265        3,409        6,834   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

    11,940        25,834        10,107        29,207   
 

 

 

   

 

 

   

 

 

   

 

 

 

Operating loss

    (11,828     (25,834     (10,107     (29,207
 

 

 

   

 

 

   

 

 

   

 

 

 

Other income (expense):

       

Interest income

    58        48        2        34   

Interest expense

    (701     (1     (1       

Change in fair value of warrant liability

    (641                     

Other income (expense), net

    9        1        (1     9   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total other income (expense)

    (1,275     48               43   
 

 

 

   

 

 

   

 

 

   

 

 

 

Loss from continuing operations

    (13,103     (25,786     (10,107     (29,164

Income (loss) from discontinued operations

    1,715        (2,274     (711       
 

 

 

   

 

 

   

 

 

   

 

 

 

Net loss and comprehensive loss

  $ (11,388   $ (28,060   $ (10,818   $ (29,164
 

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) per share, basic and diluted:

       

Continuing operations

  $ (4.96   $ (9.47   $ (3.75   $ (9.93

Discontinued operations

    0.65        (0.83     (0.27       
 

 

 

   

 

 

   

 

 

   

 

 

 

Net loss per share, basic and diluted (1)

  $ (4.31   $ (10.30   $ (4.02   $ (9.93
 

 

 

   

 

 

   

 

 

   

 

 

 

Weighted-average common shares used in computing net loss per share, basic and diluted (1)

    2,643,912        2,722,943        2,692,909        2,936,483   
 

 

 

   

 

 

   

 

 

   

 

 

 

Pro forma loss per share, basic and diluted:

       

Continuing operations (unaudited)

    $ (2.23     $ (2.17

Discontinued operations (unaudited)

      (0.20         
   

 

 

     

 

 

 

Pro forma net loss per share, basic and diluted (unaudited) (2)

    $ (2.43     $ (2.17
   

 

 

     

 

 

 

Weighted-average common shares used to compute pro forma net loss per share, basic and diluted (unaudited) (2)

      11,550,492          13,410,313   
   

 

 

     

 

 

 

 

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(1) See note 1 to our consolidated financial statements included elsewhere in this prospectus for an explanation of the method used to calculate the historical basic and diluted net loss per share.
(2) The unaudited pro forma weighted average common shares used in computing pro forma net loss per share (basic and diluted) has been prepared to give effect to the automatic conversion of all outstanding shares of preferred stock into 10,531,698 shares of common stock.

 

     As of
June 30, 2016
 
    
     (in thousands)  

Balance sheet data:

  

Cash and cash equivalents

   $ 19,602   

Total assets

     32,734   

Total liabilities

     16,768   

Accumulated deficit

     (92,498

Total stockholders’ deficit

     (88,832

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

You should read the following discussion and analysis of our financial condition and results of operations together with our financial statements and related notes thereto included elsewhere in this prospectus. Some of the information contained in this discussion and analysis or set forth elsewhere in this prospectus, including information with respect to our plans and strategy for our business and related financing, includes forward-looking statements that involve risks and uncertainties. As a result of many factors, including those factors set forth in the “Risk Factors” section of this prospectus, our actual results could differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.

Overview

We are a late-stage pharmaceutical company focused on redefining the standard of care in dermatology through the development and commercialization of innovative therapies using our nitric oxide platform. Nitric oxide plays a vital role in the natural immune system response against microbial pathogens and is a critical regulator of inflammation. Our ability to harness nitric oxide and its multiple mechanisms of action has enabled us to create a platform with the potential to generate differentiated first-in-class product candidates. The two key components of our nitric oxide platform are our proprietary Nitricil technology, which drives the creation of NCEs, and our topical formulation science, both of which we use to tune our product candidates for specific indications. We are using our platform to transform a useful, naturally occurring molecule into a therapeutic pipeline for a host of skin diseases.

We are rapidly advancing programs in five dermatological conditions with significant unmet medical need. These are some of the most prevalent diseases in dermatology and together represent a large market opportunity with a patient population surpassing 150 million Americans and 1.5 billion individuals globally.

Our lead product candidate is SB204, a cosmetically elegant topical gel that targets multiple mechanisms of action for the treatment of acne vulgaris, the most common skin disease in the United States. We commenced two identically designed Phase 3 pivotal clinical trials in the first quarter of 2016 and expect to report top-line results from these pivotal trials in the first quarter of 2017. Assuming successful completion of a long-term safety study in the second half of 2017, we are targeting submission of an NDA for SB204 by year-end 2017. Our other product candidates include SB206, SB208 and SB414, which are targeted toward the treatment of either a specific microorganism or inflammatory components of a disease pathology. SB206 is a first-in-class, topical anti-viral gel in Phase 2 clinical development for the treatment of viral skin infections such as external genital and perianal warts caused by HPV. We initiated our Phase 2 clinical trial for SB206 in 2015, and we expect to announce top-line results in the second half of 2016. SB208 is a topical broad-spectrum anti-fungal product candidate for the treatment of fungal infections of the skin and nails. We commenced Phase 2 clinical testing of SB208 for the treatment of infections caused by dermatophytes such as T. rubrum in July 2016. SB414, a topical cream in preclinical development for the treatment of inflammatory skin diseases such as psoriasis and atopic dermatitis, rounds out our current pipeline.

We believe that our ability to conveniently deploy nitric oxide on demand in topical formulations allows us the potential to significantly improve patient outcomes in a variety of skin diseases and positions us to be a commercially successful leader in dermatology.

Since our inception in 2006, we have devoted substantially all of our efforts to developing our product candidates, including conducting preclinical and clinical trials and providing general and administrative support for these operations. We have not generated any revenue from product sales and, to date, have funded our operations primarily through private placements of our convertible preferred stock, convertible

 

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notes and government research contracts and grants. From inception through June 30, 2016, we have raised total equity and debt proceeds of $103.9 million to fund our operations, of which $99.7 million was from the sale of preferred stock, and $3.5 million and $0.7 million were from the issuance of debt and common stock, respectively. In addition, we have received $11.8 million from government research contracts and grants during that period.

We have never generated revenue from product sales and have incurred net losses in each year since inception. As of June 30, 2016, we had an accumulated deficit of $92.5 million. We incurred net losses of $11.4 million and $28.1 million in the years ended December 31, 2014 and 2015, respectively, and net losses of $10.8 million and $29.2 million in the six months ended June 30, 2015 and 2016, respectively. We do not expect to generate revenue from product sales unless and until we obtain regulatory approval from the FDA for SB204 or another one of our product candidates and, in any case, not earlier than the end of 2018. If we obtain regulatory approval for SB204, or any of our other product candidates, we expect to incur significant commercialization expenses related to product sales, marketing, manufacturing and distribution. In addition, we expect that our expenses will increase substantially as we continue clinical trials and preclinical studies for, and research and development of, our other product candidates and maintain, expand and protect our intellectual property portfolio. As a result, we will need substantial additional funding to support our operating activities. Adequate funding may not be available to us on acceptable terms, or at all. We currently anticipate that we will seek to fund our operations through public or private equity or debt financings or other sources, such as potential collaboration agreements. Our failure to obtain sufficient funds on acceptable terms as and when needed could have a material adverse effect on our business, results of operations and financial condition. As further discussed in our audited financial statements and related footnotes appearing elsewhere in this prospectus, these matters raise substantial doubt about our ability to continue as a going concern.

Separation Transaction

On December 16, 2015, our board of directors approved the formation of KNOW Bio, LLC, a wholly owned subsidiary, or KNOW Bio, formed for the purpose of giving effect to the legal separation of certain non-core assets from our company. These non-core assets are non-dermatological assets consisting mainly of intellectual property rights, which were valued at $1.8 million as of December 30, 2015. On December 30, 2015, we made a cash contribution of $5.2 million to KNOW Bio in order to provide it with working capital, and we distributed all of the outstanding member interests of KNOW Bio pro rata to our stockholders. These stockholders were not required to pay any cash or other consideration for the equity interests of KNOW Bio and were not required to surrender or exchange shares of our stock in order to receive the member interests. We refer to the foregoing transactions collectively as the Separation Transaction.

As a result of the Separation Transaction, new stockholders in this offering will not have an interest in the non-dermatological assets we owned prior to the Separation Transaction. Immediately following the distribution of its member interests on December 30, 2015, KNOW Bio became an independent, privately held company. We have no obligation or intention to provide further funding to KNOW Bio. The cash included in the Separation Transaction was recorded as a dividend distribution. The historical financial position and results of operations for the activities attributed to KNOW Bio have been reflected in our consolidated statements of operations, retrospectively, as discontinued operations. Additionally, the related assets and liabilities associated with the discontinued operations in the December 31, 2014 consolidated balance sheet and liabilities outstanding as of December 31, 2015 not assumed by KNOW Bio as part of the distribution are classified as discontinued operations. See “Note 2 – Discontinued Operations” to our consolidated financial statements included in this registration statement.

 

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Components of our Results of Operations

Government Contracts and Grants Revenue

To date, we have not generated revenue from the sale of any products. All of our revenue has been derived from government research contracts and grants, which relates to the research and development of our nitric oxide platform. We have recognized $0.1 million in revenue from January 1, 2014 through June 30, 2016 from these sources. Revenue is recognized when all of the following criteria are met: (1) persuasive evidence that an arrangement exists; (2) delivery of the products or services has occurred; (3) the selling price is fixed or determinable; and (4) collectability is reasonably assured.

We currently do not expect to derive substantial additional revenue from government contracts and grants and we do not expect to generate any revenue from any product candidates that we develop unless and until we obtain regulatory approval and commercialize our products or enter into other potentially revenue-generating collaborative agreements with third parties.

Research and Development Expenses

Since our inception, we have focused our resources on our research and development activities, including conducting preclinical studies and clinical trials, manufacturing development efforts and activities related to regulatory filings for our product candidates. Research and development expenses, including those paid to third parties for which there is no alternative use, are expensed as they are incurred. Research and development expenses include:

 

  n   external research and development expenses incurred under agreements with contract research organizations, or CROs, investigative sites and consultants to conduct our clinical trials and preclinical and non-clinical studies;

 

  n   costs to acquire, develop and manufacture supplies for clinical trials and preclinical studies, including fees paid to contract manufacturing organizations, or CMOs;

 

  n   legal and other professional fees related to compliance with FDA requirements;

 

  n   licensing fees and milestone payments incurred under license agreements;

 

  n   salaries and related costs, including stock-based compensation and travel expenses, for personnel in our research and development functions; and

 

  n   facilities, depreciation and other allocated expenses, which include direct and allocated expenses for rent, maintenance of facilities, equipment and other supplies.

From inception through June 30, 2016, we have incurred approximately $64.2 million in research and development expenses to develop, expand or otherwise improve our nitric oxide platform. The table below sets forth our external research and development expenses incurred for current product candidates, expenses incurred under government contracts and grants and unallocated internal research and development expenses for the years ended December 31, 2014 and 2015 and the six months ended June 30, 2015 and 2016. Government contracts and grants expenses include salaries and overhead attributable to those contracts and grants. All other research and development salaries and related costs are included in unallocated internal research and development expenses.

 

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    Year Ended
December 31,
    Six Months Ended
June 30,
 
    2014     2015     2015     2016  
   

(in thousands)

 
External:                        

SB204

  $ 4,208      $ 8,569      $ 3,790      $ 15,701   

SB206

    162        2,141        1,083        1,784   

Other programs

    113        975        116        1,119   

Government contracts and grants

    81        —          —          —     

Unallocated internal research and development expenses

    2,206        4,884        1,709        3,769   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total research and development expenses

  $   6,770      $ 16,569      $   6,698      $   22,373   
 

 

 

   

 

 

   

 

 

   

 

 

 

We expect that for the foreseeable future, the substantial majority of our research and development efforts will be focused on our clinical programs, SB204, SB206 and SB208. For SB204, we initiated Phase 3 clinical trials in the first quarter of 2016. For SB206, we are currently conducting a Phase 2 clinical trial and expect data from this trial in the second half of 2016. If this trial is successful, we intend to advance clinical development with either an additional Phase 2 trial or by initiating a Phase 3 clinical program for SB206 in the second half of 2017. For SB208, we initiated a Phase 2 clinical development program in July 2016. We are currently conducting preclinical studies with SB414. We plan to commence toxicology studies for SB414 in the second half of 2016 followed by initiation of clinical development in the second half of 2017. Historical costs associated with our SB208 and SB414 programs are included in “Other Programs” in the table above.

We expect our research and development expenses to increase substantially in the future as we continue development of our product candidates. In particular, we expect to incur substantial research and development expenses in the second half of 2016 as we continue to conduct our SB204 Phase 3 clinical trials and as we initiate and conduct our SB208 Phase 2 clinical development program.

The successful development of our product candidates is highly uncertain. At this time, we cannot reasonably estimate the nature, timing or costs required to complete the remaining development of SB204, SB206, SB208 or any future product candidates. This is due to the numerous risks and uncertainties associated with the development of product candidates. See “Risk Factors” for a discussion of the risks and uncertainties associated with our research and development projects.

General and Administrative Expenses

Our general and administrative expenses consist primarily of salaries and related costs, including stock-based compensation and travel expenses, for personnel in our executive, finance, corporate development and other administrative functions. Other general and administrative expenses include depreciation and facility-related costs, legal costs of pursuing patent protection of our intellectual property, and professional services fees for auditing, tax and general legal services.

We expect our general and administrative expenses to increase substantially in the future as we expand our operating activities and prepare for potential commercialization of our product candidates, increase our headcount and support our operations as a public company, including increased expenses related to legal, accounting, regulatory and tax-related services associated with maintaining compliance with exchange listing and SEC requirements, directors’ and officers’ liability insurance premiums and investor relations activities.

Other Income (Expense)

Other income and expense consists primarily of interest earned on cash and cash equivalents, income deemed to be earned upon the expiration of preferred stock warrants, interest incurred on our convertible note and re-measurement gain or loss associated with the change in the fair value of our preferred stock warrant liability.

 

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We estimate the fair value of our warrant liability using the Black-Scholes option pricing model. We base the estimates in the Black-Scholes option pricing model, in part, on subjective assumptions, including stock price volatility, risk-free interest rate, dividend yield and the fair value of the preferred stock underlying the warrants. The re-measurement gain or loss associated with the changes in the fair value of our preferred stock warrant liability in each reporting period is recognized as a component of other income (expense).

Results of Operations

Comparison of Six Months Ended June 30, 2015 and 2016

The following table sets forth our results of operations for the periods indicated:

 

    Six Months Ended
June 30,
    Increase
(Decrease)
    % Increase
(Decrease)
 
    2015     2016      
    (in thousands, except percentages)  

Operating expenses:

       

Research and development

  $ 6,698      $ 22,373      $ 15,675        234

General and administrative

   
3,409
  
    6,834        3,425        100
 

 

 

   

 

 

   

 

 

   

Total operating expenses

    10,107        29,207        19,100        189
 

 

 

   

 

 

   

 

 

   

Operating loss

    (10,107     (29,207     (19,100     189
 

 

 

   

 

 

   

 

 

   

Other income:

       

Interest income

    2        34        32        *   

Interest expense

    (1            1        *   

Other income (expense), net

 

 

 

 

(1

 

 

 

 

 

9

 

  

 

 

 

 

10

 

  

   

 

*

 

  

 

 

 

 

   

 

 

   

 

 

   

Total other income

           43        43        *   
 

 

 

   

 

 

   

 

 

   

Loss from continuing operations

    (10,107     (29,164     (19,057     189

Loss from discontinued operations

    (711            711        (100 %) 
 

 

 

   

 

 

   

 

 

   

Net loss

  $ (10,818   $ (29,164   $ (18,346     170
 

 

 

   

 

 

   

 

 

   

 

* Not meaningful

Research and development expenses

Research and development expenses increased by $15.7 million from $6.7 million during the six months ended June 30, 2015 to $22.4 million during the six months ended June 30, 2016. The increase in research and development expenses was due to increases of $11.9 million in the SB204 program, $0.7 million in the SB206 program, $1.0 million in other external programs and $2.1 million in other unallocated internal research and development expenses. During the six months ended June 30, 2016, we commenced the Phase 3 clinical trials for SB204, conducted the Phase 2 clinical trial for SB206 and expanded preclinical research and development for our other programs. The increase in our other unallocated internal research and development expenses was primarily the result of increased personnel and related costs.

General and administrative expenses

General and administrative expenses increased by $3.4 million from $3.4 million during the six months ended June 30, 2015 to $6.8 million during the six months ended June 30, 2016. The increase in general and administrative expenses was primarily due to the increase of personnel and related costs to support the growth of our research and development activities and to perform various other administrative functions as well as increased market research, consulting, legal and accounting costs.

 

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Comparison of Years Ended December 31, 2014 and 2015

The following table sets forth our results of operations for the periods indicated:

 

    Years Ended
December 31,
    Increase
(Decrease)
    % Increase
(Decrease)
 
    2014     2015      
    (in thousands, except percentages)  

Government contracts and grants revenue

  $ 112      $      $ (112     (100 )% 
 

 

 

   

 

 

   

 

 

   

Operating expenses:

       

Research and development

    6,770        16,569        9,799        145  % 

General and administrative

    5,170        9,265        4,095        79  % 
 

 

 

   

 

 

   

 

 

   

Total operating expenses

    11,940        25,834        13,894        116  % 
 

 

 

   

 

 

   

 

 

   

Operating loss

    (11,828     (25,834     (14,006     (118 )% 
 

 

 

   

 

 

   

 

 

   

Other income (expense):

       

Interest income

    58        48        (10     (17 )% 

Interest expense

    (701     (1     700        100  % 

Change in fair value of warrant liability

    (641            641        100  % 

Other income, net

    9        1        (8  

 

 

 

(89

 

)% 

 

 

 

   

 

 

   

 

 

   

Total other income (expense)

    (1,275     48        1,323        *   
 

 

 

   

 

 

   

 

 

   

Loss from continuing operations

    (13,103     (25,786     (12,683     97  % 

Income (loss) from discontinued operations

    1,715        (2,274     (3,989     *   
 

 

 

   

 

 

   

 

 

   

Net loss

  $ (11,388   $ (28,060   $ (16,672     146  % 
 

 

 

   

 

 

   

 

 

   

 

* Not meaningful

Government contracts and grants revenue

Government research contracts and grants revenue decreased from $0.1 million for the year ended December 31, 2014 to $0 for the year ended December 31, 2015 as a result of completing a contract with a government agency in the first half of 2014.

Research and development expenses

Research and development expenses increased by $9.8 million from $6.8 million during the year ended December 31, 2014 to $16.6 million during the year ended December 31, 2015. The increase in research and development expenses was primarily due to increases of $4.4 million in the SB204 program, $1.9 million in the SB206 program, $0.9 million in other external programs and $2.7 million in other unallocated internal research and development expenses. These increases were partially offset by a decrease in research and development expense for government research contracts and grants of $0.1 million. During the year ended December 31, 2015, we were conducting and completed the Phase 2 clinical trial for SB204, commenced the Phase 2 clinical trial for SB206 and expanded preclinical research and development for our other programs. The increase in our other unallocated internal research and development expenses was the result of increased personnel and related costs, including stock-based compensation, attributable to increased personnel for clinical programs, formulation process development and analytical support.

General and administrative expenses

General and administrative expenses increased by $4.1 million from $5.2 million during the year ended December 31, 2014 to $9.3 million during the year ended December 31, 2015. The increase in general and administrative expenses was primarily due to the increase of personnel and related costs, including stock-based compensation, to support the growth of our research and development activities and to perform various other administrative functions as well as increased market research, consulting, legal and accounting costs.

 

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Other income (expense)

Other income (expense) increased from expense of $(1.3) million for the year ended December 31, 2014 to income of $48,000 for the year ended December 31, 2015, due primarily to the following factors. Interest expense decreased from $0.7 million during the year ended December 31, 2014 to $1,000 during the year ended December 31, 2015, as a result of the conversion of our convertible notes to shares of Mezzanine A preferred stock during the year ended December 31, 2014. Other expense resulting from the change in fair value of our warrant liability decreased from $(0.6) million during the year ended December 31, 2014 to $0 during the year ended December 31, 2015.

Liquidity and Capital Resources

Since our inception through June 30, 2016, we have financed our operations primarily with $103.9 million in net proceeds from the issuance and sale of equity securities and convertible debt securities. In addition, we have generated revenues of $11.8 million from government research contracts and other grants. As of June 30, 2016, we had $19.6 million of cash and cash equivalents. Our cash and cash equivalents are held in a variety of interest-bearing instruments, including money market accounts. Cash in excess of immediate requirements is invested with a view toward liquidity and capital preservation, and we seek to minimize the potential effects of concentration and degrees of risk.

Cash Flows

The following table sets forth our cash flows for the periods indicated:

 

    Year Ended
December 31,
    Six Months Ended
June 30,
 
    2014     2015     2015     2016  
   

(in thousands)

 

Net cash provided by (used in):

       

Continuing operating activities

  $ (10,401   $ (20,765   $ (8,501   $ (22,061

Continuing investing activities

    (772     (1,751     (760     (2,409

Continuing financing activities

    16,063        62,351        34,268        (1,359

Net increase (decrease) in cash and cash equivalents –discontinued operations

    1,792        (1,566     (491     (257
 

 

 

   

 

 

   

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

  $ 6,682      $ 38,269      $ 24,516      $ (26,086
 

 

 

   

 

 

   

 

 

   

 

 

 

Net Cash Used in Continuing Operating Activities

During the year ended December 31, 2014, net cash used in operating activities was $10.4 million and consisted primarily of a net loss of $11.4 million, which was the result of cash used in our research and development activities with adjustments for income from discontinued operations of $1.7 million, non-cash amounts related primarily to depreciation expense of $0.4 million, interest expense of $0.7 million, the change in fair value of warrant liability of $0.6 million, stock-based compensation expense of $0.2 million and $0.8 million in changes in assets and liabilities.

During the year ended December 31, 2015, net cash used in operating activities was $20.8 million and consisted primarily of a net loss of $28.1 million, which was the result of cash used in our research and development activities, with adjustments for loss from discontinued operations of $2.3 million, non-cash amounts related primarily to depreciation expense of $0.6 million, stock-based compensation expense of $2.0 million, a $0.6 million increase in prepaid expenses related to CRO pre-funding payments and a $3.0 million increase in accrued liabilities, primarily related to higher research and development accruals.

During the six months ended June 30, 2015, net cash used in operating activities was $8.5 million and consisted primarily of a net loss of $10.8 million, which was the result of cash used in our research

 

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and development activities with adjustments for loss from discontinued operations of $0.7 million, non-cash amounts related primarily to depreciation expense of $0.3 million, stock-based compensation expense of $0.5 million and $0.8 million in changes in assets and liabilities.

During the six months ended June 30, 2016, net cash used in operating activities was $22.1 million and consisted primarily of a net loss of $29.2 million, which was the result of cash used in our research and development activities, with adjustments for non-cash amounts related primarily to depreciation expense of $0.4 million, stock-based compensation expense of $0.5 million, and $6.2 million in changes in assets and liabilities. The favorable net change in assets and liabilities was primarily due to a $5.1 million increase in accrued outside research and development services during the period. The increase in these services was related to our increased development program activities, including the commencement and conduct of our SB204 Phase 3 clinical trials and the conduct of our SB206 Phase 2 clinical trial.

Net Cash Used in Continuing Investing Activities

During the years ended December 31, 2014 and 2015, net cash used in investing activities was $0.8 million and $1.8 million, respectively. Net cash used in investing activities during the year ended December 31, 2014 represented purchases of property and equipment. Net cash used in investing activities during the year ended December 31, 2015 represented purchases of property and equipment of $1.3 million and $0.5 million restricted to secure a letter of credit.

During the six months ended June 30, 2015 and 2016, net cash used in investing activities was $0.8 million and $2.4 million, respectively. Net cash used in investing activities during the six months ended June 30, 2015, represented purchases of property and equipment. Net cash used in investing activities during the six months ended June 30, 2016, represented purchases of property and equipment of $2.3 million and the purchase of intangible assets of $0.1 million.

Net Cash Provided by (Used in) Continuing Financing Activities

During the year ended December 31, 2014, net cash provided by financing activities was $16.1 million, consisting of proceeds from the issuance of preferred stock of $12.0 million, proceeds from the issuance of convertible notes of $3.5 million and proceeds from the exercise of preferred stock warrants of $0.6 million.

During the year ended December 31, 2015, net cash provided by financing activities was $62.4 million, consisting of $67.1 million from proceeds from the issuance of preferred stock and $0.5 million from the issuance of common stock in connection with the exercise of stock options, offset in part by the $5.2 million of cash distributed as part of the Separation Transaction.

During the six months ended June 30, 2015, net cash provided by financing activities was $34.3 million, consisting primarily of proceeds from the issuance of preferred stock.

During the six months ended June 30, 2016, net cash used in financing activities was $1.4 million, consisting primarily of payments related to this public offering.

Capital Requirements

To date, we have not generated any revenue from product sales. We do not know when, or if, we will generate any revenue from product sales. We do not expect to generate revenue from product sales unless and until we obtain regulatory approval of and commercialize one of our current or future product candidates. We anticipate that we will continue to generate losses for the foreseeable future, and we expect the losses to increase as we continue the development of, and seek regulatory approvals for, our product candidates, and begin to commercialize any approved products. We are subject to all of the risks incident in the development of new pharmaceutical products, and we may encounter unforeseen expenses, difficulties, complications, delays and other unknown factors that may adversely affect our business. Upon the closing of this offering, we expect to incur additional costs associated with operating as a public company.

 

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We believe that our existing cash and cash equivalents, together with the proceeds from this offering, will be sufficient to meet our anticipated cash requirements for at least the next 15 months. Our primary use of cash is to fund our operating expenses, which consist principally of research and development expenditures. As of June 30, 2016, we had an accumulated deficit of $92.5 million and there was substantial doubt about our ability to continue as a going concern if we did not secure additional financing. We anticipate that we will need substantial additional funding in connection with our continuing operations.

We have based our projections of operating capital requirements on assumptions that may prove to be incorrect and we may use all of our available capital resources sooner than we expect. Because of the numerous risks and uncertainties associated with research, development and commercialization of pharmaceutical products, we are unable to estimate the exact amount of our operating capital requirements. Our future funding requirements will depend on many factors, including, but not limited to:

 

  n   the initiation, progress, timing, costs and results of preclinical studies and clinical trials for our product candidates, including clinical trials for SB204, SB206 and SB208;

 

  n   the initiation, progress, timing, costs and results of preclinical studies relating to other potential applications of our nitric oxide platform;

 

  n   the number and characteristics of product candidates that we pursue;

 

  n   our success in scaling our manufacturing process;

 

  n   the outcome, timing and costs of seeking regulatory approvals;

 

  n   the terms and timing of any future collaborations, licensing, consulting or other arrangements that we may establish;

 

  n   the amount and timing of any payments we may be required to make, or that we may receive, in connection with the licensing, filing, prosecution, defense and enforcement of any patents or other intellectual property rights;

 

  n   the costs of preparing, filing and prosecuting patent applications, maintaining and protecting our intellectual property rights;

 

  n   defending against intellectual property related claims;

 

  n   the extent to which we in-license or acquire other products and technologies; and

 

  n   subject to receipt of marketing approval, revenue received from commercial sales of our product candidates.

We expect capital expenditures to be approximately $3.5 million in the remainder of 2016. These anticipated expenditures reflect our plan to invest in information technology systems, equipment and leasehold improvement costs for our planned corporate headquarters and manufacturing facility in Durham, North Carolina.

Contractual Obligations and Contingent Liabilities

The following summarizes our significant contractual obligations as of December 31, 2015:

 

    Total      Less than
1 year
     1 - 3
years
     3 - 5
years
     More than
5 years
 
    (in thousands)  

Operating leases(1)

  $ 196       $ 196       $  –       $  –       $  –   

Facility financing obligations(2)

    12,508         592         2,238         2,375         7,303   

Research and development contract obligations(3)

    110         110                           
 

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total obligations

  $ 12,814       $ 898       $ 2,238       $ 2,375       $ 7,303   
 

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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(1) Represents a non-cancelable operating lease agreement for facilities which expires in August 2016.
(2) Facility financing obligations consist of our obligations for the facility leased in Durham, North Carolina that is accounted for as a build-to-suit lease.
(3) Represents minimum annual license fees payable under our license agreements. We are a party to various license agreements with universities and other third parties, as well as patent assignment agreements, under which we have obtained rights to patents, patent applications and know-how. Under these agreements, in addition to minimum annual license fees, we have agreed to pay the other parties milestone payments upon the achievement of specified clinical, regulatory and commercialization events and royalties based on future sales of products. We have not included these payments in the table as we cannot estimate if, when or in what amounts such payments will become due under these agreements.

We entered into a lease agreement in August 2015 for a facility totaling approximately 51,350 square feet in Durham, North Carolina and intend to relocate our corporate headquarters to this facility in the second half of 2016. The term of the lease commenced April 1, 2016 and terminates June 2026. The total estimated lease payments for this facility over the term of the lease are approximately $12.5 million. In addition, we are obligated to pay the landlord for facility leasehold improvements to the extent their cost exceeds the amount the landlord has agreed to contribute to the project. Construction commenced in April 2016 and we paid the landlord $1.2 million for estimated excess facility leasehold improvement costs. Through June 2016, construction costs have not exceeded the amount the landlord has agreed to contribute.

We enter into contracts in the normal course of business with clinical research organizations for clinical trials and clinical supply manufacturing and with vendors for preclinical research studies, research supplies and other services and products for operating purposes. These contracts generally provide for termination on notice, and therefore we believe that our non-cancelable obligations under these agreements are not material.

Off-Balance Sheet Arrangements

We did not have during the periods presented, and we do not currently have, any off-balance sheet arrangements, as defined under Securities and Exchange Commission rules.

Net Operating Loss and Research and Development Tax Credit Carryforwards

As of December 31, 2015, we had federal and state net operating loss carryforwards of approximately $48.1 million and $50.6 million, respectively. The net operating loss carryforwards begin to expire in 2028 and 2023 for federal and state tax purposes, respectively. We had charitable contribution carryforwards of approximately $0.2 million available to offset future federal taxable income, which will expire in 2017. We have research and development tax credits of approximately $2.2 million to offset future federal taxes. These credits begin to expire in 2028.

We record a valuation allowance to offset any net deferred tax assets if, based upon the available evidence, it is more likely than not that we will not recognize some or all of the deferred tax assets. We have had a history of net losses since inception, and, as a result, we have established a 100% valuation allowance of $20.7 million for our net deferred tax assets as of December 31, 2015. If circumstances change and we determine that we will be able to realize some or all of these net deferred tax assets in the future, we will record an adjustment to the valuation allowance.

The Tax Reform Act of 1986 contains provisions which limit the ability to utilize the net operating loss carryforwards in the case of certain events including significant changes in ownership interests. If our net operating loss carryforwards are limited, and we have taxable income which exceeds the permissible yearly net operating loss carryforwards, we would incur a federal income tax liability even though net operating loss carryforwards would be available in future years.

Jumpstart Our Business Startups Act of 2012 (JOBS Act)

In April 2012, the JOBS Act was signed into law. The JOBS Act contains provisions that, among other things, reduce certain reporting requirements for an “emerging growth company.” As an

 

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“emerging growth company,” we are electing not to take advantage of the extended transition period afforded by the JOBS Act for the implementation of new or revised accounting standards, and, as a result, we will comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for non-emerging growth public companies. Section 107 of the JOBS Act provides that our decision not to take advantage of the extended transition period is irrevocable. We have chosen to rely on the other exemptions and reduced reporting requirements provided by the JOBS Act. Subject to certain conditions set forth in the JOBS Act, as an “emerging growth company” we are not required to, among other things, (i) provide an auditor’s attestation report on our system of internal controls over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act, (ii) provide all of the compensation disclosure that may be required of non-emerging growth public companies under the Dodd-Frank Act, (iii) comply with any requirement that may be adopted by the Public Company Accounting Oversight Board regarding mandatory audit firm rotation or a supplement to the auditor’s report providing additional information about the audit and the financial statements (auditor discussion and analysis) and (iv) disclose certain executive compensation-related items, such as the correlation between executive compensation and performance and comparisons of the chief executive officer’s compensation to median employee compensation. We may remain an emerging growth company until the last day of the fiscal year following the fifth anniversary of the completion of this offering. However, if certain events occur prior to the end of such five-year period, including if we become a “large accelerated filer,” our annual gross revenue equals or exceeds $1.0 billion or we issue more than $1.0 billion of non-convertible debt in any three-year period, we will cease to be an emerging growth company prior to the end of such five-year period.

Recent Accounting Pronouncements

Accounting Pronouncements Adopted

In April 2014, the United States Financial Accounting Standards Board, or FASB, issued Accounting Standards Update, or ASU, No. 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. This new standard raises the threshold for a disposal to qualify as a discontinued operation and requires new disclosures of both discontinued operations and certain other disposals that do not meet the definition of a discontinued operation. We adopted this standard for the year ended December 31, 2015.

In June 2014, the FASB issued ASU No. 2014-12, Compensation—Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could be Achieved after the Requisite Service Period, which requires us to assess share-based awards with performance targets that could be achieved after the requisite service period for potential treatment as performance conditions. Under the ASU, compensation expense is to be recognized when the performance target is deemed probable and should represent the compensation expense attributable to the periods for which service has already been rendered. If the performance target is reached prior to achievement of the service period, the remaining unrecognized compensation cost should be recognized over the remaining service period. The ASU is effective for annual and interim periods beginning after December 15, 2015 with early adoption permitted. This standard is effective for us as of January 1, 2016. The adoption of this standard did not have a material impact on its financial statements.

In November 2014, the FASB issued ASU No. 2014-16, Determining Whether the Host Contract in a Hybrid Financial Instrument Issued in the Form of a Share Is More Akin to Debt or to Equity. The guidance requires an entity to determine the nature of the host contract by considering all stated and implied substantive terms and features of the hybrid financial instrument, weighing each term and feature on the basis of the relevant facts and circumstances (commonly referred to as the whole-instrument approach). ASU 2014-16 applies to all entities and is effective for annual periods beginning after December 15, 2015, and interim periods thereafter. This standard is effective for us as of January 1, 2016. Adoption of this standard did not have a material impact on our financial statements.

 

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In February 2015, the FASB issued ASU 2015-2, Amendments to the Consolidation Analysis, which provides clarification regarding the guidance surrounding consolidation of certain legal entities. This guidance is effective for annual and interim periods beginning after December 15, 2015. This standard is effective for us as of January 1, 2016. The adoption of this standard did not have a material impact on our financial statements.

Accounting Pronouncements Being Evaluated

In May 2014, the FASB and the International Accounting Standards Board issued a converged standard on the recognition of revenue from contracts with customers. The converged standard has been codified within Topic 606, Revenue from Contracts with Customers within the FASB Accounting Standards Codification. The objective of the new standard is to establish a single comprehensive revenue recognition model that is designed to create greater comparability of financial statements across industries and jurisdictions. Under the new standard, companies will recognize revenue to depict the transfer of goods or services to customers in amounts that reflect the consideration to which a company expects to be entitled in exchange for those goods or services. The new standard also will require expanded disclosures on revenue recognition and changes in assets and liabilities that result from contracts with customers. In July 2015, the FASB delayed the effective date of the new standard by one year. Early adoption as of January 1, 2017 is permitted. In March, April and May of 2016, the FASB issued additional ASUs to amend Topic 606 and to provide expanded or clarifying guidance associated with the application of certain principles within the revenue recognition model, including the areas of principle and agent, identification of performance obligations, licensing, and other improvements and practical expedients will adopt the new standard by January 1, 2018, as required. We are currently evaluating the impact of this new standard on our financial statements.

In August 2014, the FASB issued ASU No. 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern, or ASU 2014-15, which provides accounting guidance related to the evaluation of an entity’s ability to continue as a going concern. ASU 2014-15 establishes management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern in connection with preparing financial statements for each annual and interim reporting period. The update also gives guidance to disclose information about relevant conditions and events when there is substantial doubt about an entity’s ability to continue as a going concern. This guidance is effective for annual and interim periods ending after December 15, 2016, with early adoption permitted. We are evaluating the guidance under ASU 2014-15 and will present the required disclosures in our financial statements at the time of adoption as necessary.

In November 2015, the FASB issued ASU 2015-17, Balance Sheet Classification of Deferred Taxes. The new guidance requires that deferred tax assets and liabilities be classified as noncurrent in a classified statement of financial position. The new standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. Early adoption is permitted. We are currently evaluating the impact of this new ASU but do not expect the adoption of this standard to have a significant impact on our consolidated financial statements.

In February 2016, the FASB issued ASU 2016-2, Leases. This guidance revises the accounting related to leases by requiring lessees to recognize a lease liability and a right-of-use asset for all leases. The new lease guidance also simplifies the accounting for sale and leaseback transactions. This ASU is effective for annual reporting periods beginning after December 15, 2018 and early adoption is permitted. We are currently evaluating the impact of the adoption of this ASU on our financial statements.

In March 2016, the FASB issued ASU 2016-09, Compensation – Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. The FASB issued ASU 2016-09 to simplify several aspects of the accounting for share-based payment transactions, including the income

 

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tax consequences. This ASU is effective for annual and interim periods ending after December 15, 2016, with early adoption permitted. We are currently evaluating the impact of the adoption of this ASU on our financial statements.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

There were no changes in or disagreements with accountants on accounting and financial disclosures.

Quantitative and Qualitative Disclosures about Market Risk

Our primary exposure to market risk is limited to our cash and cash equivalents, all of which have maturities of less than three months. The primary objectives of our investment activities are the preservation of principal, maintenance of liquidity for the purpose of funding operations and maximizing total return. The related interest income sensitivity is affected by changes in the general level of short-term U.S. interest rates. We place our cash and cash equivalents with high-credit quality financial institutions. Our investment policy prohibits us from holding corporate bonds, auction rate securities, asset-backed securities, municipal obligations, structured investment vehicles, extendable commercial paper or collateralized debt/loan obligations.

As of June 30, 2016, we had cash and cash equivalents of $19.6 million. We believe that an immediate one percentage point increase in interest rates would not materially affect the fair value of these instruments. We do not believe that our cash and cash equivalents have significant risk of default or illiquidity and do not expect our operating results or cash flows to be affected significantly by a sudden change in market interest rates. While we believe our cash and cash equivalents do not contain excessive risk, we cannot provide absolute assurance that in the future our investments will not be subject to adverse changes in fair value. In addition, we maintain significant amounts of cash and cash equivalents at one or more financial institutions that are in excess of federally insured limits.

Critical Accounting Policies and Use of Estimates

Our management’s discussion and analysis of financial condition and results of operations is based on our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States, 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 revenue and expenses during the reporting periods. These items are monitored and analyzed by us for changes in facts and circumstances, and material changes in these estimates could occur in the future. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Changes in estimates are reflected in reported results for the period in which they become known. Actual results may differ materially from these estimates under different assumptions or conditions.

While our significant accounting policies are more fully described in the notes to our financial statements included elsewhere in this prospectus, we believe that the following accounting policies are critical to the process of making significant judgments and estimates in the preparation of our financial statements and understanding and evaluating our reported financial results.

Revenue Recognition

Our revenue generally consists of research related revenue under contracts and grants with Federal government agencies. Revenue is recognized when all of the following criteria are met: (1) persuasive evidence that an arrangement exists; (2) delivery of the products or services has occurred; (3) the selling price is fixed or determinable; and (4) collectability is reasonably assured.

 

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Under the terms of the contracts and grants awarded, we are entitled to receive reimbursement of our allowable direct expenses, allocated overhead, general and administrative expenses and payment of other specified amounts. Revenues from development and support activities under federal research grants are recorded in the period in which the related costs are incurred for cost reimbursement grants. Revenue is recognized when earned and expenses are recognized when incurred.

Any of the funding sources may request reimbursement for expenses or return of funds, or both, as a result of noncompliance by us with the terms of the grants. No reimbursement of expenses or return of funds for noncompliance has been requested or made since inception of the contract and grants.

Accrued Research and Development Expenses

As part of the process of preparing financial statements, we are required to estimate accrued expenses. This process involves reviewing open contracts and purchase orders, communicating with applicable vendor personnel to identify services that have been performed on our behalf and estimating the level of service performed and the associated cost incurred for the service when we have not yet been invoiced or otherwise notified of actual cost. The majority of our service providers invoice us monthly in arrears for services performed. We make estimates of our accrued expenses as of each balance sheet date in our financial statements based on facts and circumstances known to us. We periodically confirm the accuracy of our estimates with the service providers and make adjustments if necessary. Examples of estimated accrued expenses include fees paid to CROs in connection with clinical trials, fees paid to investigative sites in connection with clinical trials, professional service fees and unpaid salaries, wages and benefits.

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

Common Stock Valuation and Stock-Based Compensation

We record the fair value of stock options, restricted stock awards and other stock-based compensation issued to employees and non-employees as of the grant date as stock-based compensation expense. We typically recognize compensation expense over the requisite service period, which is typically the vesting period. We recorded noncash stock-based compensation expense from continuing operations for employee and nonemployee stock option grants of $0.2 million and $2.0 million for the years ended December 31, 2014 and 2015, respectively, and $0.5 million and $0.5 million for the six months ended June 30, 2015 and 2016, respectively.

We estimate the fair value of our stock-based awards to employees and non-employees using the Black-Scholes option-pricing model, which requires the input of highly subjective assumptions, including (a) the expected volatility of our stock, (b) the expected term of the award, (c) the risk-free interest rate and (d) expected dividends. Due to the lack of a public market for the trading of our common stock and a lack of company-specific historical and implied volatility data, we have based our estimate of expected volatility on the historical volatility of a group of similar companies that are

 

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publicly traded. In connection with the Separation Transaction, we considered if our peer companies required adjustment to more closely align with our dermatological focus and determined that no adjustment was necessary. Our peer companies utilized have similar clinical-stage research and development activities coupled with recent clinical successes in the dermatological space. We also considered characteristics such as industry, stage of life cycle, financial leverage, enterprise value, risk profiles and position within the industry, and with historical share price information sufficient to meet the expected life of the stock-based awards. We compute the historical volatility data using the daily closing prices for the selected companies’ shares during the equivalent period of the calculated expected term of our stock-based awards. We will continue to apply this process until a sufficient amount of historical information regarding the volatility of our own stock price becomes available.

We have estimated the expected term of our employee stock options using the “simplified” method, whereby, the expected life equals the average of the vesting term and the original contractual term of the option. The risk free interest rate is based on the yields of U.S. Treasury securities with maturities similar to the expected term of granted stock-based awards. We have never declared or paid any cash dividends to common stockholders and do not presently plan to pay cash dividends in the foreseeable future. Consequently, we use an expected dividend yield of zero.

We are also required to estimate forfeitures at the time of grant, and to revise those estimates in subsequent periods if actual forfeitures differ from estimates. We use historical data to estimate pre-vesting option forfeitures and record stock-based compensation expense only for those awards that are expected to vest. To the extent that actual forfeitures differ from our estimates, the difference is recorded as a cumulative adjustment in the period the estimates were revised. Stock-based compensation expense recognized in the financial statements is based on awards that are ultimately expected to vest.

In determining the fair value of stock options granted, the following weighted average assumptions were used in the Black-Scholes option-pricing model for awards granted in the periods indicated:

 

    Year Ended December 31,     Six Months Ended June 30,  
    2014     2015     2015     2016  

Estimated dividend yield

    0.00%        0.00%        0.00%        0.00%   

Expected volatility

    102.77%        65.96% - 102.77%        65.96 - 102.77%        71.16%   

Risk-free interest rate

    1.88%        1.48 - 1.81%        1.65%        1.33%   

Expected life of options (in years)

    6.00        5.1 - 5.9        5.75        5.73   

Weighted-average fair value per share

  $ 6.59 - $7.06        $6.83        $3.96        $9.79   

Determination of the Fair Value of Stock-Based Compensation Grants

There are significant assumptions and estimates required in determining the fair value of our common stock. Due to the absence of an active market for our common stock, the fair value of our common stock was determined in good faith by our board of directors, with the assistance and upon the recommendation of management, based on a number of objective and subjective factors consistent with the methodologies outlined in the American Institute of Certified Public Accountants Practice Aid, Valuation of Privately-Held-Company Equity Securities Issued as Compensation, referred to as the AICPA Practice Aid, including:

 

  n   contemporaneous valuations of our shares of common stock;

 

  n   the prices of each of our series of preferred stock sold by us to outside investors in arm’s length transactions, and the rights, preferences and privileges of each of these series of preferred stock relative to our common stock;

 

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  n   our consolidated results of operations, financial position and the status of our research and development efforts;

 

  n   the composition of our management team and board of directors;

 

  n   the material risks related to our business;

 

  n   the market performance of publicly traded companies in the life sciences and biotechnology sectors;

 

  n   the likelihood of achieving a liquidity event for the holders of our shares of common stock, such as a sale of the company or an initial public offering, given prevailing market conditions;

 

  n   the lack of marketability of our common stock; and

 

  n   external market conditions affecting the life sciences and biotechnology industry sectors.

Although it is reasonable to expect that the completion of our initial public offering will increase the value of our common stock as a result of increased liquidity and marketability and the elimination of the liquidation preferences of our convertible preferred stock, the amount of additional value cannot be measured with precision or certainty. If we had made different assumptions than those described below, the fair value of the underlying common stock and amount of our stock-based compensation expense, net loss and net loss per share amounts would have differed. Following the closing of our initial public offering, the fair value per share of our common stock for purposes of determining stock-based compensation will be the closing price of our common stock as reported on the applicable grant date.

The following table summarizes the grant dates, number of underlying shares and related fair value of stock options granted to employees from January 1, 2014 through June 30, 2016.

 

Date of grant

  Number of
Shares Granted
     Fair Value
Estimate per
Common Share
 

March 14, 2014

    88,500       $ 7.00   

July 30, 2014

    48,000       $ 7.47   

December 30, 2014

    117,300       $ 7.47   

January 1, 2015

    90,000       $ 7.47   

March 12, 2015

    24,000       $ 6.68   

May 1, 2015

    33,000       $ 6.68   

July 8, 2015

    10,500       $ 9.00   

July 30, 2015

    22,500       $ 9.00   

August 28, 2015

    36,191       $ 9.00   

October 21, 2015

    165,000       $ 12.00   

November 17, 2015

    3,000       $ 12.00   

December 2, 2015…

    21,600       $ 12.00   

December 14, 2015

    34,500       $ 12.00   

February 29, 2016

    225,000       $ 15.00   

In valuing our common stock, our board of directors determined the equity value of our business using a combination of the “Last Money In” approach and Market-Based, or Comps, approach. The “Last Money In” approach considered our prior financing rounds, which can provide meaningful indications to determine our enterprise value. The Comps approach considered our enterprise value through an analysis of recent sales and offerings of comparable companies. Consideration was given to the financial condition and operating performance of our company relative to those of private and publicly-traded companies operating in the same or similar lines of business, potentially subject to corresponding economic, environmental and political factors and considered to be reasonable investment alternatives.

 

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For valuations through June 30, 2016, the option pricing method, or OPM, treats common stock and preferred stock as call options on an equity value, with exercise prices based on the liquidation preference of the preferred stock. Therefore, common stock has value only if funds available for distribution to stockholders exceed the value of the liquidation preference at the time of a liquidity event such as a merger, sale or initial public offering, assuming the enterprise has funds to make a liquidation preference meaningful and collectible by stockholders. The common stock, including applicable conversion of convertible preferred stock, is modeled to be a call option with a claim on enterprise value at an exercise price equal to the remaining value immediately after the preferred stock liquidation preference is satisfied.

The valuation of our common stock included contemporaneous valuation analyses to determine the then current fair value of our common stock as of December 31, 2013, December 31, 2014, June 30, 2015, September 30, 2015, December 31, 2015 and February 26, 2016. In performing these valuation analyses, key assumptions reflected in the OPM calculations included the anticipated timing of a potential liquidity event, the estimated volatility of our common stock, and the discount for lack of marketability of our common stock. The Market-Based or “Comps” approach considered our enterprise value through an analysis of enterprise values of comparable companies and through applying revenue multiples to our government contract and grant revenues. During 2014, we issued shares of our Mezzanine A preferred stock, which provided indications of enterprise value as of December 31, 2014 and introduced additional liquidation preference. The valuation results as of December 31, 2014 reflect our declining government contracts and grants revenue and increased liquidation preference attributable to our Mezzanine A preferred stock.

Warrant Liability

As of December 31, 2014, all of the warrants to purchase shares of our Series 3 preferred stock had been exercised or expired. Because our Series 3 preferred stock is subject to redemption under circumstances outside of our control, the outstanding shares of this series of preferred stock are presented as temporary equity. Consequently, the warrants to purchase shares of Series 3 convertible preferred stock are accounted for as liabilities and adjusted to fair value at the end of each reporting period. The fair value of the warrants classified as liabilities is estimated using the Black-Scholes option pricing model. The estimates in Black-Scholes option pricing model are based, in part, on subjective assumptions, including stock price volatility, term of the warrants, risk-free interest rate, dividend yield and fair value of the Series 3 convertible preferred stock underlying the warrants. The gain or loss associated with the change in the fair value of the preferred stock warrant liability from the prior period is recognized as a component of other income (expense).

 

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BUSINESS

Overview

We are a late-stage pharmaceutical company focused on redefining the standard of care in dermatology through the development and commercialization of innovative therapies using our nitric oxide platform. Nitric oxide plays a vital role in the natural immune system response against microbial pathogens and is a critical regulator of inflammation. Our ability to harness nitric oxide and its multiple mechanisms of action has enabled us to create a platform with the potential to generate differentiated, first-in-class product candidates. The two key components of our nitric oxide platform are our proprietary Nitricil technology, which drives the creation of new chemical entities, or NCEs, and our topical formulation science, both of which we use to modulate, or “tune,” our product candidates for specific indications. We are using our platform to transform a useful, naturally occurring molecule into a therapeutic pipeline for a host of skin diseases.

We are rapidly advancing programs in five dermatological conditions with significant unmet medical need. These are some of the most prevalent diseases in dermatology, and together represent a large market opportunity with an underserved patient population surpassing 150 million Americans and 1.5 billion individuals globally.

Our lead product candidate is SB204, a cosmetically elegant topical gel that targets multiple mechanisms of action for the treatment of acne vulgaris, the most common skin disease in the United States. We commenced two identically designed Phase 3 pivotal clinical trials in the first quarter of 2016 and expect to report top-line results from these pivotal trials in the first quarter of 2017. Assuming successful completion of a long-term safety study in the second half of 2017, we are targeting submission of a new drug application, or NDA, for SB204 by year-end 2017. Our other product candidates include SB206, SB208 and SB414, which are targeted toward the treatment of either a specific microorganism or inflammatory components of a disease pathology. SB206 is a first-in-class, topical anti-viral gel in Phase 2 clinical development for the treatment of viral skin infections such as external genital and perianal warts, caused by human papillomavirus, or HPV. We initiated our Phase 2 clinical trial for SB206 in the second quarter of 2015, and we expect to announce top-line results in the second half of 2016. SB208 is a topical broad-spectrum anti-fungal product candidate for the treatment of fungal infections of the skin and nails. We commenced Phase 2 clinical testing of SB208 for the treatment of infections caused by dermatophytes such as T. rubrum in July 2016. SB414, a topical cream in preclinical development for the treatment of inflammatory skin diseases such as psoriasis and atopic dermatitis, rounds out the current pipeline.

We believe that our ability to conveniently deploy nitric oxide on demand in topical formulations allows us the potential to significantly improve patient outcomes in a variety of skin diseases and positions us to be a commercially successful leader in the dermatology market.

Nitric oxide is one of the most researched molecules in human physiology and has been extensively studied in many areas of medicine including in microbial diseases and in the modulation of inflammation. As a fundamental component in host immune response against invading organisms, cells of the immune system naturally generate nitric oxide using the enzyme nitric oxide synthase, or NOS, and the amino acid precursor L-arginine. Nitric oxide is released in a targeted manner to kill microbial pathogens, including bacteria, fungi and viruses. Nitric oxide and its metabolites drive cell death within bacteria and fungi by targeting metal centers or amino acids on proteins critical to sustaining microbial viability. In virally infected cells, nitric oxide inhibits viral replication by binding directly to key enzymes or by inducing apoptosis, or programmed cell death, in these cells where tumor suppressors have been degraded or disabled. Beyond nitric oxide’s essential role in pathogen control, a large number of cells produce and respond to nitric oxide for several other immunoregulatory functions. The anti-inflammatory and immunosuppressive effects of nitric oxide occur in part through the inhibition of T cell proliferation and leukocyte recruitment.

 

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However, the scarcity of nitric oxide-based therapeutic products is due to the challenges associated with controlling the release of a gas, the poor stability and low storage capacity of nitric oxide-loaded molecules, the inability to target specific tissues and the toxicity of several small molecules used as backbones to store nitric oxide. We believe the following key components of our nitric oxide platform fuel the creation of differentiated product candidates and address each of these limitations:

(1) Our Nitricil technology enables us to engineer tunable NCEs that allow for the stable chemical storage of large amounts of nitric oxide in solid form by loading it on an inert macromolecule, or polymer. The advantages of our proprietary Nitricil technology include tunability, stability, high storage capacity, targeted delivery and what we believe is an attractive safety profile. Our ability to select from several nitric oxide-loaded starting materials has driven our library of over 200 Nitricil compositions, each of which possesses a unique nitric oxide release profile.

(2) Our formulation science enables us to further tune the release of nitric oxide when applied to the skin by using proprietary combinations of inactive ingredients. This additional level of control enables us to use one NCE for multiple indications by altering the nitric oxide pharmacology with the composition of the topical formulation. This component of our nitric oxide platform creates an additional barrier to entry, which we believe positions us to prolong the period of market exclusivity for each of our product candidates. Additionally, our formulation science allows us to customize the drug delivery method for the relevant anatomical location of a skin disease while considering physician and patient preferences for aesthetically pleasing and convenient products.

We are developing our lead product candidate, SB204, as a once-daily, fast-acting, topical first-line monotherapy for the treatment of acne vulgaris. In the first quarter of 2016, we commenced two identically designed Phase 3 pivotal clinical trials of SB204 in a total of 2,600 patients with acne vulgaris. Acne vulgaris is the most common skin disease in the United States, affecting approximately 40 to 50 million Americans annually, according to the American Academy of Dermatology. Despite this, we believe the current treatment landscape significantly underserves patient needs, due to the difficulty of balancing efficacy, systemic safety and cutaneous tolerability. Prior to initiating our Phase 3 trials, our 630-patient clinical program for SB204 included one first-in-human trial, six Phase 1 clinical trials and two Phase 2 clinical trials involving patients suffering from acne vulgaris, in each of which SB204 was well tolerated. In each of our Phase 2 clinical trials, we observed statistically significant reductions in both inflammatory and non-inflammatory lesion counts after 12 weeks of treatment. We designed the protocol for our Phase 3 clinical trials based on feedback we received from the FDA during our end-of-Phase 2 meeting in September 2015. Assuming successful completion of our Phase 3 clinical trials and our long-term safety study, we will target submission of our NDA for SB204 to the FDA by the end of 2017.

Our second most advanced product candidate, SB206, represents a new approach to the treatment of HPV skin infections. In our preclinical studies, we observed complete inhibition of papilloma virus growth in vivo and inhibition of HPV viral replication in vitro. We have initially chosen to evaluate the anti-viral potential of nitric oxide in a Phase 2 randomized, double-blind, vehicle-controlled clinical trial in 120 patients with genital warts caused by HPV. All warts, including genital warts, are caused by HPV, and we estimate that the population suffering with warts exceeds 3 million people in the United States. We believe that SB206 has the potential to provide substantial improvements over currently approved topical therapies for warts, including shorter treatment duration, improved efficacy due to the direct anti-viral effect of nitric oxide, better local tolerability and decreased incidence of wart recurrence.

We are developing SB208 as a topical anti-fungal for the treatment of fungal infections of the skin and nails. In July 2016, we commenced Phase 2 clinical development of SB208 for the treatment of infections caused by dermatophytes such as T. rubrum, including tinea pedis, or Athlete’s Foot, and

 

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onychomycosis. Onychomycosis is a chronic fungal infection of the nails that we estimate affects over 40 million people in the United States. We believe SB208 has the potential to elevate the standard of care in fungal infections such as athlete’s foot and onychomycosis by delivering high concentrations of nitric oxide to rapidly penetrate targeted tissues and potentially improve upon current efficacy rates observed with topical therapies while maintaining an attractive safety profile.

Our pipeline also includes SB414, a topical cream product candidate, for which we are currently conducting preclinical studies for the treatment of inflammatory skin diseases such as psoriasis and atopic dermatitis. SB414 utilizes a slower nitric oxide-releasing cream formulation for which we have observed potent inflammatory cytokine inhibition in preclinical models. We plan to commence toxicology studies for SB414 in 2016 in support of the submission of an IND to the FDA, and are targeting initiation of clinical development of our anti-inflammatory program in the second half of 2017.

We maintain exclusive, worldwide commercial rights for all product candidates currently in our pipeline. Our intent is to build a dermatology-focused sales organization, with approximately 75 representatives in the field, to sell our product candidates that receive regulatory approval in the United States. Our sales force will initially target high-volume prescribing dermatologists and other healthcare providers. Our commercialization strategy will leverage our NCEs with differentiated mechanisms of action to enhance reimbursement potential and facilitate broad patient access. We are also evaluating strategic partnerships to commercialize our dermatology products in select international markets. We believe that our management team’s significant experience in nitric oxide science, drug development and commercialization of dermatological products positions us to execute on our vision to be a commercially successful leader in the field of dermatology.

Our Dermatology-Focused Nitric Oxide Platform

Why Nitric Oxide?

Nitric oxide, or NO, is a two-atom molecule that is produced naturally by the human body. Since the Nobel Prize-winning discovery in 1998 that nitric oxide is responsible for regulating blood flow, or vasodilation, the effects of nitric oxide have been extensively studied in many areas of physiology, including in microbial diseases and in the modulation of inflammation.

As a fundamental component in host defense against invading organisms, cells of the immune system naturally generate nitric oxide using the enzyme nitric oxide synthase, or NOS, and the amino acid precursor L-arginine. Nitric oxide is released in a targeted manner to kill microbial pathogens, including bacteria, fungi and viruses. Nitric oxide and its metabolites drive cell death within bacteria and fungi by targeting metal centers or amino acids on proteins critical to sustaining microbial viability. In virally infected cells, nitric oxide inhibits viral replication by binding directly to free sulfurs or metals that are a part of key enzymes that can induce apoptosis, or programmed cell death, in cells where tumor suppressors have been degraded or disabled.

We believe that nitric oxide has significant potential as a novel antimicrobial agent due to its multiple mechanisms of action and its ability as a gas to diffuse freely through cell membranes unlike many other pharmaceutical agents. Importantly, the pharmacologic activity of nitric oxide is such that its production is localized at or near the site of infection. Because nitric oxide is a key component of the immune system’s natural response to invading organisms, we believe that it may provide an ideal therapeutic solution for degrading and killing microorganisms without the development of antimicrobial resistance.

Beyond nitric oxide’s essential role in pathogen control, a large number of cells produce and respond to nitric oxide for several other immunoregulatory functions. According to an article published in Nature Immunology in 2001, nitric oxide exerts its anti-inflammatory and immunosuppressive effects

 

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in part through the inhibition of T cell proliferation and leukocyte recruitment. The modulation of signaling cascades, transcription factors like NF- LOGO B, and enzymes that process cytokine precursors are all mechanisms by which nitric oxide exerts its anti-inflammatory effects. Additionally, macrophage production of nitric oxide has been reported to suppress T helper type 1 cell responses and lead to the induction of a new class of nitric oxide-derived regulatory T cells, reported in the Proceedings of the National Academy of Sciences in 2007 to inhibit the pro-inflammatory Th17 differentiation and function.

Figure 1 summarizes how nitric oxide is released as a critical regulator in human immune response. A physiological stimulant signals the production of NOS via NF- LOGO B activation, which then leads to transcription and translation of the active NOS enzyme. NOS transforms the essential amino acid, L-arginine, into L-citrulline and liberates one gaseous nitric oxide molecule in the process, which is then free to diffuse outside of the cell and exert its vital regulatory functions in the body.

Figure 1:

 

 

LOGO

Limitations of Other Nitric Oxide-Based Approaches

Despite its therapeutic potential, there is currently only one FDA-approved use of nitric oxide, which is for the treatment of pulmonary hypertension in neonatal infants with nitric oxide gas. However, the delivery of nitric oxide from a gas tank is inconvenient and limits practical applications. The scarcity of nitric oxide-based products is due to the historical challenges associated with developing safe and effective approaches for the chemical storage and controlled release of a gas for therapeutic applications. Synthetic approaches for creating molecules that store nitric oxide in solid form have significant limitations that have prevented the translation of these laboratory chemistries into commercially viable products. Some of these key limitations include:

 

  n   Lack of tunability — Therapeutic delivery of nitric oxide to patients at safe and effective levels requires the ability to control the release rate to selectively modulate a specific disease pathology. Other chemical approaches release or donate nitric oxide either too fast or too slow, rendering them potentially unsafe or therapeutically ineffective.

 

  n   Unfavorable stability profile — Most nitric oxide-loaded molecules in development decompose too rapidly, prematurely releasing nitric oxide and impairing shelf life stability. Based on the chemistries involved, slight increases in temperature, exposure to ambient humidity or irradiation with light all significantly diminish nitric oxide potency.

 

  n  

Low storage capacity — Other small molecule strategies only permit the loading, or storage, of one or two units of nitric oxide per unit of drug, leaving them with an inability to deliver

 

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sufficient therapeutic quantities of nitric oxide to the desired site. Conversely, macromolecular scaffolds to date have had limited storage sites to bind nitric oxide as a percentage of total weight.

 

  n   Lack of targeting — Other nitric oxide-based approaches are primarily small molecule-based and are limited in their ability to be delivered to or target specific tissues, and the organ destination or systemic half-life is dictated by the molecule to which nitric oxide was attached.

 

  n   Backbone toxicity — Several small molecules developed in laboratory settings used to store nitric oxide have never been translated into clinical use due to the carcinogenic potential of nitrosamines or risk of cyanide poisoning from sodium nitroprusside.

Advantages of Our Nitric Oxide Platform

We believe that our platform harnesses the potential of nitric oxide in a manner that leads to the creation of differentiated product candidates that address all these limitations by (1) engineering tunable NCEs using our Nitricil technology and (2) using our formulation science to customize the drug delivery method for the anatomical location of a skin disease.

As a result, we believe that we are able to unlock the therapeutic potential of nitric oxide in numerous dermatological indications. We have chosen to focus on dermatology because nitric oxide’s multiple mechanisms of action converge in the largest organ of the body, the skin. All of the major cell types that comprise the three layers of the skin, including keratinocytes, fibroblasts, melanocytes and endothelial cells, are capable of producing nitric oxide at different rates, and these cells play an important part in organizing the skin’s unique ability to repair itself and maintain barrier function. Our ability to tune its release profile allows us to deploy nitric oxide into its wide range of pharmacological effects when host systems fail or are overwhelmed by invading microorganisms.

We believe that our nitric oxide platform is well suited to disrupt the large and growing dermatology market, reported to be $28 billion in the United States in 2014, according to IMS. Despite the size of this market, innovation in medical dermatology has been largely stagnant for decades. For example, the widespread use of antibiotics and retinoids to treat acne vulgaris has been unchanged for over 30 years and, in our view, has failed to balance efficacy, tolerability and growing concerns over antibiotic resistance in a single product. As a result, we believe our nitric oxide platform is ideally suited to address the limitations of the current treatment landscape and therefore positions us to redefine the standard of care in dermatology.

The two key components of our nitric oxide platform are described below in further detail.

(1) Our Nitricil Technology

Our innovative Nitricil technology allows for the chemical storage of large amounts of nitric oxide in solid form by loading it on a polysiloxane macromolecule. The macromolecule is a polymer comprised of two monomers, one that forms the scaffold and the other that stores nitric oxide by converting amines to diazeniumdiolate nitric oxide donors. The resulting salts of nitric oxide in solid form are stable under ambient conditions, but can liberate nitric oxide in aqueous physiological environments. Upon application to the body, Nitricil compounds release the gaseous nitric oxide with release rates further controlled by local pH. Details on the synthesis and characterization of Nitricil have been published in peer reviewed journals by Novan co-founder, Dr. Mark Schoenfisch.

Our ability to select from eight unique nitric oxide loaded monomers and two discrete scaffold monomers, to alter the polymerization ratio between the two monomers, and to vary the counterion has led to our current library of over 200 different Nitricil compositions, each of which possesses a unique nitric oxide release profile. We use our Nitricil technology to generate new NCEs tailored to address the pharmacological needs of specific skin diseases.

 

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The macromolecular delivery vehicles created by our Nitricil technology are designed to address the limitations associated with the delivery of nitric oxide. The key advantages of our Nitricil technology include:

 

  n   Tunability — We employ a synthetic approach that allows us the ability to engineer NCEs, each with unique nitric oxide release properties, through the alteration of the macromolecule size, hydrophobicity, buffer capacity and the targeted local chemical environment.

 

  n   Favorable stability profile — The ability to keep nitric oxide covalently bound as a salt on the macromolecule enables drug stability and therefore prolonged storage until administration to the patient.

 

  n   High storage capacity — Our proprietary selection of monomeric starting materials allows us to avoid dependence on external polymer chemistry that is not rationally designed to load nitric oxide. This customized approach for the assembly of Nitricil macromolecules enables us to store a large percentage of nitric oxide by weight, and at the storage level we believe is necessary to deliver therapeutic quantities of nitric oxide.

 

  n   Ability to be targeted — The macromolecular scaffold overcomes the challenges of site-specific delivery through control over particle size, electrostatic potential and surface functionality, all tailored to bind to a specific tissue target. For example, we have the ability to build our macromolecular scaffold to a desired size, ranging from small nanometer sized particles up to micron sized particles required to localize the delivery to the skin and prevent systemic exposure.

 

  n   Attractive safety profile — We use an inert and biocompatible macromolecular scaffold that does not interact adversely with the body following the release of nitric oxide.

 

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Figure 2 below illustrates our chemical flexibility to combine NO-loaded monomers with scaffold monomers to create NCEs with diverse nitric oxide release properties:

Figure 2:

 

 

LOGO

NVN1000 rapidly releases the large concentrations of nitric oxide needed to replicate the burst created by immune cells. NVN1000-based product candidates are aimed at deploying the antibacterial, antiviral and antifungal activity of nitric oxide and are currently in development for the treatment of acne vulgaris (SB204), HPV-associated genital warts (SB206) and onychomycosis (SB208). NVN4000, on the opposite end of the spectrum, is a slow-releasing NCE which may have applications for indications where a more sustained concentration of nitric oxide is required.

(2) Our Formulation Science

The topical formulations of dermatology products have a significant impact on product performance and synthesizing a stable NCE is only half of the process required to unlock drugable nitric oxide. The nitric oxide must remain stable when compounded into the final product, and classical approaches in formulation science may be incompatible with our Nitricil compounds. Our Nitricil-based NCEs are very sensitive to small changes in formulation. As a result, we select a customized set of ingredients based on their known safety profile, chemical compatibility, lack of irritation potential and the desired cosmetic properties, while allowing for the controlled release of nitric oxide when administered to the patient. This fine tuning of nitric oxide release rate using a proprietary combination of inactive ingredients creates a unique nitric oxide release profile for each indication of interest. In our discussions with the FDA, the agency has indicated its understanding of the importance of release rate on pharmacology and as a critical quality attribute of our potential products.

 

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Historically, the prescribing behavior of dermatologists has been significantly influenced by formulation type. Cosmetically elegant formulations are desired in acne vulgaris care to maintain patient compliance while ointment formulations are known to drive penetration of the active ingredients deeper into the plaques of psoriasis. Hard-to-treat locations of the body, such as the top of the head, are more accessible with sprays and foams. Creams provide both moisturizing and barrier-repair components useful for cracked, drying or irritated skin like that found with atopic dermatitis. Therefore, we plan to utilize dermatologist and patient preferences for certain topical formulations to create differentiated nitric oxide therapies. In addition to tailoring the product formulation, we are able to adjust the dose to target specific diseases and plan to package our product candidates in indication-specific containers.

As shown in Figure 3 below, our Nitricil technology and formulation science are used in combination to effectively transform a useful, naturally occurring molecule into a therapeutic pipeline of product candidates.

Figure 3:

Our Nitric Oxide Platform

LOGO

Our goal with each product candidate is to balance the need for safe, effective and convenient delivery of nitric oxide with physician and patient preferences for formulation aesthetics. Furthermore, we believe our nitric oxide platform allows us to leverage our knowledge of the analytical methodologies, process development, scale-up manufacturing and tracking of nitric oxide metabolites in vivo, and a safety profile that translates across multiple Nitricil based NCEs to reduce future development expenses and timelines across our entire product candidate pipeline.

Our Strategy

Our strategy is to develop and commercialize novel nitric oxide-based therapies that redefine the standard of care in dermatology. We are focused on creating topical, dermatological therapies in indications with underserved patient populations and well-defined clinical and regulatory development pathways. In order to pursue our strategy, we plan to:

 

  n  

Complete development of our late-stage product candidate, SB204 and submit for regulatory approval in the United States. In the first quarter of 2016, we initiated two identically designed Phase 3 pivotal clinical trials for our lead product candidate, SB204 to treat

 

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acne vulgaris, and we expect to report top-line results in the first quarter of 2017. These trials are designed to further evaluate the safety and efficacy of SB204 in 2,600 patients with acne vulgaris. Assuming successful completion of our Phase 3 pivotal clinical trials and our long-term safety study, we will target submitting our NDA to the FDA for SB204 by the end of 2017.

 

  n   Achieve proof-of-concept for our other product candidates and advance them into late-stage development. We are expanding our platform through the initiation of Phase 2 proof-of-concept trials to evaluate the therapeutic potential of nitric oxide as an anti-viral and anti-fungal agent. In 2015, we commenced a Phase 2 clinical trial with SB206 to evaluate tolerability, safety and efficacy in patients with external genital and perianal warts, and we expect top-line results in the second half of 2016. Depending on the results of our Phase 2 trial, we will evaluate moving forward with an end-of-Phase 2 meeting with the FDA and potential initiation of our Phase 3 development for the anti-viral gel in the second half of 2017. As part of our ongoing efforts targeting microbial skin infections, we initiated our Phase 2 clinical program with SB208 in the July 2016. The Phase 2 program will include the ongoing clinical trial designed to assess tolerability, safety and anti-fungal activity of SB208 in patients with Athlete’s Foot infected with dermatophytes such as T. rubrum and a second dose-ranging clinical trial of SB208 in patients with onychomycosis, a T. rubrum infection of the nails. We also have a dermatological inflammatory disease program, within which we are currently conducting preclinical studies in both psoriasis and atopic dermatitis. We plan to commence toxicology studies to support for both of these indications in the second half of 2016, and we expect to initiate clinical development under a new IND in our anti-inflammatory program in the second half of 2017.

 

  n   Expand our existing pipeline by efficiently developing topical nitric oxide-based product candidates for new dermatological indications. We believe that the breadth of our nitric oxide platform will enable us, independently or with strategic collaborators, to develop and commercialize future nitric oxide-based product candidates for the treatment of several additional anti-microbial and anti-inflammatory dermatological indications beyond our current focus. Also, we believe that our technology may be further applied to the field of medical aesthetics. Finally, we believe that our focus on topical dermatological applications for nitric oxide enables efficiently developed product candidates that potentially have lower development costs, reduced risk of side effects and a faster time to market than systemically administered therapies.

 

  n   Establish our own sales and marketing organization to commercialize our products in the United States. Our intent is to build a dermatology-focused sales organization, with approximately 75 representatives in the field to sell our product candidates that receive regulatory approval in the United States. Our sales force will initially target high-volume prescribing dermatologists and other healthcare providers. Our commercialization strategy will also leverage our NCEs with new mechanisms of action to enhance reimbursement potential and facilitate broad patient access. We have begun to execute on this strategy by hiring key executives with a strong track record in commercializing dermatology products. Additionally, we continue to evaluate strategic partnerships to commercialize our dermatology products in select international markets.

 

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Our Product Candidates

We have conducted and plan to conduct the clinical development of our product candidates under one or more INDs filed with the FDA. We are the sponsor of a single IND that became effective in September 2012, which covers the NVN1000 NCE and product candidates SB204, SB206 and SB208. Assuming successful completion of our planned toxicology studies for SB414, we expect to submit an IND covering the slower releasing cream product candidate and initiate clinical development of SB414 in the second half of 2017. The status of our development programs is summarized in Table 1.

Table 1:

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SB204 for the Treatment of Acne Vulgaris

We are developing SB204 as a once-daily, fast-acting, topical first-line monotherapy for the treatment of acne vulgaris. SB204 contains the NVN1000 active pharmaceutical ingredient. We commenced two identically designed Phase 3 pivotal clinical trials of SB204 for the treatment of acne vulgaris in the first quarter of 2016. We believe that acne vulgaris, in addition to being the most common skin disease in the United States, continues to be characterized by unmet medical needs, given the tradeoff between efficacy and safety and the growing concern with anti-bacterial resistance with existing therapies. To date, SB204 has been well-tolerated and has shown evidence of efficacy in both inflammatory and non-inflammatory lesion types.

We have completed two Phase 2 clinical trials in patients with acne vulgaris, in each of which we observed statistically significant reductions in both inflammatory and non-inflammatory lesion counts after 12 weeks of treatment with SB204. In our 630-patient SB204 clinical development program, topical application of SB204 was well-tolerated with no significant safety concerns identified. In a maximal-use pharmacokinetic study that we conducted in adult patients with acne vulgaris, we observed no detectable systemic exposure from SB204 following its topical application.

The protocol for our two Phase 3 pivotal clinical trials is based on feedback from our end-of-Phase 2 meeting with the FDA in September 2015. Assuming successful completion of our Phase 3 pivotal clinical trials and our long-term safety study, we will target submission of our NDA to the FDA for SB204 by the end of 2017.

Acne Vulgaris Disease Overview

Acne vulgaris is the most common skin disease in the United States. According to The American Academy of Dermatology, approximately 40 to 50 million Americans have acne vulgaris. The disease ranges in severity from mild to severe cystic acne vulgaris and causes both physical and psychological effects, including permanent scarring, anxiety, depression and poor self-esteem. Even in cases of mild acne vulgaris, the social stigma associated with the disease frequently results in significant emotional distress and other psychological issues. Due to the frequency of recurrence or relapse and necessary treatment over a prolonged number of years, the American Academy of Dermatologists considers acne vulgaris to be a chronic inflammatory disease.

 

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Acne vulgaris is caused by genetic and environmental factors and results from the complex interplay of four major pathogenic factors:

 

  n   overproduction of oils, or sebum, by the sebaceous gland;

 

  n   abnormal keratinization in the follicle, narrowing the pores;

 

  n   colonization by the anaerobic, lipophilic bacterium Propionibacterium acnes, or P. acnes; and

 

  n   release of pro-inflammatory mediators into the skin.

There are two types of acne lesions, inflammatory and non-inflammatory. The effective treatment of acne vulgaris often requires resolution of both types of lesions. Acne lesions begin when excess sebum production, a pro-inflammatory cascade, or both, result in abnormal proliferation of the cells of the epidermis to clog a follicle, forming a microscopic lesion known as a microcomedo. Non-inflammatory lesions occur when a microcomedo progresses to an open or closed comedone, commonly referred to as a “blackhead” or “whitehead,” respectively.

Inflammatory lesions occur when P. acnes proliferates in the anaerobic, lipid-rich environment of the microcomedo. P. acnes is central to the disease pathology because its endotoxins stimulate pro-inflammatory mediators like toll-like receptors and other inflammatory pathways. These inflammatory lesions are red and painful, and are manifested as papules, pustules or cysts.

Current Treatment Landscape

For more than 30 years, the prescription treatment landscape for acne vulgaris has been predominately served by topical retinoids for the treatment of the non-inflammatory component of the disease and antibiotics for the treatment of the inflammatory component of the disease. Table 2 below describes the prescription treatment landscape for acne adapted from a recent review in Expert Opinion of Emerging Drugs in 2015.

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Topical retinoids, such as tretinoin, adapalene and tazarotene, target the abnormal proliferation of cells to stop the narrowing of the follicle and also inhibit the pro-inflammatory cascade that initiates lesion formation. Retinoids often show efficacy over prolonged treatment durations, but can lead to undesirable dryness, irritation and scaling.

 

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Antibiotics, topical and systemic, have long been the mainstay of dermatologists to manage the inflammatory lesion component of the disease due to the link between P. acnes and inflammation. However, the widespread use and extended treatment periods of antibiotics for over 30 years has led to the emergence of the antibiotic resistance of P. acnes and, in turn, the virtual discontinuation of some drugs such as erythromycin from clinical use. Recent attention from the U.S. Centers for Disease Control and Prevention, or CDC, and the World Health Organization, or WHO, on the use of antibiotics and microbial resistance highlights the increasing need to curtail the overuse of antibiotics. According to a 2014 article in Dermatology Times, dermatologists represent 1% or less of the U.S. physician population but prescribe almost 5% of the antibiotic prescriptions. Despite the onset of antibiotic resistance, the topical antibiotic clindamycin and clindamycin combination products continue to be prescribed to manage the inflammatory component of the disease. As shown in Table 3 below, according to IMS, approximately seven million units of products containing clindamycin, monotherapies and combination products combined, were dispensed in the United States in 2015.

As disease severity increases, oral antibiotics are employed to supplement topical antibiotics in the management of inflammatory lesions, but often demonstrate limited efficacy against the non-inflammatory lesion component of the disease, which continues to be managed with topical retinoids. For example, Solodyn, a branded oral minocycline, achieved sales of over $700 million in 2011, according to IMS, notwithstanding its narrowly defined indication for inflammatory lesions of moderate to severe acne vulgaris. In addition, the prescribing information for Solodyn specifically states that it did not demonstrate any effect on non-inflammatory acne vulgaris lesions. Oral antibiotics are also associated with systemic side effects, including gastrointestinal tract irritation, photosensitivity of skin, headache, dizziness, anemia, bone and joint pain, and nausea.

The most effective therapies for acne vulgaris are those that can address more than one of the major causes of acne vulgaris pathogenesis. This has led to the development of fixed-dose combination products that combine antibiotics, retinoids or the over-the-counter agent benzoyl peroxide, or BPO, to create new branded medicines. Approved topical combination products have demonstrated modest improvements in clinical efficacy over monotherapies but also combine the tolerability issues and side effects associated with each active ingredient in the combination drug. These combination products highlight the limited innovation in acne care products over the last 30 years. Product manufacturers have successfully negotiated with managed care providers to ensure patient access to these branded products in a heavily genericized market, despite these products constituting the combination of two generically available agents. For example, Epiduo, the branded topical combination of benzoyl peroxide and adapalene, had U.S. sales volume of over one million units in 2015, amounting to $470 million in sales, according to IMS.

The oral retinoid isotretinoin, also known as Accutane, is the only drug claiming to affect all four pathogenic factors associated with acne vulgaris. However, the strong efficacy profile of isotretinoin is compromised by its severe side effect profile, given that the drug is a known teratogen that can cause birth defects and has also been linked to depression, psychosis and, in extreme circumstances, suicide. Therefore, its use has been reserved for the most severe form of the disease, and in 2009, the manufacturer of Accutane withdrew the branded product from the market.

As a result of the limited ability of single agent antibiotics and retinoids to act significantly on both the non-inflammatory and inflammatory components of acne vulgaris, physicians have adopted a poly-pharmacy approach to treatment by prescribing several treatment modalities for the management of the disease.

 

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Table 3 below highlights the limitations with various once-daily treatment approaches and illustrates the tradeoff dermatologists and patients make when electing a course of prescription therapy, and, with the addition of prescription data, highlights the size of the United States prescription acne market in 2015 at approximately 24 million units of products dispensed for the treatment of acne, according to IMS.

Table 3:

 

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1 IMS, 2015

Our Nitric Oxide-Based Solution for the Treatment of Acne Vulgaris

We believe that SB204 has the potential to address the limitations of the current treatment landscape by potentially offering an efficacious topical monotherapy for both lesion types with a favorable safety profile. In our preclinical studies, nitric oxide was effective in rapidly killing P. acnes. Moreover, after many lifecycles exposed to our drug, the bacteria did not develop resistance to our drug. The antimicrobial activity of nitric oxide is due to the multiple nitrosative species generated upon exposure to nitric oxide that lead to bacterial damage.

Nitric oxide is also an endogenous component of the innate immune response. According to a 2015 report in the Journal of Investigative Dermatology, nitric oxide inhibits P. acnes-stimulated inflammatory cytokine release in peripheral blood mononuclear cells and cultured human keratinocyte cells through inhibition of caspase-1. Caspase-1 is known to activate pro-inflammatory cytokines, including IL-1ß, a cytokine known to induce keratinocyte proliferation and lead to the narrowing of the follicle at the beginning of an acne vulgaris lesion.

 

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We believe that SB204 is a first-in-class immunomodulatory agent and has the following potential advantages over other topical therapies currently used for the treatment of acne vulgaris:

 

  n   activity against both lesion types from a single NCE with dual mechanisms of action;

 

  n   a superior safety profile due to the lack of systemic exposure;

 

  n   favorable skin tolerability profile;

 

  n   elimination of patient, parental and societal concerns arising from antibiotic resistance;

 

  n   improved patient compliance due to the non-bleaching, non-staining and non-irritating properties of the formulation;

 

  n   first-in-class NCE with no generically equivalent substitutes;

 

  n   a more rapid onset of action due to the ability to target more than one mechanism of the disease; and

 

  n   a convenient, once-daily dosing schedule with no limitations on sunlight exposure.

In a survey conducted by a third party and commissioned by us, over 400 dermatologists, non-dermatologist physicians, nurse practitioners and physician assistants were asked to rank on a scale of 1 to 7 a number of approved acne products with which they had real-world experience with respect to both efficacy and tolerability. Using the same scale, the respondents were also asked to rank a hypothetical product with characteristics similar to those we have observed in our clinical trials of SB204. Survey respondents ranked the theoretical product as being more efficacious than antibiotic combination products and more tolerable than BPO/retinoid combination products.

We believe that SB204 has the potential to redefine the standard of care in acne vulgaris, and if approved will be the first NCE specifically developed for the treatment of acne vulgaris in more than 20 years.

SB204 Clinical Development Program

To date, the SB204 clinical development program includes one completed first-in-human trial, six completed Phase 1 clinical trials and two completed Phase 2 clinical trials involving patients suffering from acne vulgaris. In both Phase 2 clinical trials, we observed reduction in lesion counts as early as week four and sustained through 12 weeks of treatment, with separation from vehicle comparable to that observed for currently available combination products. Vehicle control in our clinical trials consists of the same topical gel formulation used in our product candidate without the active ingredient.

As shown in Figure 4 below, the combined results of our Phase 2a and Phase 2b clinical trials showed a dose-dependent response against inflammatory lesions. These data were important in selecting SB204 4% once-daily as the minimum effective dose among those doses studied. The net percent reduction over vehicle on inflammatory lesions plateaued at 40 milligrams of NVN1000 per day, approximately a 22% greater reduction than was observed for vehicle-treated patients and nearly double the reduction observed with 20 milligrams per day. No additional reduction was observed at 80 milligrams per day in either Phase 2 study. Elevated doses beyond those evaluated in the Phase 2 trials, including 160 milligrams of NVN1000 per day or SB204 8% BID, were not evaluated for efficacy in order to preserve the favorable tolerability profile of SB204.

 

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Figure 4:

 

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a NI-AC201 Phase 2a study for the treatment of acne vulgaris, 153 patients

b NI-AC202 Phase 2b study for the treatment of acne vulgaris, 213 patients

The topical application of SB204 in over 400 individuals with acne vulgaris has been well-tolerated, with no safety concerns identified. In a completed maximal-use pharmacokinetic study, we observed no detectable systemic exposure to the drug itself and no difference in biomarkers for nitric oxide exposure between patients treated twice-daily with an 8% concentration of SB204, or SB204 8%, or vehicle. The analysis of electrocardiograph data on patients treated with the therapeutic dose SB204, 4%, or with three times the therapeutic dose of SB204, 12%, showed no clinically significant effects on heart rate or any other cardiovascular assessments. The adverse events, or AE, profile has been similar in SB204- and vehicle-treated patients for the entire development program and no treatment-related serious AEs have been reported. Asymptomatic, transient erythema has been observed in some patients treated with SB204, but was resolved within minutes following its application. To date, we have not observed any clinically significant changes in laboratory results, including methemoglobin.

Phase 3 Clinical Program

Based on the results from our development program to date, we initiated two identically designed Phase 3 pivotal clinical trials in the first quarter of 2016 with SB204 4% once-daily. We have completed an end-of-Phase 2 meeting with the FDA and submitted the protocols for the Phase 3 program under a special protocol assessment, or SPA, for review by the FDA. We have reached agreement with the FDA on the primary endpoints for our Phase 3 clinical trials, but do not intend to pursue a full formal SPA agreement with the FDA. We have also completed the non-clinical studies and chemistry, manufacturing and controls, or CMC, activities required to support initiation of the following clinical trials:

 

  n   NI-AC301 and NI-AC302: two multi-center, randomized, double-blind vehicle-controlled Phase 3 clinical trials assessing the safety and efficacy of SB204 4% dosed once-daily in patients with acne vulgaris over 12 weeks. Each of these trials will consist of approximately 1,300 patients.

 

  n   NI-AC303: a long-term multi-center, open-label safety trial assessing the safety of treatment with a SB204 4% once-daily for up to 40 weeks, in eligible patients who have completed 12 weeks of treatment in the NI-AC301 or NI-AC302 trials.

Trials NI-AC301 and NI-AC302 are being conducted in patients above the age of nine suffering from acne vulgaris. Patients who satisfy the inclusion criteria will be randomized in a ratio of 1:1 to a treatment with SB204 4% once-daily or vehicle. Investigational drug will be delivered from a dual

 

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chamber pump dispenser consistent with both of our Phase 2 clinical trials. The pump dispenses product from two chambers, containing active gel in one chamber and a buffered hydrogel in the other, or the corresponding vehicle gel in one chamber and a buffered hydrogel in the other, which will be mixed together in the palm for approximately five seconds by the patient and applied to the entire face once-daily after washing. We intend to use this dispensing method in our commercial product, if approved. Cutaneous tolerability assessments include evaluation of facial erythema, scaling, dryness, itching and burning or stinging. Other safety assessments include reportable adverse events, physical exams, blood pressure, pulse rate and urine pregnancy tests. Patients will return for post-baseline evaluation after weeks two, four, eight and 12 or prior to an early termination, or ET.

The co-primary efficacy endpoints in our Phase 3 clinical trials are:

 

  n   the absolute change in inflammatory lesion counts from baseline to week 12 or ET;

 

  n   the absolute change in non-inflammatory lesion counts from baseline to week 12 or ET; and

 

  n   the proportion of success according to the dichotomized investigator global assessment, or IGA. A patient will be considered a success if the IGA at week 12/ET is either “clear”, with a score of 0, or “almost clear”, with a score of 1, and is at least two grades below the baseline score.

The IGA is a widely used method of measuring the severity of acne vulgaris that involves a subjective assessment of lesion severity by the investigator on a five-point scale ranging from 0, or “clear”, to 4, or “severe”. In a dichotomized assessment, each patient is characterized either as a success or as a failure.

The secondary efficacy endpoints are:

 

  n   the percent change in inflammatory lesion count from baseline to week 12 or ET;

 

  n   the percent change in non-inflammatory lesion count from baseline to week 12 or ET;

 

  n   the median time to improvement as assessed by a 35% reduction from baseline in inflammatory lesion counts; and

 

  n   the median time to a minimum two-grade improvement in IGA score.

We expect to report top-line results from the two Phase 3 trials in the first quarter of 2017 and from NI-AC303, the long-term safety study, in the second half of 2017.

Additional planned clinical work, which is consistent with other dermatology product development programs, in support of a future NDA submission for SB204 includes:

 

  n   a pediatric pharmacokinetic study in adolescents ages 9 to 17 suffering from acne vulgaris, which we plan to initiate in 2016 and complete prior to an NDA submission; and

 

  n   Phase 1 clinical trial dermal safety studies required to screen all dermatological drugs in healthy volunteers, which we plan to complete prior to an NDA submission.

NI-AC202: A Phase 2, Multi-Center, Randomized, Evaluator-Blinded, Vehicle-Controlled Clinical Trial Comparing the Efficacy, Tolerability, and Safety of SB204 and Vehicle Once or Twice-Daily in the Treatment of Acne Vulgaris

In a Phase 2 multi-center, double-blind, clinical trial, 213 patients between the ages of 12 and 40 with moderate to severe acne vulgaris were enrolled and treated over 12 weeks with SB204 2% twice-daily, or BID, SB204 4% twice-daily, SB204 4% once-daily, or vehicle once or twice-daily. The patients enrolled in the study were randomized in a 2:2:2:1:1 ratio, yielding approximately 50 patients per SB204 dose group. More than 92% of the patients in each SB204 dose group completed the study, and approximately 79% of the patients in the vehicle group completed the study. The clinical trial was

 

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conducted across 20 sites throughout the United States. The primary endpoints were absolute change in the number of each of inflammatory and non-inflammatory lesions and the proportion of success at the end of treatment, according to the IGA score, with success being defined as achieving IGA score of 0 or 1, and an improvement of at least two grades in the IGA score from baseline.

Our three goals for this Phase 2 clinical trial were to 1) evaluate the efficacy of once versus twice-daily dosing regimens to establish the dosing frequency for Phase 3 trials; 2) conduct a time-to-event analysis to strengthen the statistical analysis on the fast-acting nature of the efficacy observed in a previous Phase 2 trial; and 3) obtain an estimate of effect size on IGA score to inform the power calculation for the Phase 3 pivotal trials.

All statistical analyses and data shown for our SB204 program are on the intent-to-treat, or ITT, population. Randomized clinical trials analyzed by the ITT approach provide unbiased comparisons among the treatment groups. In an ITT population, none of the patients are excluded and the patients are analyzed according to the randomization scheme. In other words, for the purposes of ITT analysis, everyone who is randomized in the trial is considered to be part of the trial regardless of whether he or she is dosed at all or completes the trial per protocol for the recommended duration of treatment. Discontinuations were treated statistically with the last observation carry forward methodology for each of the SB204 Phase 2 program data sets shown below. P-value is a conventional statistical method for measuring the statistical significance of clinical results. A p-value of less than 0.050 is generally considered to represent statistical significance, meaning that there is a less than five percent likelihood that the observed results occurred by chance. Unless otherwise specified, the p-values shown herein represent a comparison of each active group to the pooled vehicle treatment groups, once-daily and twice-daily combined together for analysis.

At baseline across all treatment groups, the mean inflammatory lesion count was 27, the mean non-inflammatory lesion count was 38, and the majority of patients had an IGA score of “moderate”, or 3. The absolute change from baseline in the number of non-inflammatory lesions was -14.1, or 37%, for SB204 4% once-daily and -7.6, or 17%, for pooled vehicle, with a p-value of 0.032. As shown in Figure 5 below, the absolute change from baseline in the number of inflammatory lesions was -11.3, or 42%, for SB204 4% once-daily and -5.8, or 19%, for pooled vehicle, with a p-value of 0.004. The SB204 4% once-daily treatment group was the only treatment arm that showed a statistically significant separation from vehicle on both lesion types.

Figure 5:

 

                Non-inflammatory Lesions

 

 

            Inflammatory Lesions

 

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Percent reduction in lesion counts from baseline at week 12 was statistically significantly different compared to vehicle for both non-inflammatory and inflammatory lesions for all SB204 dose groups. Percent change from baseline at week 12 in the number of non-inflammatory lesions was 34% for SB204 2% twice-daily, 37% for SB204 4% once-daily, 33% for SB204 4% twice-daily and 17% for pooled vehicle, with a p-value for each dose group of 0.05 or less. Percent change from baseline at week 12 in the number of inflammatory lesions was 42% for SB204 2% twice-daily, 42% for SB204 4% once-daily, 42% for SB204 4% twice-daily and 19% for pooled vehicle, with a p-value for each dose group of 0.05 or less.

The percent change in lesion counts over time from baseline to week 12 is shown below in Figure 6, illustrating the similarity of each treatment group and the separation from vehicle on both lesion types following treatment with any of the tested doses of SB204.

Figure 6:

 

        Non-inflammatory Lesions

 

 

                         Inflammatory Lesions

 

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The dichotomized IGA success rate, defined as achieving an IGA score of 0 or 1 and at least a two-grade improvement in the IGA score, was 7.4% for the vehicle once-daily and 6.9% for the vehicle twice-daily resulting in combined 7.1% for the pooled vehicle arm, compared to 15.1% for the SB204 2% twice-daily arm, 11.5% for the SB204 4% once-daily arm, and 13.7% for the SB204 4% twice-daily arm, as shown in Figure 7 below. The number of IGA successes varied between six and eight patients for each of the SB204 dose groups.

Figure 7:

 

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Given the similarity in inflammatory lesion reduction observed for all SB204 treated groups and the known correlation between inflammatory lesion reduction and IGA success, we pooled each of the active treatment groups to get a better estimate of the standard deviation for the future Phase 3 clinical trials endpoint. We used a 7.1% success rate for vehicle-treated patients and a 13.5% pooled success rate for SB204 treated patients to estimate the sample size required to power the Phase 3 pivotal clinical trials with a 95% confidence interval. The 650 patients per arm in each of the 2 pivotal trials is also sufficient to power the other co-primary endpoints. Additionally, sensitivity analyses were performed to assess the appropriateness of the Phase 3 sample size using the multiple imputation statistical analysis planned for the Phase 3 pivotal trials as well as with the per-protocol population reduction in both lesion types that excludes patients that discontinued during treatment.

We believe that our dose selection of SB204 4% once-daily for our Phase 3 clinical trials is further supported by our secondary efficacy analyses which included a Kaplan-Meier analysis for median time to improvement as assessed by the reduction from baseline in inflammatory lesion counts. With an efficacy threshold of a 35% reduction in the number of inflammatory lesions, we observed a time-to-median reduction of 4.1 weeks with the SB204 4% once-daily treatment compared to 11.6 weeks for vehicle, with a p-value of 0.014. As shown in Figure 8 below, the SB204 4% once-daily treatment was the fastest acting of all treatment groups at this efficacy threshold, and consistently demonstrated the highest percentage of successes by week 2 across all efficacy thresholds tested (data not shown).

Figure 8:

 

 

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We also assessed cutaneous tolerability by recording the erythema, scaling, dryness, itching and burning or stinging on a four-point scale from 0 to 3 at baseline and at each visit. These measurements are either measured by the physician or reported by the patient. Overall, the active and vehicle treatments were well tolerated. The cutaneous tolerability data for SB204 4% administered once-daily is shown in comparison to vehicle-treated patients in Table 4 below. The table reflects the percentage of patients in each category. Acne patients are often experiencing many of these local intolerabilities at baseline, before ever initiating treatment with study drug. As shown below, none of the scores at the end of treatment were markedly elevated compared to baseline incidence for the SB204 or vehicle treatment groups, illustrating the favorable tolerability profile of SB204. More than 95% of patients had scores of “mild” or “no” intolerability for each of the scoring criteria at Week 12.

 

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Table 4:

 

 

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1  Physician observations
2  Patient reported

The aggregate scores of 1, for “mild”, 2, for “moderate”, or 3, for “severe,” on dryness, itching or burning/stinging at most time points throughout the conduct of the study were observed as being a few percentage points higher in patients treated with SB204 4% twice-daily than patients treated once-daily with the same dose, further supporting our selection of the 4% once-daily regimen for the Phase 3 program. The sum of the maximum severities observed at any time point during treatment is shown below in Figure 9 for each SB204 treatment group and the pooled vehicle group both before and during treatment. The maximum incidence of a patient showing any mild, moderate or severe score at any of the assessment time points during treatment with SB204 4% once-daily for each of the tolerability categories was 39.2% erythema, 19.2% scaling, 21.2% dryness, 11.8% itching and 19.2% burning/stinging. For comparison, topical retinoid products have maximum severities of approximately 40% for erythema, 45-60% for scaling and burning/stinging and 60% for dryness (information for itching not publicly available).

Figure 9:

 

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NI-AC201: A Multi-Center, Randomized, Evaluator-Blinded, Vehicle-Controlled, Parallel Group, 3-arm Study Comparing the Efficacy, Tolerability, and Safety of Two Concentrations of SB204 and Vehicle Twice-Daily in the Treatment of Acne Vulgaris

We conducted a Phase 2 clinical trial to evaluate safety, tolerability and efficacy of twice-daily administration of SB204 1%, SB204 4% and vehicle. A total of 153 male and female patients between the ages of 12 and 40 with mild, moderate or severe acne vulgaris, as measured on the IGA scale, were enrolled in the study and treated twice-daily over a period of 12 weeks. The study was conducted across four sites throughout Latin America. The primary endpoint was the absolute change in the number of non-inflammatory lesions at the end of treatment. Secondary endpoints included the absolute change in the number of inflammatory lesions at the end of treatment.

At baseline, the mean inflammatory lesion count was 29, the mean non-inflammatory lesion count was 50, and the majority of patients had an IGA score of 3, or moderate. As shown in Figure 10 below, the absolute change from baseline in the number of non-inflammatory lesion counts was -0.3 for vehicle, -12.1 for SB204 1% twice-daily, with a p-value of 0.022, and -11.0 for SB204 4% twice-daily, with a p-value of 0.031. The absolute change from baseline in the number of inflammatory lesion counts was -9.3 for vehicle, -13.7 for SB204 1% twice-daily, which was not statistically significant, and -15.5 for SB204 4% twice-daily, with a p-value of 0.018. In a post-hoc analysis, SB204 4% twice-daily produced statistically significant reductions in both lesion types as early as week 4.

Figure 10:

 

            Non-inflammatory Lesions

 

                Inflammatory Lesions

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The percent reduction in non-inflammatory and inflammatory lesion counts over time for both SB204 dose groups as compared to vehicle is shown below in Figure 11.

 

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Figure 11:

 

        Non-Inflammatory Lesion Counts

 

  

          Inflammatory Lesion Counts

 

 

 

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There were no statistically significant differences in the dichotomized IGA ‘success’ rate, defined as achieving an IGA score of 0 or 1 and a minimum two-grade improvement in the IGA score between baseline and Week 12 between the vehicle and SB204 1% or SB204 4% treatment groups. In the SB204 treatment groups, there was a decrease from baseline in the number of patients with “moderate” or “severe” IGA scores. At the end of treatment, 58% of the 4% SB204 twice-daily treatment group experienced “moderate” or “severe” IGA scores compared to 92% at baseline.

Overall, the active and vehicle treatments were well-tolerated. We observed no serious AEs. The rates of AEs, changes in vital signs and methemoglobin levels were observed to be similar in each of the SB204-treated groups and vehicle-treated group. Two patients were reported to have contact dermatitis, one of whom was treated with vehicle and the other of whom was treated with SB204 4% twice-daily, while another patient was reported to have contact urticaria and treated with SB204 4% twice-daily.

NI-AC104: A Thorough ECG Clinical Trial in Subjects with Acne Vulgaris Treated With SB204

All NCEs submitted to the FDA for approval are required to conduct a cardiovascular safety study to measure the effect of the drug on the QT interval, a measure of the time between the start of the Q wave and the end of the T wave in the heart’s electrical cycle. In further support of our SB204 program, we executed a four-period cross-over trial in the fourth quarter of 2015 to examine the effect of SB204 on the QT interval in 48 adult patients with acne vulgaris. Patients were randomized and each received topical treatment to approximately 17% of their body surface area. The four treatment arms were: SB204 4% once-daily; SB204 12% once-daily; vehicle; and moxifloxacin. Moxifloxacin, which is known to promote the lengthening of the QT interval, was included as an active control arm. Electrocardiograph, or ECG, recordings and blood samples to assess pharmacokinetics were obtained at multiple time points after each treatment. The primary endpoint was to define the ECG effect of SB204 at therapeutic and supratherapeutic dose concentrations as measured by the difference between the time-matched baseline-adjusted QTcF interval for the groups receiving SB204 and vehicle. The secondary endpoint was a categorical analysis of the QTc interval to determine number and percentage of time points and patients by dose group with absolute QT/QTc greater than 450, 480 and 500 ms.

The results showed no systemic absorption of SB204 and no tolerability or safety concerns. The analysis of ECG data on patients treated with either the proposed therapeutic dose or three times the therapeutic dose of SB204 showed no clinically significant effects on heart rate, QT interval or any other cardiovascular assessments. We submitted the results from this trial to the FDA prior to the start of the Phase 3 pivotal clinical trials in the first quarter of 2016.

 

 

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NI-AC101: A Phase 1, Single-center, Double-Blind, Randomized, Cross-over Pharmacokinetic, Safety and Tolerability Trial of SB204 8%, or Vehicle

We conducted a maximal-use pharmacokinetic trial in 18 patients with acne vulgaris and observed no detectable exposure to the NVN1000 NCE and no difference in plasma levels of nitrate in patients treated with SB204 8% or vehicle. The total daily dose selected for evaluation of pharmocokinetics in this trial was four times higher than SB204 4% once-daily, the dose we have selected for the Phase 3 pivotal clinical trials and commercial use for the treatment of acne vulgaris, if approved. The formulation used in NI-AC101 is the same formulation being used in the Phase 3 clinical trials.

In this trial, the 18 patients with moderate to severe acne vulgaris were randomized, and in the first treatment period administered either SB204 8% or vehicle, applied topically, twice-daily to the maximal-use surface area, consisting of 17% of their body surface area, including on the face, chest, back and upper shoulders. Patients received a low nitrate diet during the five-day treatment period. After a nine-day washout period, dosing was re-initiated with the opposite regimen (active or vehicle) for a second treatment period. Serial plasma samples were obtained at day one and day five for each patient for both treatment periods. The primary endpoint was the pharmacokinetic assessment of nitrate and silicon in the plasma of patients treated with SB204. Secondary endpoints included safety assessments based on physical exams, electrocardiogram tests, serum chemistry, hematology, urinalysis and an assessment of cutaneous tolerability. Eighteen patients completed the first treatment period, but one patient did not return for the second treatment period due to family emergency. Seventeen patients entered the second treatment period, but one patient discontinued due to contact dermatitis on the fifth day of treatment with SB204 8%.

Upon topical application of SB204, the NVN1000 NCE releases nitric oxide from the polysiloxane macromolecule. The assessment of systemic exposure was determined by evaluating the primary pharmacokinetic profiles of metabolites from both the NVN1000 NCE and nitric oxide.

NVN1000 exposure was assessed by measuring plasma concentrations of hMAP3, a product from the hydrolysis of NVN1000. The results showed no measurable systemic exposure to NVN1000 and all plasma hMAP3 values were below the lower limit of quantitation. Nitric oxide exposure was assessed separately by measuring plasma nitrate concentrations. Nitrate forms following the rapid oxidation of nitric oxide under physiological conditions. The mean plasma nitrate concentration-time profiles for SB204 8% and vehicle on days one and five are shown in Figure 12 below. Our analysis showed no change in systemic nitrate levels. These results showed that background systemic levels of nitrate were not affected by administration of SB204 8%.

 

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Figure 12:

 

 

                    Plasma Nitrate Concentrations Over Time

 

                  Plasma Nitrate AUCs on Days 1 and 5
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Based on these data, we have characterized the pharmacokinetic profile of hMAP3 and nitrate following topical treatment with SB204 8% under maximal use conditions in patients with moderate to severe acne vulgaris, and we did not observe any systemic exposure.

NI-AC006: A Phase 1, Multiple-Dose, Evaluator-Blind, Randomized, Parallel-Group Clinical Trial Evaluating the Safety and Cutaneous Tolerability of SB204 in Healthy Volunteers

We conducted a Phase 1 evaluator-blind trial evaluating the safety and cutaneous tolerability of SB204 in 30 healthy adult patients. Patients with elevated P. acnes counts on the face were enrolled and randomized in the ratio of 2:1 for SB204 4% twice-daily or vehicle twice-daily for 14 days. The primary endpoint was to evaluate cutaneous tolerability with additional endpoints exploring the safety of the drug as well as an assessment of the change in P. acnes counts following treatment.

A total of 29 patients completed treatment. Both SB204 4% and vehicle were well-tolerated. We observed a greater than 90% reduction of P. acnes in two out of 20 patients when treated with SB204 compared to zero out of ten vehicle-treated patients exhibiting such a marked response. Overall, we observed a mean reduction of 69% in P. acnes counts in patients treated with SB204 4% compared to a 49% reduction in vehicle-treated patients. This decrease in P. acnes was statistically significant with a p-value of 0.029. This magnitude of response is consistent with reductions of P. acnes following treatment with topical clindamycin monotherapy reported in a review published in the American Journal of Clinical Dermatology in 2001. In the studies reviewed in that report, the percentage reduction in P. acnes achieved after one week of treatment with topical clindamycin gel, lotion and solution was 30%, 56% and 62%, respectively.

Preclinical Safety

We have completed over 30 preclinical studies with NVN1000 to assess pharmacology, pharmacokinetics, biodistribution and toxicology. In our pharmacokinetic evaluations of NVN1000, we evaluated administration by dermal, intravenous, intra-muscular and oral routes on mice, rats, rabbits and miniature swine. We observed from the resulting toxicokinetic data from miniature swine that systemic absorption of NVN1000 after dermal administration at supra-therapeutic doses was minimal.

 

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We have conducted several preclinical toxicology studies to evaluate the local safety and tolerability of NVN1000, both the active pharmaceutical ingredient by itself and formulated as SB204, following dermal administration. Dermal toxicology studies involving repeat doses of SB204 have included 4-week and 13-week dermal toxicology studies in miniature swine and a 13-week dermal toxicology study in both rats and mice. In the case of both the miniature swine and mice, we did not observe any significant toxicological effects from doses of NVN1000 up to 28-fold higher in concentration compared to our expected clinical doses and applied on more than 3-fold larger surface area. The most relevant and persistent finding has been transient dermal erythema that is concentration-dependent and believed to be a consequence of a vascular dilation “flushing” effect. During the chronic, 39-week repeat dose dermal toxicology study conducted with SB204 in miniature swine we observed no systemic toxicity and minimal to moderate findings as a function of dose at the skin dose-site. Microscopic observations of thickening of epithelium and inflammatory cell infiltration were observed, which are consistent with an irritant contact dermatitis, presumably due to the high pH of the test article at the SB204 8% BID dose. The findings were considered to be non-adverse upon pathological review and led to a NOAEL, or no observable adverse effect level, of SB204 8% BID. No effect on acute dermal irritation or skin sensitization was observed in additional safety studies in rabbits and guinea pigs. As expected, due to its alcohol-based formulation, NVN1000 gel was found to be an ocular irritant.

We observed NVN1000 to be positive for genotoxicity in a standard in vitro assay in bacteria, negative in a chromosome aberration test in cultured human peripheral blood lymphocytes and negative in three in vivo mutagenicity assays. Additionally, in SEG I and II reproductive toxicology studies conducted in rats and rabbits, the oral administration of NVN1000 resulted in supratherapeutic levels of nitrate and hMAP3 showed minimal effects on fertility or fetal development.

SB206, a Topical Anti-viral for the Treatment of External Genital and Perianal Warts

We are developing SB206 as a nitric oxide-releasing topical anti-viral gel for the treatment of viral skin infections, such as warts caused by HPV. All warts, including genital warts, are caused by HPV, and we believe that SB206 is well-positioned to address several wart indications. We have initially chosen to evaluate SB206’s anti-viral mechanism of action in an ongoing, randomized, double blind, vehicle-controlled Phase 2 clinical trial in 120 patients with genital warts caused by HPV. We expect to report top-line results for our Phase 2 clinical trial in the second half of 2016. In our preclinical studies, we observed complete inhibition of papilloma virus growth in vivo and inhibition of HPV viral replication in vitro. Specific preclinical observations included:

 

  n   dose responsive pharmacological effects against papilloma virus infections;

 

  n   evidence of direct anti-viral activity via inhibition of viral replication.

Pending results of the ongoing Phase 2 clinical trial, we intend to continue further clinical development with SB206. If the Phase 2 clinical trial suggests one or more advantages over currently marketed topical agents, we will seek regulatory input via an end-of-Phase 2 meeting with the FDA and proceed to Phase 3 development in the second half of 2017. Our preliminary analysis indicates that the Phase 3 clinical development program for the genital and perianal wart indication will require substantially fewer patients to be enrolled compared to the current acne vulgaris Phase 3 clinical development program because we believe the SB204 program will have generated substantial clinical safety data required for the first FDA approval of the NVN1000 NCE. The FDA has published a guideline entitled “The extent of population exposure to assess clinical safety: For drugs intended for longterm treatment of non-life-threatening condition,” which was prepared by the International Conference on Harmonisation of the Technical Requirements for Registration of Pharmaceuticals for Human Use. The guideline recommends that 1,500 individuals be exposed to an investigational new drug, including short-term exposure. At the completion of our SB204 development program, we anticipate having more than 1,500 patients dosed with the NVN1000 active ingredient across a range

 

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of concentrations and what we believe will be a large safety data set to utilize for a second indication with this active ingredient. We plan to solicit FDA feedback on this approach as part of the SB206 development program and have had no correspondence with the FDA on the SB206 Phase 3 program to date.

Human Papillomavirus Disease Overview

HPV refers to a large family of double-stranded DNA viruses that induce hyperproliferative lesions of either cutaneous or mucosal surfaces. HPV affects nearly 80 million Americans, and an estimated 14 million people become infected with the virus each year, according to the CDC. There are over 100 subtypes of the virus, characterized as low risk or high risk based on their oncogenic potential. Several HPV vaccines have successfully been developed that target certain cancer-causing subtypes for the prevention of cervical neoplasias and cervical cancer, but these vaccines do not cover the range of HPV subtypes that cause the multitude of skin lesions. The virus is typically transmitted through direct skin-to-skin contact through disruptions in the normal epithelial barrier of the skin. Examples of skin warts caused by HPV that could potentially be addressable with our nitric oxide platform include:

 

  n   genital and perianal warts, collectively typically classified as genital warts;

 

  n   common warts on the hands, elbows and knees;

 

  n   flat warts found on the face and forehead in children;

 

  n   plantar warts found on the soles of the feet; and

 

  n   subungual and periungual warts that appear under and around the fingernails or toenails.

Genital and Perianal Warts

Genital warts, which include both genital and perianal warts, are among the world’s most common sexually transmitted diseases. Genital warts are usually flesh-colored growths, or lesions, that can be raised, flat or cauliflower-shaped. In males, they can appear on the surface of the penis, scrotum, thigh or groin, or in and around the anus. In females, warts can grow inside the vagina or on the cervix, making them hard to see. Genital warts carry a substantial psychosocial burden due to the shame and embarrassment related to having a sexually transmitted disease, as well as the inconvenience and discomfort of current treatment modalities.

Current Treatment Landscape

Currently, there are no FDA-approved treatments with an anti-viral mechanism of action for the treatment of genital warts. The Gardasil HPV vaccine, which is primarily indicated for the prevention of cervical neoplasias and cervical cancer, is also indicated for the prevention of genital warts caused by HPV subtypes 6 and 11. The adoption rates of eligible adolescent males and females in the United States remains approximately 50%, according to the CDC, and this product cannot be used to treat genital warts. Current treatment strategies for HPV-induced skin lesions target removing the hyperproliferative growth instead of eliminating the underlying viral infection. These treatments are currently administered either as topical therapies or locally destructive, or ablative, procedures.

Topical therapies consist of three classes of drugs that are most often prescribed for genital warts—imiquimod, marketed as Aldara and Zyclara, podofilox, marketed as Condylox, and sinecatechins, marketed as Veregen. Developing treatments for warts caused by HPV has historically been problematic due to the inability of drugs to penetrate the heavily keratinized wart. Thus, the available topical therapies are slow-acting, which drives a large number of patients toward painful ablative or surgical removal of the warts. The modest efficacy of topical products along with inconvenient dosing schedules and local application site inflammatory reactions lead to poor compliance and inadequate patient outcomes. As an example, the manufacturer of Zyclara reports only a 27% to 29% incidence of complete clearance of warts present at baseline after 16 weeks.

 

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Ablative procedures effect local tissue destruction at the site of the wart and include cryotherapy, lasers, electrodessication and curettage. Patients commonly experience pain during the procedure and may also suffer from persistent hypopigmentation or hyperpigmentation. Rarely, treatment can result in disabling chronic pain syndromes, including vulvodynia and hyperesthesia of the treatment site, or, in the case of perianal warts, painful defecation or fistulas.

According to the CDC’s Sexually Transmitted Disease Control Guidelines issued in 2015, there is no definitive evidence that any of the available treatments are superior to any other and no single treatment is ideal for all patients. Both topical and ablative therapies are associated with high recurrence rates because the cells surrounding the damaged tissue still remain infected with HPV DNA and over a period of time take over the host cells to proliferate and grow new warts. Treatments for genital warts remain largely ineffective in achieving long-term wart eradication, with average recurrence rates ranging from 30% to 70% within the first 6 months, according to Expert Review of Dermatology.

Our Nitric Oxide-Based Solution for the Treatment of Genital and Perianal Warts

We are developing a topical nitric oxide-releasing gel therapy for the treatment of viral skin infections, the first indication of which will be in genital and perianal warts. Nitric oxide has been reported to inhibit the replication of a variety of viruses, such as DNA viruses, RNA viruses and retroviruses, and therefore we believe it may inhibit HPV viral replication to promote viral clearance and to prevent further spread of the virus. In preclinical studies, we observed that a faster burst of nitric oxide is more effective at inhibiting the growth of warts than slow, sustained release. This led to our selection of the NVN1000 NCE for further development. We believe the release profile of nitric oxide generated from NVN1000 promotes greater skin penetration and may enhance the probability of eliminating HPV-induced genital warts. The nitric oxide gas released from NVN1000 can diffuse through the calloused skin layers and overcomes the historical inability of drugs to penetrate the heavily keratinized wart.

SB206 utilizes the same NCE as SB204, but the nitric oxide release profile has been modulated via the chemical properties of the topical formulation to promote a faster release rate and delivery of elevated doses of nitric oxide to the skin. We believe that SB206 could potentially deliver the following advantages over other topical therapies currently used for genital warts:

 

  n   higher level of efficacy than existing topical therapies, with a greater clearance of warts;

 

  n   lower rates of genital wart recurrence based on the antiviral mechanism of action;

 

  n   a shortened duration of therapy;

 

  n   a convenient dosing schedule that helps patients better adhere to therapy; and

 

  n   easy application to affected areas.

NI-WA201: An Ongoing Phase 2, Multi-Center, Double-Blind, Randomized, Vehicle-Controlled, Ascending Dose Study Assessing Tolerability, Safety, and Efficacy of Topical NVN1000 in Subjects with External Genital Warts and Perianal Warts

In this randomized, double-blind, vehicle-controlled clinical trial, we are evaluating the safety and efficacy of SB206 in patients with external genital warts and perianal warts. We anticipate enrolling approximately 120 patients in this trial. We are exploring dose and dosing frequency of SB206 in four ascending dose cohorts. Patients are being randomized in a 3:1 ratio to either SB206 or vehicle and treated for up to 12 weeks with doses including SB206 4% twice-daily, 4% once-daily, 8% once-daily, and the highest dose planned to be evaluated, 12% once-daily. Patients eligible for this clinical trial are males or females who are 18 to 50 years of age with 2 to 20 warts on the genital or perianal area.

 

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The primary endpoint for this clinical trial is the proportion of patients who are completely clear of warts that were present at baseline at or before week 12. Secondary endpoints include percent reduction in baseline wart count at each visit and the tolerability of SB206 as determined by investigator scores on a four-point grading scale for erythema, edema, erosions or ulcers and burning or stinging. This clinical trial was initiated in the second quarter of 2015, and top-line results from the complete study are expected in the second half of 2016.

Cohort 1, SB206 4% twice-daily, and Cohort 2, SB206 4% once-daily, are complete. An interim analysis was conducted to assess the appropriateness of the doses in the final two cohorts and to provide evidence to inform the design of future studies.

Local tolerability scores of severe among all tolerability evaluations were more frequent in patients treated with SB206 4% twice-daily when compared to those observed for SB206 4% once-daily and for vehicle. The most frequently reported treatment-emergent adverse events were application site reactions, which were highest in patients treated with SB206 4% twice-daily.

Based on the tolerability and local application site adverse event profile, twice-daily dosing was discontinued and Cohorts 3 and 4 are being dosed once-daily at two-fold and three-fold higher concentrations of NVN1000, respectively. To date, no patients have been discontinued for tolerability concerns in these cohorts.

In the interim analysis, 5 out of 24, or 21%, of the patients achieved complete clearance of all warts by week 12 when treated with SB206 4% once-daily, compared to only 1 out of 8, or 13%, of the patients achieving complete clearance with vehicle once-daily. Based on the small number of patients in the vehicle arm at the time of this analysis, no definitive conclusions can be drawn regarding the magnitude of efficacy or relationship between active and vehicle treatments. Statistical conclusions on efficacy of SB206 in this trial can only be drawn when the full data set is available based on the distribution of patient numbers across active- and vehicle-treated groups. By design, the majority of the patients in this trial were preserved for enrollment at the highest doses, where enhanced anti-viral activity was observed in preclinical animal models.

Preclinical Pharmacology Studies

In a cottontail rabbit papillomavirus, or CRPV, model, we evaluated several nitric oxide-releasing drug candidates to determine the effect of release rate on the inhibition of papilloma formation. Two weeks following viral inoculation, topical treatment was initiated with daily treatment occurring five times per week for five weeks. Using this model, we observed that the modulation of nitric oxide dose and release rate both influence anti-viral activity. Lower concentrations of drug and formulations with slower nitric oxide release rates showed limited efficacy, leading to our selection of SB206 as the lead candidate. As shown in Figure 13 below, in an in vivo CRPV study, we observed a dose responsive inhibition of both wild type and E8 mutant papilloma growth following daily topical treatment of SB206 gel, five doses per week for five weeks compared to imiquimod as a positive control. We observed complete inhibition of the E8 mutant CRPV papillomas with SB206 at the highest dose compared to 26% inhibition for imiquimod. Biopsies from animals treated with SB206 10% lacked any evidence of viral infection. We also observed that histological assessment of inflammation and quantitative cytokine gene expression were similar across all dose groups, suggesting immune activation was not a significant component of the anti-viral activity observed with SB206 treatment.

 

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Figure 13:

 

            Wild Type Papilloma Growth

 

                E8 Mutant Papilloma Growth

LOGO   LOGO

The anti-viral activity of the NVN1000 used in SB206 was then measured in organotypic cultures of primary human keratinocytes infected with HPV-18. We observed dose responsive inhibition of viral replication as determined by quantitative polymerase chain reaction analysis following the exposure of HPV-18 infected raft cultures for one hour per day for six days. As shown in Figure 14 below, NVN1000 at 0.75, 1.0, and 1.5 mg/mL inhibited viral copy number by 25%, 62% and 85%, respectively. No significant cytotoxicity was observed at any dose in human keratinocyte cultures. In follow-on preclinical studies in the raft culture model, we observed direct anti-viral activity of nitric oxide against high risk HPV, fundamentally decreasing viral protein expression.

Figure 14:

HPV-18 Viral Replication in Human Raft Cultures

 

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SB208, a Topical Anti-fungal for the Treatment of Onychomycosis

We are developing SB208 as a topical anti-fungal gel utilizing the NVN1000 NCE for the treatment of fungal infections, such as athlete’s foot and onychomycosis. NVN1000 has been observed in vitro to release nitric oxide that rapidly diffuses through human nails and directly kills fungal species, as opposed to only inhibiting the growth of the fungus. NVN1000 has demonstrated broad-spectrum activity in vitro against Trichophyton mentagrophytes, or T. mentagrophytes, and Candida albicans, or C. albicans, in addition to T. rubrum. We recently initiated our Phase 2 program in the second half of 2016 with a six-week clinical trial designed to assess tolerability, safety and anti-fungal activity of three doses of SB208 in patients with athlete’s foot infected with dermatophytes such as T. rubrum to narrow

 

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the dose range prior to beginning work in onychomycosis. Approximately 170 patients will be randomized 1:1:1:1 to three active and one vehicle treatment arms, applying either SB208 Gel (2%, 4% or 16%) or vehicle once daily for two weeks, followed by a four-week post-treatment observation. Endpoints will include assessments of mycological cure, clinical cure and therapeutic cure, which includes both clinical cure and mycological cure. We expect to report top-line results from the six-week Phase 2 trial in the first half of 2017. The results of the ongoing Phase 2 trial will position us to conduct a second 52-week Phase 2 trial in patients with onychomycosis. We believe the safety data generated in our other NVN1000 trials supports our ability to proceed directly to late-stage development with SB208, consistent with our approach and regulatory strategy with SB206.

Onychomycosis Disease Overview

Onychomycosis is a chronic fungal infection of the nails, and we estimate that it affects more than 40 million people in the United States. The prevalence of disease increases with age, and more than 50% of patients are 70 years or older. The dermatophytes T. rubrum, and T. mentagrophytes, are causative agents for the majority of infections and often result in a painful thickening, deformation and discoloration of the nail and sometimes splitting, separation of the nail plate from the nail bed and an inability of the nail to perform its natural protective function. Because the fungi that cause onychomycosis are present in many common locations such as floors, the soil, socks and shoes, the nail can become re-infected and additional courses of treatment are frequently required after successful treatment.

Onychomycosis is particularly dangerous in diabetic patients. In a 2015 report in Podiatry Management, the risk of diabetic patients contracting onychomycosis was reported to be 2.77 times greater than that of non-diabetic individuals. This enhanced susceptibility is further compounded by the fact that onychomycosis is now considered an important predictor of diabetic foot infection, with a three-fold higher risk of gangrene or foot ulcers in diabetic patients. The combination of morbidity now linked to onychomycosis in diabetic patients, the growing diabetic population, the diminished ability of diabetic patients to fight infection due to elevated blood glucose levels and restrictions on diabetic patients taking oral therapeutic drugs due to concomitant medications create a serious need for topical interventions for the diabetic population.

There are currently five commonly used classes of chemicals for the treatment of onychomycosis: allylamines, azoles, morpholines, dihydropyrimidinones and the newly approved oxaboroles. Despite new therapeutic options approved in recent years, approximately 60% to 70% of patients fail to achieve complete cures with oral therapies.

Treatments are segmented into two approaches, either oral therapies, such as terbinafine, or topical products, such as Jublia, an azole, and Kerydin, an oxaborole. Worldwide sales of the branded terbinafine product Lamisil, the most prescribed systemic drug for onychomycosis, were $1.2 billion in 2004 and $978 million in 2006, when it became generically available. A 12 week course of oral therapy was historically the only method of treatment, but the potential for liver failure and interactions between drugs, particularly for an aging patient population with common comorbidities, created the demand for safer and more effective treatment options.

Given the significant safety issues associated with oral therapy, topical therapies are now increasingly used due to their better safety profile. However, topical therapies administered for 48 weeks are associated with significantly more modest efficacy profiles, including complete cure rates of less than 20%. The lack of safe oral therapies has driven physicians to prescribe these topical therapies despite their limited effectiveness. For example, Jublia, a topical therapy, had sales of $106 million in the third quarter of 2015, in only the second full year of its launch. In addition, the incidence of anti-fungal resistance is increasing. We believe that there is an unmet need in the treatment landscape for onychomycosis for a novel therapeutic solution that improves efficacy without compromising safety.

We are aware of certain drugs in development, including reformulations of terbinafine, topical luliconazole and orally administered VT-1161.

 

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Our Nitric Oxide-Based Solution for the Treatment of Onychomycosis

We believe SB208 has the potential to redefine the standard of care in onychomycosis by improving upon current efficacy rates observed with topical therapies while maintaining an attractive safety profile. According to reports in the Journal of Applied Microbiology and the Journal of American Academy of Dermatology, nitric oxide has been effective in vitro against the dermatophytes T. rubrum and T. mentagrophytes, and has shown evidence of clinical efficacy against tinea pedis, or athlete’s foot, which is also routinely caused by T. rubrum and T. mentagrophytes. We believe that a significant barrier to translating anti-fungal efficacy into a successful onychomycosis treatment is the difficulty in achieving adequate penetration of the drug through the nail plate to reach the nail bed and treat the fungal infection. For example, in the two clinical trials cited in Jublia’s prescribing information, only 17.8% and 15.2% of patients, respectively, treated with Jublia achieved complete cure as defined by clear nail growth, the absence of detectable fungus and negative fungal cultures.

In contrast to azoles or other antifungals, when applied topically, nitric oxide as a gas quickly diffuses across the nail bed reaching the underlying nail bed tissues that harbor the fungal infection. Additionally, the dense keratin fibers of the nail are rich in cysteine residues that can react with nitric oxide to generate nitrosothiols, which serve as secondary reservoirs for nitric oxide within the nail bed to amplify the antifungal activity.

We believe the potential advantages of a topical nitric oxide-based onychomycosis product include:

 

  n   improved efficacy beyond that observed with current topical therapies over a similar treatment duration;

 

  n   shorter treatment durations, potentially fewer than 48 weeks of treatment, with an efficacy profile comparable to topical therapies due to the rapid penetration of nitric oxide through the nail plate;

 

  n   lower recurrence rates due to the broad spectrum and direct fungicidal activity of nitric oxide; and

 

  n   a better safety profile than that observed with current oral therapies.

Preclinical Pharmacology Studies

We have observed in vitro that nitric oxide exhibits rapid fungicidal activity. NVN1000, the NCE used in SB208, was added to T. rubrum cultures and evaluated for fungicidal effects at increasing concentrations. As early as four hours after the addition of NVN1000, we observed a greater than 1.0-log, or 90%, reduction in fungal growth in all concentrations of NVN1000. At 24 hours after exposure, we observed greater than 4-log, or 99.99%, reduction in bacterial counts, with 2, 4, and 8 mg/mL NVN1000.

We further evaluated multiple nitric oxide-releasing formulations, including gel, cream and lacquer-based compositions in a preclinical model designed to measure fungal kill through the human nail plate using ChubTur cells. This model was utilized previously in the drug development of Kerydin, as reported in the Journal of Drugs in Dermatology in 2015, and Jublia, as reported in the Journal of Antimicrobial Agents and Chemotherapy in 2014. Organism viability on the underside of the nail following topical treatment was measured using an adenosine triphosphate assay. As shown in Figure 15 below, three candidate formulations were screened for antifungal efficacy in T. rubrum infected human nails with Jublia as a positive control. Following a single application, all three formulations decreased fungal viability as much or more than Jublia. NVN1000 incorporated into experimental formulations at a concentration of 16% resulted in variable percent reductions up to 99%, compared to untreated infected control nails, illustrating our ability to tune the drug’s activity by adjusting the formulation. We optimized the SB208 gel formulation based on our observations in this preclinical study and repeated the infected human nail assay with multiple applications of both a low dose, SB208 1.6%, and a high dose, SB208 16%, of NVN1000. As shown in Figure 15, the onset of antifungal activity was rapid and dose dependent, increasing to approximately 99% killed after once daily applications for seven days in both treatment groups.

 

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Figure 15:

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Inflammatory Skin Disease Program

SB414 is our cream-based product candidate that contains our NVN4000 NCE and is currently in preclinical studies for the topical treatment of inflammatory skin diseases such as psoriasis or atopic dermatitis. While the healthcare market has seen an increase in the introduction of systemic therapies, including biologics, to treat severe psoriasis, and there is at least one near-term biologic in development for atopic dermatitis, systemic therapies are only indicated for patients with moderate-to-severe disease. According to a study published in the International Journal of Pharmacy and Life Science, these patients with moderate-to-severe disease comprise only 20% of the afflicted population. Our intent is to develop SB414 and potentially future product candidates for patients with mild-to-moderate inflammatory skin diseases who are not eligible for systemic therapy and who have limited topical treatment choices. We plan to initiate toxicology studies for SB414 in the second half of 2016 in support of an IND submission to the FDA, followed by initiation of clinical development in one or both indications of psoriasis and atopic dermatitis in the second half of 2017.

Current Treatment Landscape

Topical corticosteroids are the predominant therapies used for both mild-to-moderate psoriasis and mild-to-moderate atopic dermatitis, with the latter also being treated with other topical immunomodulators. However, treatment-related side effects associated with corticosteroid use, such as local application-site reactions, including skin atrophy with prolonged use, and profound effects on hypothalamic-pituitary-adrenal axis function, which can lead to growth retardation in adolescents and an increased risk for diabetes, underscoring the need for novel therapies to treat this disease. Non-steroidal topical therapies used in the treatment of atopic dermatitis also include topical calcineurin inhibitors, but boxed warnings for rare malignancies and other side effects have limited their use. These treatments attempt to reduce inflammation and itchiness associated with atopic dermatitis and maintain the protective integrity of the skin, but no topical treatments indicated for atopic dermatitis specifically address the contribution of Staphylococcus aureus, or S. aureus, colonization and microbiome imbalance to the disease.

 

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Our Nitric Oxide-Based Solution for Inflammatory Skin Diseases

We believe that the use of a topical nitric oxide product has the potential to significantly improve outcomes in patients with inflammatory skin diseases, using new mechanisms of action and will have an improved safety profile over currently approved topical therapies. The ointment and cream-based product candidates have slower nitric oxide release profiles needed to deliver sustained concentrations of nitric oxide in order to exert its immunomodulatory effects in chronic inflammatory diseases. Our initial efforts in inflammatory skin diseases are focused on psoriasis and atopic dermatitis. According to a study published in the American Journal of Pathology, psoriatic patients have an overexpression of the enzyme arginase that degrades L-arginine and thus eliminates the production of sufficient levels of nitric oxide needed to clear the skin. We believe higher levels of topically applied nitric oxide can restore the normal healing process and break the unending cycle of keratinocyte proliferation that would otherwise lead to thick scaly plaque. Additionally, we believe nitric oxide potentially suppresses inflammatory cytokines that would otherwise go unchecked and continue to propagate chronic inflammation. Moreover, we believe that our anti-inflammatory product candidate will have a favorable safety profile, due to nitric oxide’s natural physiological role and based on the clinical safety data we have gathered across our nitric oxide platform.

Preclinical Evidence for Psoriasis

As shown in Figure 16 below, application of a topical NVN1000 ointment in an IL-23-induced psoriasis mouse model showed statistically significant reductions of pro-inflammatory cytokines when compared to vehicle. Dexamethasone, a corticosteroid, was used as a positive control. IL-23 stimulates Th17 cells to produce the cytokine IL-17 which in turn signals keratinocytes to release IL-1ß and IL-6 among other cytokines. Decreases in the levels of the pro-inflammatory cytokines IL-1ß and IL-6 suggest that topical treatment with nitric oxide may function as an IL-17 inhibitor. Furthermore, IL-17 normally stimulates keratinocytes to produce more IL-23 and continue the inflammatory loop important for prolonging the psoriatic lesion. We believe the statistically significant reduction of IL-23p40 we observed with topical nitric oxide compared to vehicle further illustrates nitric oxide’s potential to dampen the inflammatory loop associated with chronic psoriasis inflammation.

Figure 16:

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* p <0.05

 

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Preclinical Evidence for Atopic Dermatitis

Atopic dermatitis has a complex disease etiology, including impaired skin barrier function and innate immune defects that contribute to a predisposition for colonization or infection with microbes, most significantly Staphylococcus aureus. More than 90% of atopic dermatitis patients have skin that is colonized with S. aureus, which may play a role in the skin aggravation that takes place. The density of S. aureus colonization has been correlated with both the severity of atopic dermatitis lesions and the degree of cutaneous inflammation. In preclinical studies, NVN1000 has demonstrated broad spectrum anti-microbial activity in vitro, including activity against Staphylococcus and Streptococcus species. In in vivo preclinical studies, NVN1000 has demonstrated dose-responsive reductions in the microbial burden of an atopic dermatitis isolate of methicillin-resistant Staphylococcus aureus in a disrupted epidermal barrier porcine model, with the highest-tested dose yielding a 99.9% reduction.

Additionally, we have observed statistically significant, dose-responsive topical anti-inflammatory activity in a series of in vivo studies using an oxazolone-induced delayed-type hypersensitivity BALB/c mouse model. This model is frequently utilized as a preliminary model to assess anti-inflammatory activity. The allergic contact dermatitis induced by oxazolone results in an immune response that aims to model the chronic phase of atopic dermatitis. As shown in Figure 17 below, topical administration of the slow releasing SB414 cream, showed a 66% decrease in inflammatory swelling and compares favorably to reductions observed for the corticosteroid dexamethasone.

Figure 17:

                Anti-inflammatory Efficacy in an

                Oxazolone-Induced Mouse Model

 

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Competition

The biotechnology and pharmaceutical industries are characterized by rapidly advancing technologies, intense competition and a strong emphasis on proprietary products. We consider our primary potential competition to be existing providers and drug developers of therapeutics to treat acne vulgaris, genital warts, onychomycosis, psoriasis and atopic dermatitis. Any product candidates that we successfully develop and commercialize will compete with these existing therapies as well as new therapies that may become available in the future. Our success will be based in part on our ability to identify, develop and manage a portfolio of product candidates that are safer and more effective than competing products.

Acne Vulgaris

If approved by the FDA for the treatment of acne vulgaris, we anticipate that SB204 would compete with branded and generic oral and topical antimicrobials, oral and topical retinoids, oral contraceptives, other prescription skin cleansers and over-the-counter treatments. We may compete

 

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with branded therapeutics, including Epiduo and Epiduo Forte, marketed by Galderma Laboratories, L.P., Aczone, marketed by Allergan plc. and Onexton, marketed by Valeant Pharmaceuticals International, Inc. There are also product candidates under development that could potentially be used to treat acne vulgaris and compete with SB204. For example, we are aware of DRM01, a topical acetyl-CoA carboxylase inhibitor product candidate being developed by Dermira Inc., FMX01, a minocycline foam product candidate being developed by Foamix Pharmaceuticals Ltd., Winlevi, a novel-topical anti-androgen candidate being developed by Cassiopea SpA, and sarecycline, a tetracycline derivative being developed by Allergan for the treatment of acne vulgaris.

Genital Warts

With respect to SB206 for the treatment of HPV-induced skin lesions, we would primarily face potential competition from Aldara, marketed by The 3M Company, Zyclara, marketed by Valeant Pharmaceuticals International, Inc., Condylox, marketed by Actavis plc, and Veregen, marketed by Fougera Pharmaceuticals, Inc., as well as their generic equivalents. There are also product candidates under development that could potentially be used to treat HPV-associated genital warts and potentially compete with SB206. CB-06-02, a tellurium-based compound is being developed by Cassiopea SPA. BTA074 is a direct-acting antiviral for the treatment of HPV 6 and 11 infections that is being developed by Biota Pharmaceuticals, Inc. and additional reformulations of generically available imiquimod are also under development.

Onychomycosis

With respect to SB208 for the treatment of onychomycosis, we would face potential competition from Lamisil, an oral therapeutic marketed by Novartis Pharmaceuticals Corporation, Jublia, a topical therapeutic marketed by Valeant, and Kerydin, a topical therapeutic marketed by Anacor Pharmaceuticals, Inc., as well as generically available oral antifungals equivalents. There are also product candidates under development that could potentially be used to treat onychomycosis and compete with SB208. For example, we are aware of various terbinafine reformulations in clinical development, including HTU-520 being developed by Hisamitsu Pharmaceutical Co., Inc. and P-3058 being developed by Polichem SA, as well as VT-1161, an oral antifungal under development by Viamet Pharmaceuticals, Inc.

Psoriasis and Atopic Dermatitis

With respect to SB414 for the topical treatment of mild-to-moderate psoriasis, we would face potential competition from companies that market corticosteroids, vitamin D analogues, combinations thereof and calcineurin inhibitors. There are also topical product candidates under development that could potentially be used to treat psoriasis and compete with SB414, including CED 90100, WBI1001, INCB018424, LAS 41004, AN2728 and PH10.

With respect to SB414 for the treatment of atopic dermatitis, we would face potential competition from companies that market branded and generic corticosteroids or the topical calcineurin inhibitors, Elidel, which is being marketed by Valeant, and Protopic, which is expected to be marketed by Leo Pharma. Product candidates under development that could potentially be used to treat atopic dermatitis and compete with SB414 include crisaborole, which is being developed by Anacor Pharmaceuticals, Inc., dupilumab, which is being developed by Regeneron Pharmaceuticals, Inc., VTP-38543, which is being developed by Vitae Pharmaceuticals, tralokinumab, which is being developed by Medimmune, GSK2894512, which is being developed by GlaxoSmithKline, and ZPL-389, which is being developed by Ziarco.

Intellectual Property

Our success depends in large part upon our ability to obtain and maintain proprietary protection for our products and technologies and to operate without infringing the proprietary rights of others. We seek to avoid the latter by monitoring patents and publications that may affect our business, and to the

 

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extent we identify such developments, evaluating and taking appropriate courses of action. With respect to the former, our policy is to protect our proprietary position by, among other methods, filing for patent applications on inventions that are important to the development and conduct of our business with the U.S. Patent and Trademark Office, or USPTO, and its foreign counterparts. We also use other forms of protection, such as trademark, copyright, and trade secret protection, to protect our intellectual property, particularly where we do not believe patent protection is appropriate or obtainable.

Patents

As of June 30, 2016, we own or have an exclusive license to 15 patents issued in the U.S. and 33 patents issued in foreign jurisdictions, and 24 pending patent applications filed in the U.S. and 56 pending non-U.S. patent applications (including applications filed in foreign jurisdictions and international or Patent Cooperation Treaty, or PCT, applications that have not yet entered national phase).

Patent coverage lasts for varying periods according to the date of filing of the patent application or the date of grant or issuance of the patent and the legal term of patents in various countries where patent protection is obtained. Generally, patents issued for regularly filed applications in the United States are granted a term of 20 years from the earliest filing date of a non-provisional patent application. In addition, in certain instances, the term of a patent can be extended to recapture a portion of the USPTO delay in issuing the patent or may be shortened if a patent is terminally disclaimed over another patent that expires earlier. The term of a patent may also be eligible for patent term extension to recapture a portion of the term effectively lost as a result of the FDA regulatory review period. However, as to the FDA component, the extension term cannot be longer than five years and the total patent term including the restoration period must not exceed 14 years following FDA approval. The duration of foreign patents varies in accordance with provisions of applicable local law, but typically is also 20 years from the earliest filing date of a non-provisional patent application. However, the actual protection afforded by a patent varies on a product by product basis from country to country and depends upon many factors, including the type of patent, the scope of its coverage, the availability of regulatory-related extensions, the availability of legal remedies in a particular country and the validity and enforceability of the patent.

Nitricil

We exclusively license from the University of North Carolina, or UNC, issued patents and pending applications directed to our library of Nitricil compounds, including patents issued in the U.S., Japan and Australia with claims intended to cover NVN1000, the NCE for our SB204, SB206 and SB208 product candidates, and NVN4000, the NCE for our pipeline candidate SB414. Additionally, one such issued patent in the U.S. has claims specifically directed to the composition of matter of NVN1000 and one such issued patent in the U.S. has claims specifically directed to the composition of matter of NVN4000. These patents and pending applications, if issued, are projected to expire in 2026 without taking into account any patent term extensions that may be available to us. Additionally, NVN1000 has been classified as an NCE, and patent term extensions may be available to extend the life of a U.S. patent that covers NVN1000 beyond 2026. We also own patents issued in the U.S., China, Germany, Spain, France, Great Britain, Ireland, Italy, and Switzerland directed to methods of manufacturing Nitricil compounds. These patents are projected to expire in 2032.

SB204, SB206 and SB208

We own one patent issued in the U.S. and pending applications filed in the U.S. and in foreign jurisdictions, including Australia, Brazil, Canada, China, Europe, Japan, South Korea and Mexico directed to methods of reducing sebum production using nitric oxide-releasing macromolecules, including, in certain embodiments, through the use of Nitricil compounds. We also own one issued U.S. patent and pending applications filed in the U.S., Brazil, Europe, and Japan directed to the alcohol gel

 

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component of SB204 and SB206 and pending applications filed in the U.S., Australia, Brazil, Canada, China, Europe and Japan directed to the SB204 and SB206 two-component formulations. We own two pending PCT applications directed to the use of nitric oxide-releasing compounds, including, in certain embodiments, Nitricil compounds, for the treatment of viral skin infections.

Altogether, our issued U.S. and foreign patents and pending U.S. and foreign patent applications, if issued, for our lead product candidates, SB204, SB206 and SB208 are projected to expire between 2026 and 2037, without taking into account any patent term extensions that may be available to us.

Other Patents

In addition to the patents and pending applications we own or have an exclusive license related to Nitricil and our product candidates, we also own or have exclusive licenses to issued patents and pending applications in the U.S. and in foreign jurisdictions covering other nitric oxide-based therapeutics and methods of use in dermatological indications.

Trade Secrets

We rely upon trade secrets and know-how and continuing technological innovation to develop and maintain our competitive position. We seek to protect our proprietary information, in part, by requiring our employees, consultants, contractors and other advisors to execute nondisclosure and assignment of invention agreements upon commencement of their respective employment or engagement. These agreements are designed to protect our proprietary information and, in the case of the invention assignment agreements, to grant us ownership of technologies that are developed through a relationship with a third party. 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 commercial partners, collaborators, employees and consultants 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.

Trademarks

Novan® is a registered trademark of our company in the United States. We have pending trademark applications for Nitricil, Micronox and Pura-T in the United States.

UNC License Agreement

We acquired exclusive rights to our library of Nitricil compounds pursuant to license agreements with UNC entered into in July 2007 and October 2009, which were subsequently amended, restated and consolidated in June 2012. Under the consolidated license agreement with UNC, we are granted an exclusive, worldwide license, with the ability to sublicense, under the licensed UNC patents, including those directed to Nitricil compounds, to develop and commercialize products utilizing the licensed technology. As partial consideration for the consolidated license agreement, we issued 229,263 shares of our common stock to UNC and paid an upfront cash payment of $5,000 to UNC. Additionally, under the consolidated license agreement, we are obligated to pay UNC a running royalty percentage in the low single digits on net sales of licensed products and are obligated to pay up to $425,000 to UNC in regulatory and commercial milestones on a licensed product by licensed product basis.

Under the consolidated license agreement, UNC controls prosecution activities with respect to licensed patents owned solely by UNC, we control prosecution activities with respect to licensed patents jointly owned by us and UNC and we are obligated to reimburse UNC for reasonable prosecution and maintenance costs. Pursuant to the consolidated license agreement, we have the first right to defend against third-party claims of patent infringement with respect to the licensed products and to enforce the licensed patents against third-party infringers.

 

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Unless earlier terminated, the consolidated license agreement remains in effect on a country by country and licensed product by licensed product basis until the expiration of the last to expire issued patent covering such licensed product in the applicable country, and upon such expiration, we receive a perpetual, unrestricted, fully-paid and royalty free right to develop and commercialize such licensed products. As of June 30, 2016, the last to expire issued patent licensed to us under the consolidated license agreement is projected to expire in 2033. UNC may terminate the agreement or render the license granted thereunder non-exclusive for our material breach of the agreement that remains uncured after 90 days of receipt of written notice thereof from UNC, and may also terminate the agreement upon providing written notice for our bankruptcy or insolvency-related events within 30 days of the occurrence of such events. We may terminate the agreement at any time for convenience upon providing written notice of not less than 30 days to UNC.

We amended the consolidated license agreement in November 2012 (as amended, the “UNC License Agreement”) to expand the scope of licensed patents to cover additional nitric oxide technologies in consideration for an upfront cash payment. We plan also to obtain similar amendments to the consolidated license agreement to expand the scope of licensed patents to cover future additional nitric oxide technologies in consideration for an upfront cash payment or as improvements on licensed technology.

Separation Transaction

In connection with the December 2015 separation of our non-dermatology assets to KNOW Bio, we granted to KNOW Bio, through two separate agreements, exclusive licenses, with the right to sublicense, to certain U.S. and foreign patents and patent applications controlled by us as of the execution date of the agreement, and, under one of the agreements, patents and patent applications which may become controlled by us during the three years immediately following the execution date of such agreement, directed towards nitric oxide-releasing compositions and methods of manufacturing thereof, including methods of manufacturing Nitricil compounds, and other nitric oxide-based therapeutics. Under the exclusive license, KNOW Bio has the right to develop and commercialize products utilizing the licensed technology (excluding products containing certain particles, including NVN1000 and NVN4000) in all fields of use except generally for the diagnosis, treatment, prevention, and palliation of diseases, conditions, or disorders of the skin, nails, hair or scalp in humans or animals, and all cosmetic uses for the skin, nails, hair or scalp, other than (i) for wound care through formulations of therapeutic product specifically designed to treat chronic wounds, thermal burns, radiation injury, accidental injury, surgical sites or scars, and (ii) therapeutic uses for treating cancer, excluding basal cell carcinoma, squamous cell carcinoma, precancerous conditions of the skin, actinic keratosis, actinic cheilitis, cutaneous horn, Bowen disease, radiation dermatosis, and dysplastic nevi (the “KNOW Bio Field”).

Under one of these exclusive license agreements, KNOW Bio granted to us an exclusive license, with the right to sublicense, under any patents and patent applications which may become controlled by KNOW Bio during the three years immediately following the execution date of such agreement and directed towards nitric oxide-releasing compositions and methods of manufacturing thereof, including methods of manufacturing Nitricil compounds, and other nitric oxide-based therapeutics, but not towards medical devices, for use in the diagnosis, treatment, prevention, and palliation of diseases, conditions, or disorders of the skin, nails, hair or scalp in humans or animals, and all cosmetic uses for the skin, nails, hair or scalp, other than (i) for wound care through formulations of therapeutic product specifically designed to treat chronic wounds, thermal burns, radiation injury, accidental injury, surgical sites or scars, and (ii) therapeutic uses for treating cancer, excluding basal cell carcinoma, squamous cell carcinoma, precancerous conditions of the skin, actinic keratosis, actinic cheilitis, cutaneous horn, Bowen disease, radiation dermatosis, and dysplastic nevi, including but not limited to SB204, SB206, SB208, SB414 and our other presently-contemplated pipeline candidates (the “Retained Dermatology Field”). KNOW Bio granted us a right of first negotiation to obtain a license under any patents and

 

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patent applications generated by KNOW Bio during the first three years following the execution date of the agreement and directed towards medical devices to develop and commercialize licensed products in the Retained Dermatology Field. Additionally, Novan and KNOW Bio also agreed that neither party will commercialize any products in the other’s field of use during the first three years following the execution date of such agreement.

Additionally, we granted to KNOW Bio exclusive sublicenses, with the ability to further sublicense, under certain of the U.S. and foreign patents and patent applications exclusively licensed to us from UNC and another third party directed towards nitric oxide-releasing compositions, including certain Nitricil compounds, to develop and commercialize products utilizing the licensed technology in the KNOW Bio Field. Under the exclusive sublicense to the UNC patents and applications, KNOW Bio is subject to the terms and conditions under the UNC License Agreement, including milestone and diligence payment obligations.

Under the exclusive license agreements and sublicense agreements, we retain all rights under our owned and exclusively licensed patents and patent applications with respect to development and commercialization of products for use in the Retained Dermatology Field. The exclusive license agreements and sublicense agreements will continue for so long as there is a valid patent claim under the respective agreement, unless earlier terminated, and upon expiration continues as a perpetual non-exclusive license. Under each agreement, Novan and KNOW Bio have the right to terminate the agreement by subsequent written notice for the other party’s material breach which remains uncured within 30 days of receipt of notice thereof. Novan also has the right to terminate each such agreement immediately upon written notice if KNOW Bio, its affiliates or sublicensees challenge the validity of any patent licensed in such agreement. KNOW Bio has the right to terminate each such agreement, with notice, for any reason upon ninety days advance written notice to us.

For additional information about the Separation Transaction and its impact on this offering, please see the sections titled “Risk Factors – New Stockholders in this offering will not have an interest in the nondermatological assets transferred to KNOW Bio, LLC in connection with the Separation Transaction,” “Certain Relationships and Related Party Transactions – Separation Transaction,” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Separation Transaction”.

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 those we are developing. 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 candidates.

U.S. Government Regulation

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.

 

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

 

  n   completion of preclinical laboratory tests, animal studies and formulation studies in compliance with the FDA’s GLP regulations;

 

  n   submission to the FDA of an IND which must become effective before human clinical trials may begin;

 

  n   approval by an independent institutional review board, or IRB, at each clinical site before each trial may be initiated;

 

  n   performance of adequate and well-controlled human clinical trials in accordance with good clinical practice, or GCP, requirements to establish the safety and efficacy of the proposed drug product for each indication;

 

  n   submission to the FDA of an NDA;

 

  n   satisfactory completion of an FDA advisory committee review, if applicable;

 

  n   satisfactory completion of an FDA inspection of the manufacturing facility or facilities at which the product is produced to assess compliance with current good manufacturing practice, or cGMP, requirements and to assure that the facilities, methods and controls are adequate to preserve the drug’s identity, strength, quality and purity; and

 

  n   FDA review and approval of the NDA.

Preclinical Studies

Preclinical studies include laboratory evaluation of product chemistry, toxicity and formulation, as well as animal studies to assess potential safety and efficacy. An IND sponsor must submit the results of the preclinical 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 preclinical 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 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 Institutional Review Board, or IRB, at each institution participating in the clinical trial must review and approve the plan for any clinical trial before it commences at that institution. Information about certain clinical trials must be submitted within specific timeframes to the National Institutes of Health, or NIH, for public dissemination on their www.clinicaltrials.gov website.

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

 

  n  

Phase 1 clinical trial: The drug is initially introduced into healthy human patients or patients with the target disease or condition and tested for safety, dosage tolerance, absorption,

 

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metabolism, distribution, excretion and, if possible, to gain an early indication of its effectiveness.

 

  n   Phase 2 clinical trial: The drug is administered to a limited patient population to identify possible adverse effects and safety risks, to preliminarily evaluate the efficacy of the product for specific targeted diseases and to determine dosage tolerance and optimal dosage.

 

  n   Phase 3 clinical trials: The drug is administered to an expanded patient population, generally at geographically dispersed clinical trial sites, in well-controlled clinical trials to generate enough data to statistically evaluate the efficacy and safety of the product for approval, to establish the overall risk-benefit profile of the product and to provide adequate information for the labeling of the product.

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. Each of Phase 1, Phase 2 and Phase 3 clinical trials may not be completed successfully within any specified period, or at all. Furthermore, the FDA or the sponsor may suspend or terminate a clinical trial at any time 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.

Special Protocol Assessment

The SPA process is designed to facilitate the FDA’s review and approval of drugs by allowing the FDA to evaluate the proposed design and size of Phase 3 clinical trials that are intended to form the primary basis for determining a drug’s efficacy. Upon specific request by a clinical trial sponsor, the FDA will evaluate the protocol and respond to a sponsor’s questions regarding, among other things, primary efficacy endpoints, trial conduct and data analysis, within 45 days of receipt of the request.

The FDA ultimately assesses whether the protocol design and planned analysis of the trial are acceptable to support regulatory approval of the product candidate with respect to effectiveness of the indication studied. All agreements and disagreements between the FDA and the sponsor regarding an SPA must be clearly documented in an SPA letter or the minutes of a meeting between the sponsor and the FDA.

Even if the FDA agrees to the design, execution and analyses proposed in protocols reviewed under the SPA process, the FDA may revoke or alter its agreement under the following circumstances:

 

  n   public health concerns emerge that were unrecognized at the time of the protocol assessment, or the director of the review division determines that a substantial scientific issue essential to determining safety or efficacy has been identified after testing has begun;

 

  n   a sponsor fails to follow a protocol that was agreed upon with the FDA;

 

  n   the relevant data, assumptions, or information provided by the sponsor in a request for SPA change, are found to be false statements or misstatements, or are found to omit relevant facts; or

A documented SPA may be modified, and such modification will be deemed binding on the FDA review division, except under the circumstances described above, if FDA and the sponsor agree in writing to modify the protocol and such modification is intended to improve the study.

Marketing Approval

Assuming successful completion of the required clinical testing, the results of the preclinical studies and clinical trials, together with detailed information relating to the product’s chemistry, manufacture,

 

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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 a goal of ten months from the date of “filing” of a standard NDA for a new molecular entity to review and act on the submission. This review typically takes twelve months from the date the NDA is submitted to FDA because the FDA has approximately two months to make a “filing” decision.

In addition, under the Pediatric Research Equity Act of 2003, or PREA, as amended and reauthorized, 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.

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

The FDA conducts a preliminary review of all NDAs within the first 60 days after submission, before accepting them for filing, to determine whether they are 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 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.

The FDA may refer an application for a novel drug 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 to assure compliance with GCP requirements.

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 may issue an approval letter, or, in some cases, a complete response letter. A complete response letter generally 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 preclinical testing in order for FDA to reconsider the application. 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.

 

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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, accelerated approval, priority review, and breakthrough therapy designation, 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.

To be eligible for a fast track designation, the FDA must determine, based on the request of a sponsor, that a product is intended to treat a serious or life-threatening disease or condition and demonstrates the potential to address an unmet medical need. The FDA will determine that a product will fill an unmet medical need if it will provide a therapy where none exists or provide a therapy that may be potentially superior to existing therapy based on efficacy or safety factors. The FDA may review sections of the NDA for a fast track product on a rolling basis before the complete application is submitted, if the sponsor provides a schedule for the submission of the sections of the NDA, the FDA agrees to accept sections of the NDA and determines that the schedule is acceptable, and the sponsor pays any required user fees upon submission of the first section of the NDA.

The FDA may give a priority review designation to drugs that offer major advances in treatment, or provide a treatment where no adequate therapy exists. 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 new PDUFA agreement, these six and ten month review periods are measured from the “filing” date rather than the receipt date for NDAs for new molecular entities, which typically adds approximately two months to the timeline for review and decision from the date of submission. Most products that are eligible for fast track designation are also likely to be considered appropriate to receive a priority review.

In addition, products studied for their safety and effectiveness in treating serious or life-threatening illnesses and that provide meaningful therapeutic benefit over existing treatments may be eligible for accelerated approval and may be approved on the basis of adequate and well-controlled clinical trials establishing that the drug product has an effect on 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. As a condition of approval, the FDA may require a sponsor of a drug receiving accelerated approval to perform post-marketing studies to verify and describe the predicted effect on irreversible morbidity or mortality or other clinical endpoint, and the drug may be subject to accelerated withdrawal procedures.

Moreover, under the provisions of the Food and Drug Administration Safety and Innovation Act, or FDASIA, passed in July 2012, a sponsor can request designation of a product candidate as a

 

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“breakthrough therapy.” A breakthrough therapy is defined as a drug that 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 also eligible for accelerated approval. The FDA must take certain actions, such as holding timely meetings and providing advice, intended to expedite the development and review of an application for approval of a breakthrough therapy.

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. We may explore some of these opportunities for our product candidates as appropriate.

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, annual user fee requirements for any marketed products and the establishments at which such products are manufactured, as well as new application fees for supplemental applications with clinical data.

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 these 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.

Once an approval 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:

 

  n   restrictions on the marketing or manufacturing of the product, complete withdrawal of the product from the market or product recalls;

 

  n   fines, warning letters or holds on post-approval clinical trials;

 

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  n   refusal of the FDA to approve pending NDAs or supplements to approved NDAs, or suspension or revocation of product approvals;

 

  n   product seizure or detention, or refusal to permit the import or export of products; or

 

  n   injunctions or the imposition of civil or criminal penalties.

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.

Coverage and Reimbursement

Sales of our product candidates, if approved, will depend, in part, on the extent to which such products will be covered by third-party payors, such as government healthcare programs, commercial insurance and managed healthcare organizations. These third-party payors are increasingly limiting coverage or reducing reimbursements for medical products and services. In addition, the U.S. government, state legislatures and foreign governments have continued implementing cost-containment programs, including price controls, restrictions on reimbursement and requirements for substitution of generic products. Adoption of price controls and cost-containment measures, and adoption of more restrictive policies in jurisdictions with existing controls and measures, could further limit our net revenue and results. Decreases in third-party reimbursement for our product candidates or a decision by a third-party payor to not cover our product candidates could reduce physician usage of our products candidates, once approved, and have a material adverse effect on our sales, results of operations and financial condition.

Healthcare Laws and Regulations

We are currently or will in the future be subject to healthcare regulation and enforcement by the federal government and the states and foreign governments in which we will conduct our business once our product candidates are approved. Failure to comply with these laws, where applicable, can result in the imposition of significant civil or criminal penalties. The healthcare laws and regulations that may affect our ability to operate include the following:

 

  n   The federal Anti-Kickback Statute makes it illegal for any person or entity to knowingly and willfully, directly or indirectly, solicit, receive, offer, or pay any remuneration that is in exchange for or to induce the referral of business, including the purchase, order, recommendation, lease of any good, facility, item or service for which payment may be made under a federal healthcare program, such as Medicare or Medicaid. The term “remuneration” has been broadly interpreted to include anything of value.

 

  n   Federal false claims and false statement laws, including the federal civil False Claims Act, prohibits, among other things, any person or entity from knowingly presenting, or causing to be presented, for payment to, or approval by, federal programs, including Medicare and Medicaid, claims for items or services, including drugs, that are false or fraudulent.

 

  n   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 or making any false, fictitious or fraudulent statement in connection with the delivery of or payment for healthcare benefits, items or services.

 

  n  

HIPAA, as amended by HITECH, and their implementing regulations, imposes obligations on certain types of people and entities regarding the electronic exchange of information in common healthcare transactions, as well as standards relating to the privacy and security of

 

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individually identifiable health information. In addition, certain state laws govern the privacy and security of health information in certain circumstances, some of which are more stringent than HIPAA and many of which differ from each other in significant ways and may not have the same effect, thus complicating compliance efforts.

 

  n   The federal Physician Payments Sunshine Act requires certain manufacturers of drugs, devices, biologics and medical supplies for which payment is available under Medicare, Medicaid or the Children’s Health Insurance Program, with specific exceptions, to report annually to the Centers for Medicare & Medicaid Services, or CMS, information related to payments or other transfers of value made to physicians (defined to include doctors, dentists, optometrists, podiatrists and chiropractors) and teaching hospitals, as well as ownership and investment interests held by physicians and their immediate family members.

Also, many states have similar laws and regulations, such as anti-kickback and false claims laws that may be broader in scope and may apply regardless of payor, in addition to items and services reimbursed under Medicaid and other state programs. Additionally, to the extent that our product is sold in a foreign country, we may be subject to similar foreign laws.

Healthcare Reform

The United States and some foreign jurisdictions are considering or have enacted a number of legislative and regulatory proposals to change the healthcare system in ways that could affect our ability to sell our products profitably. By way of example, in March 2010, the ACA was signed into law, which intended to broaden access to health insurance, reduce or constrain the growth of healthcare spending, enhance remedies against fraud and abuse, add transparency requirements for the healthcare and health insurance industries, impose taxes and fees on the health industry and impose additional health policy reforms. Among the provisions of the ACA of importance to our potential drug candidates are:

 

  n   an annual, nondeductible fee on any entity that manufactures or imports specified branded prescription drugs and biologic agents, apportioned among these entities according to their market share in certain government healthcare programs;

 

  n   an increase in the statutory minimum rebates a manufacturer must pay under the Medicaid Drug Rebate Program to 23.1% and 13.0% of the average manufacturer price for branded and generic drugs, respectively;

 

  n   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;

 

  n   extension of a manufacturer’s Medicaid rebate liability to covered drugs dispensed to individuals who are enrolled in Medicaid managed care organizations;

 

  n   expansion of eligibility criteria for Medicaid programs by, among other things, allowing states to offer Medicaid coverage to certain individuals with income at or below 133% of the federal poverty level, thereby potentially increasing a manufacturer’s Medicaid rebate liability;

 

  n   a new Medicare Part D coverage gap discount program, in which manufacturers must agree to offer 50% point-of-sale discounts to negotiated prices of applicable brand drugs to eligible beneficiaries during their coverage gap period, as a condition for a manufacturer’s outpatient drugs to be covered under Medicare Part D;

 

  n   expansion of the entities eligible for discounts under the Public Health Service pharmaceutical pricing program;

 

  n   a new requirement to annually report drug samples that manufacturers and distributors provide to physicians; and

 

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  n   a new Patient-Centered Outcomes Research Institute to oversee, identify priorities in, and conduct comparative clinical effectiveness research, along with funding for such research.

There have been judicial and Congressional challenges to ACA and there may be additional challenges and amendments to ACA in the future. We expect that the ACA, as well as other healthcare reform measures that may be adopted in the future, may result in more rigorous coverage criteria and lower reimbursement, and in additional downward pressure on the price that we receive for any approved product. Moreover, recently there has been heightened governmental scrutiny over the manner in which manufacturers set prices for their commercial products. We cannot predict what healthcare reform initiatives may be adopted in the future.

Manufacturing

We currently manufacture our Nitricil NCEs at our facility in Durham, North Carolina for all product candidates in our preclinical studies and clinical trials. We believe that our manufacturing capabilities are unique in the pharmaceutical industry and represent a core competency for our Nitricil technology. We currently contract with a contract manufacturing organization, or CMO, to manufacture SB204, including compounding and primary packaging, for the Phase 3 clinical trials initiated in the first quarter of 2016. We expect to qualify other CMOs for the manufacture of drug product for the potential commercialization of SB204, if approved by the FDA, as well as in connection with later-stage trials and commercialization of our other product candidates.

We manufacture our investigational materials in accordance with current good manufacturing practices, or cGMP, required by the FDA, International Committee on Harmonization and other regulatory bodies. Our facilities have been audited for cGMP and Good Laboratory Practice compliance. In addition, our NCE manufacturing processes and operating conditions have been evaluated and tested by qualified vendors to ensure a safe operating environment. These tests include raw materials and product handling, process chemistry, air quality and waste disposal and containment.

Facilities

We currently operate out of two facilities. Our corporate headquarters is in Durham, North Carolina, where we lease 7,220 square-feet for corporate offices, under a lease expiring in 2016. In an adjacent building in Durham, we lease a 12,147 square foot facility for pharmaceutical development and manufacturing, under a lease expiring in 2016.

In addition, we have leased an existing 51,350 square foot facility located in Durham, North Carolina, with an expected occupancy in the second half of 2016, under a lease expiring in 2026. The building will house large scale NCE manufacturing, laboratories and associated office space to support our nitric oxide technology, and will replace our existing facilities.

We also plan to establish a second facility for production manufacturing to mitigate the risk of producing the Nitricil technology in a single facility. We will also evaluate the potential for transferring our NCE manufacturing process to a CMO for commercial production. All drug product commercial manufacturing is expected to be performed through qualified CMOs.

Employees

As of June 30, 2016 we had 63 employees, including 29 dedicated to the API development and manufacturing capability, seven in clinical and non-clinical development, six in regulatory and pharmaceutical development and 21 in general and administrative functions. None of our employees is subject to a collective bargaining agreement or represented by a labor or trade union. We believe that our relations with our employees are good.

Legal Proceedings

We are not currently a party to any material legal proceedings. We may at times be involved in litigation and other legal claims in the ordinary course of business.

 

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MANAGEMENT

Executive Officers and Directors

The following table sets forth the name and position of each of our executive officers and directors and his or her age as of August 15, 2016:

 

Name

      Age       

Position(s)

Nathan Stasko

  36   

President, Chief Executive Officer and Director

Richard Peterson

  48   

Chief Financial Officer

Brian Johnson

  50   

Chief Commercial Officer

M. Joyce Rico

  62   

Chief Medical Officer

Jeff N. Hunter

  59   

Vice President of Technical Operations

Robert A. Ingram

  73   

Chairman of the Board of Directors

W. Kent Geer

  62   

Director

Robert J. Keegan

  69   

Director

G. Kelly Martin

  57   

Director

Sean Murphy

  64   

Director

John Palmour

  55   

Director

Nathan Stasko is one of our co-founders and has served as our President, Chief Executive Officer and a member of our board of directors since 2006. We believe that Dr. Stasko’s extensive experience in chemistry, life sciences and technology qualifies him to serve on our board of directors.

Richard Peterson has served as our Chief Financial Officer since September 2015. Prior to joining Novan, Mr. Peterson was the Chief Financial Officer of Medicis Pharmaceutical Corporation from 2008 to 2012 and from 1995 to 2012, he served as Senior Vice President. He currently serves as a member of the board of directors of Universal Insurance Holdings, Incorporated.

Brian Johnson has served as our Chief Commercial Officer since September 2015. Prior to joining Novan, Mr. Johnson worked at Galderma Laboratories, L.P. from 2003 to 2014, and most recently served as Vice President of Prescription Marketing and Chief Digital Officer. He also currently serves as principal and sole advisor of Two Hearts Group, LLC, a consulting company focused on drug development companies.

M. Joyce Rico has served as our Chief Medical Officer since 2012. Prior to joining Novan, Dr. Rico served as Vice-President, Medical Affairs at Fujisawa Astellas, a Japanese pharmaceutical company, from 2000 to 2012.

Jeff N. Hunter has served as our Vice President of Technical Operations since 2006. Mr. Hunter is the brother of Neal Hunter, the former Chairman of our board of directors.

Robert A. Ingram is the Chairman of our board of directors and has served as a member of our board of directors since 2011. Since 2007, he has been a General Partner at Hatteras Venture Advisors III, LLC, a venture capital firm. Mr. Ingram currently serves on the board of directors of Valeant Pharmaceuticals International, Cree, Inc., Edwards Lifesciences Corporation, Regeneron Pharmaceuticals, Inc. and PhaseBio Pharmaceuticals, Inc. We believe that Mr. Ingram’s significant experience and leadership in the pharmaceutical industry qualifies him to serve as Chairman of our board of directors.

W. Kent Geer has served as a member of our board of directors since 2015. Mr. Geer was an audit partner with Ernst & Young LLP from 1989 to 2011. Beginning in 2012, Mr. Geer served as the Chairman of the board of directors of PowerSecure International, Inc. until the successful sale of the company in May 2016. We believe that Mr. Geer’s significant experience and leadership in the biotechnology, pharmaceutical, technology and financial industries qualifies him to serve on our board of directors.

 

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Robert J. Keegan has served as a member of our board of directors since 2016. Mr. Keegan held the roles of Chief Executive Officer and Chairman of the board of directors of Goodyear Tire and Rubber Co. from 2000 to 2010. Most recently, he was an operating partner of the San Francisco-based private equity firm Friedman, Fleischer & Lowe. From 1972 to 2000, Mr. Keegan held various marketing, financial and managerial posts at Eastman Kodak, except for a two-year period from 1995 to 1997 when he worked as an Executive Vice President of the Avery Dennison Corporation. Mr. Keegan is Chairman of the Board of Loparex, Inc., serves on the boards of the Xerox Corporation. We believe that Mr. Keegan’s broad business experience, executive leadership expertise and extensive knowledge of financial and operational matters qualifies him to serve on our board of directors.

G. Kelly Martin has served as a member of our board of directors since 2015. Since August 2015, Mr. Martin has served as the Chief Executive Officer of Malin Corporation PLC, a biotechnology company. Previously, he served as Chief Executive Officer of Elan Corporation PLC, a biotechnology company, from February 2003 to December 2013, and he founded Brandon Point Industries, a life sciences company, in January 2014, where he currently serves as director. Mr. Martin also currently serves on the board of directors of Viamet Pharmaceuticals Holdings, LLC. We believe that Mr. Martin’s extensive experience and leadership in the biotechnology and financial industries qualifies him to serve on our board of directors.

Sean Murphy has served as a member of our board of directors since 2015. Since 2011, Mr. Murphy has been a senior advisor at Evercore Partners, an investment banking advisory firm. Mr. Murphy also currently serves on the board of directors of Malin Corporation PLC and Immucor Inc. We believe that Mr. Murphy’s extensive experience and leadership in the life sciences and financial industries qualifies him to serve on our board of directors.

John Palmour has served as a member of our board of directors since 2010. Since 1987, Dr. Palmour has worked at Cree, Inc., a company he co-founded and for which he currently serves as a Vice President and the Chief Technology Officer, Power & Radio Frequency. We believe that Dr. Palmour’s significant experience and leadership in the technology field and the advancement of innovation to broad-scale product commercialization qualifies him to serve on our board of directors.

Board Composition

The primary responsibilities of our board of directors are to provide oversight, strategic guidance, counseling and direction to our management. Our board of directors meets on a regular basis and additionally as required. Our board of directors currently consists of seven directors. The members of our board of directors were elected in compliance with the provisions of our certificate of incorporation and a voting agreement among certain of our stockholders. The voting agreement will terminate upon the closing of this offering and none of our stockholders will have any special rights regarding the election or designation of members of our board of directors.

In accordance with our amended and restated certificate of incorporation that will go into effect upon the closing of this offering, our board of directors will be divided into three classes with staggered, three-year terms. At each annual meeting of stockholders, the successors to directors whose terms then expire will be elected to serve from the time of election and qualification until the third annual meeting following election. Effective upon the closing of this offering, our directors will be divided among the three classes as follows:

 

  n   the Class I directors will be             and             and their terms will expire at our first annual meeting of stockholders following this offering;

 

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  n   the Class II directors will be             and             , and their terms will expire at our second annual meeting of stockholders following this offering; and

 

  n   the Class III directors will be             ,             and             , and their terms will expire at the third annual meeting of stockholders following this offering.

Our amended and restated certificate of incorporation and amended and restated bylaws that will go into effect upon the closing of this offering will provide that the authorized number of directors may be changed only by resolution of the board of directors. Any additional directorships resulting from an increase in the number of directors will be distributed among the three classes so that, as nearly as possible, each class will consist of one-third of the directors. The division of our board of directors into three classes with staggered three-year terms may delay or prevent a change of our management or a change in control of our company. Our directors may be removed only for cause by the affirmative vote of the holders of at least two-thirds of our outstanding voting stock entitled to vote in the election of directors.

Director Independence

Upon the completion of this offering, we anticipate that our common stock will be listed on The NASDAQ Global Market. Under the listing requirements and rules of The NASDAQ Global Market, independent directors must compose a majority of a listed company’s board of directors within 12 months after its initial public offering. In addition, the rules of The NASDAQ Global Market require that, subject to specified exceptions and phase in periods following its initial public offering, each member of a listed company’s audit, compensation and nominating and governance committee be independent. Under the rules of The NASDAQ Global Market, 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 independence criteria set forth in Rule 10A-3 under the Exchange Act, or Rule 10A-3. To be considered to be 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 a company’s audit committee, the company’s 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.

Our board of directors has undertaken a review of its composition, the composition of its committees and the independence of each director. Based upon information requested from and provided by each director concerning his or her background, employment and affiliations, including family relationships, our board of directors has determined that each of Robert A. Ingram, G. Kelly Martin, Sean Murphy, Kent Geer, Robert J. Keegan and John Palmour does not have a relationship that would interfere with the exercise of independent judgment in carrying out the responsibilities of a director and that each of these directors is “independent” as that term is defined under the applicable rules and regulations of the listing requirements and rules of The NASDAQ Global Market. In making this determination, our board of directors considered the current and prior relationships that each non-employee director has with us and all other facts and circumstances our board of directors deemed relevant in determining their independence, including the beneficial ownership of our capital stock by each non-employee director.

Our board of directors also determined that Kent Geer, Robert J. Keegan and John Palmour, each of the three members of our audit committee, upon the completion of this offering, satisfy the independence standards for the audit committee established by applicable SEC rules and the listing standards of The NASDAQ Global Market and Rule 10A-3.

 

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Our board of directors has determined that Robert J. Keegan, Kent Geer and Kelly Martin, the three members of our compensation committee, upon the completion of this offering, will be “outside directors” as that term is defined in Section 162(m) of the Code and the treasury regulations issued thereunder, or Section 162(m).

Each member of the nominating and corporate governance committee is independent within the meaning of the applicable The NASDAQ Global Market listing standards, is a non-employee director and is free from any relationship that would interfere with the exercise of his or her independent judgment.

Board Committees

Our board of directors has established 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. Members serve on these committees until their resignation or until otherwise determined by our board of directors.

Audit Committee

Our audit committee consists of Kent Geer, Robert J. Keegan and John Palmour. The chair of our audit committee is Kent Geer, who our board of directors has determined is an “audit committee financial expert” as that term is defined by the SEC rules implementing Section 407 of the Sarbanes-Oxley Act, and possesses financial sophistication, as defined under the listing standards of The NASDAQ Global Market. Our board of directors has also determined that each member of our audit committee can read and understand fundamental financial statements in accordance with applicable requirements. In arriving at these determinations, the board of directors has examined each audit committee member’s scope of experience and the nature of their experience in the corporate finance sector.

The responsibilities of our audit committee include:

 

  n   appointing, approving the compensation of, and assessing the independence of our registered public accounting firm;

 

  n   overseeing the work of our registered public accounting firm, including through the receipt and consideration of reports from such firm;

 

  n   reviewing and discussing with management and the registered public accounting firm our annual and quarterly financial statements and related disclosures;

 

  n   monitoring our internal control over financial reporting, disclosure controls and procedures and code of business conduct and ethics;

 

  n   discussing our risk management policies;

 

  n   reviewing and approving or ratifying any related person transactions; and

 

  n   preparing the audit committee report required by SEC rules.

Compensation Committee

Our compensation committee consists of Robert J. Keegan, Kent Geer and Kelly Martin. The chair of our compensation committee is Robert J. Keegan.

The responsibilities of our compensation committee include:

 

  n   reviewing and approving, or recommending that our board of directors approve, the compensation of our chief executive officer and our other executive officers;

 

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  n   reviewing and recommending to our board of directors the compensation of our directors;

 

  n   selecting independent compensation consultants and advisers and assessing whether there are any conflicts of interest with any of the committees compensation advisers; and

 

  n   reviewing and approving, or recommending that our board of directors approve, incentive compensation and equity plans.

Nominating and Corporate Governance Committee

Our nominating and corporate governance committee consists of              and             . The chair of our nominating and corporate governance committee is             .

The responsibilities of our nominating and corporate governance committee include:

 

  n   identifying individuals qualified to become members of our board;

 

  n   recommending to our board the persons to be nominated for election as directors and for appointment to each of the board’s committees;

 

  n   reviewing and making recommendations to our board with respect to management succession planning;

 

  n   developing and recommending to our board corporate governance principles; and

 

  n   overseeing a periodic evaluation of our board.

Role of the Board in Risk Oversight

The audit committee of our board is primarily responsible for overseeing our risk management processes on behalf of our board. Going forward, we expect that the audit committee will receive reports from management on at least a quarterly basis regarding our assessment of risks. In addition, the audit committee reports regularly to our board, which also considers our risk profile. The audit committee and our board focus on the most significant risks we face and our general risk management strategies. While our board oversees our risk management, management is responsible for day-to-day risk management team processes.

Code of Business Conduct and Ethics

We have adopted a written code of business conduct and ethics that applies to our directors, officers and employees, including our principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions. Upon completion of this offering, our code of business conduct and ethics will be available under the Corporate Governance section of our website at www.Novan.com. In addition, we intend to post on our website all disclosures that are required by law or the listing standards of The NASDAQ Global Market concerning any amendments to, or waivers from, any provision of the code. The reference to our website address does not constitute incorporation by reference of the information contained at or available through our website, and you should not consider it to be a part of this prospectus.

Compensation Committee Interlocks and Insider Participation

None of the members of our compensation committee has ever been an officer or employee of the Company. None of our executive officers serves, or has served during the last fiscal year, as a member of the board of directors, compensation committee or other board committee performing equivalent functions of any entity that has one or more executive officers serving as one of our directors or on our compensation committee.

 

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EXECUTIVE COMPENSATION

This section discusses the material components of the executive compensation program for our executive officers who are named in the “Summary Compensation Table for Fiscal Year 2015” below. In 2015, our “named executive officers” and their positions were as follows:

 

  n   Nathan Stasko, Ph.D., President, Chief Executive Officer;

 

  n   Richard Peterson, Chief Financial Officer; and

 

  n   Brian Johnson, Chief Commercial Officer.

This discussion may contain forward-looking statements that are based on our current plans, considerations, expectations and determinations regarding future compensation programs. Actual compensation programs that we adopt following the completion of this offering may differ materially from the currently planned programs summarized in this discussion.

Summary Compensation Table for Fiscal Year 2015

The following table sets forth information concerning the compensation of our named executive officers for the year ended December 31, 2015.

 

Name and Principal

Position

  Salary
($)
    Bonus
($)
    Option
Awards
($)(1)
     All Other
Compensation
($)
    Total
($)
 

Nathan Stasko, Ph.D.

    340,000        174,000 (4)              5,518 (7)      519,518   

President, Chief Executive Officer

          

Richard Peterson

    91,582 (2)      56,920 (5)      708,125         7,447 (8)      864,074   

Chief Financial Officer

          

Brian Johnson

    95,200 (3)      54,137 (6)      589,580         5,617 (9)      744,534   

Chief Commercial Officer

          

 

(1) Amounts reflect the grant-date Black-Scholes value of the stock options granted during 2015 computed in accordance with ASC Topic 718, rather than the amounts paid to or realized by the named individual. We provide information regarding the assumptions used to calculate the value of all stock awards and option awards made to executive officers under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
(2) Mr. Peterson has served as our Chief Financial Officer since September 28, 2015. The amount reflects his salary from his commencement date through December 31, 2015.
(3) Mr. Johnson has served as our Chief Commercial Officer since September 16, 2015. The amount reflects his salary from his commencement date through December 31, 2015.
(4) Amount reflects discretionary annual bonuses of $4,000 and $170,000 for the 2015 calendar year, paid on September 11, 2015 and on February 1, 2016, respectively.
(5) Amount reflects a one time, lump sum cash signing bonus of $25,000, paid on October 30, 2015 and a discretionary annual bonus of $31,920 for the 2015 calendar year, paid on February 1, 2016.
(6) Amount reflects a one time, lump sum cash signing bonus of $35,000, paid on October 30, 2015 and a discretionary annual bonus of $19,137 for the 2015 calendar year, paid on February 1, 2016.
(7) Amount includes $5,300 of matching contributions made under our 401(k) plan and $218 for executive life insurance.
(8) Amount includes $7,447 for temporary housing and travel expenses.
(9) Amount includes (i) $816 of matching contributions made under our 401(k) plan, and (ii) $4,801 for temporary housing and travel expenses.

 

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Narrative to Summary Compensation Table

Annual Base Salaries

The named executive officers receive a base salary to compensate them for services rendered to us. The base salary payable to each named executive officer is intended to provide a fixed component of compensation reflecting the executive’s skill set, experience, role and responsibilities. None of our named executive officers is currently party to an employment agreement or other agreement or arrangement that provides for automatic or scheduled increases in base salary. In 2015, we paid an annual base salary of $340,000 to Dr. Stasko, $350,400 to Mr. Peterson (pro-rated for his period of employment), and $326,400 to Mr. Johnson (pro-rated for his period of employment). See “—Arrangements with our Named Executive Officer” for changes made to executive officer salaries in 2016.

Annual Bonuses

In addition to base salaries, our executive officers were eligible to receive discretionary cash bonuses based on company and individual performance during the 2015 fiscal year. On February 1, 2016, we paid discretionary bonuses of $170,000 to Dr. Stasko, $31,920 to Mr. Peterson, and $19,137 to Mr. Johnson with respect to the 2015 calendar year.

Pursuant to the employment agreements entered into with each named executive officer, with respect to the 2016 fiscal year and each fiscal year thereafter, Dr. Stasko will be eligible to receive an annual bonus with a target amount equal to 60% of his base salary, Mr. Peterson will be eligible to receive an annual bonus with a target amount equal to 45% of his base salary, and Mr. Johnson will be eligible to receive an annual bonus with a target amount equal to 35% of his base salary, in each case as determined under the terms and conditions of our Senior Executive Annual Incentive Plan or another bonus plan established by Novan. See “Executive Annual Incentive Plan.” In addition, Mr. Johnson will be entitled to receive a one-time, $50,000 cash bonus for assisting with the preparation of an S-1 filing and our subsequent IPO payable upon the successful consummation of such IPO.

Equity Compensation

We currently sponsor the Novan, Inc. 2008 Stock Plan, or the 2008 Plan, pursuant to which approximately 50 of our employees, including our named executive officers, have received stock option awards. For additional information about the outstanding stock options held by our named executive officers pursuant to the 2008 Plan, please see the “Outstanding Equity Awards at Fiscal Year End” table below.

On April 13, 2016, we adopted the Novan, Inc. 2016 Incentive Award Plan, referred to below as the 2016 Plan, in order to facilitate the grant of cash and equity incentives to our directors, employees, including our named executive officers, and consultants and certain of our affiliates and to enable us and certain of our affiliates to obtain and retain services of these individuals, which is essential to our long-term success. The 2016 Plan is effective on the day prior to the effective date of this offering, subject to approval of such 2016 Plan by our stockholders and following the adoption of the 2016 Plan, no further awards will be made under the 2008 Plan. For additional information about the 2008 Plan and the 2016 Plan, see “Equity Compensation Plans” below.

Other Elements of Compensation

Retirement Plans

We currently maintain the Novan, Inc. 401(k) Plan, a defined contribution retirement savings plan, or the 401(k) Plan, for the benefit of our employees, including our named executive officers, who

 

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satisfy certain eligibility requirements. Our named executive officers are eligible to participate in the 401(k) Plan on the same terms as other full-time employees. The Code allows eligible employees to defer a portion of their compensation, within prescribed limits, on a pre-tax basis through contributions to the 401(k) Plan. Through December 31, 2015, we matched contributions made by participants in the 401(k) Plan up to 2% of the employee’s base salary. Beginning in 2016, we increased our matching contributions for all participants up to 3% of the employee’s base salary. These matching contributions are fully vested as of one year following the date on which they are made. We believe that providing a vehicle for tax-deferred retirement savings though our 401(k) Plan, and making matching contributions, adds to the overall desirability of our executive compensation package and further incentivizes our employees, including our named executive officers, in accordance with our compensation policies.

Employee Benefits and Perquisites

Health/Welfare Plans. All of our full-time employees, including our named executive officers, are eligible to participate in our health and welfare plans, including:

 

  n   medical, dental and vision benefits;

 

  n   medical and dependent care flexible spending accounts;

 

  n   short-term and long-term disability insurance; and

 

  n   life insurance.

Perquisites. In addition to the health and welfare benefits described above, our named executive officers participate in a company-paid executive life insurance plan. We generally do not provide any other perquisites to our named executive officers. However, in connection with their commencement of employment and relocation, Mr. Peterson is entitled to receive reimbursement of temporary housing expenses up to $2,500 per month for the first nine months of employment (i.e., through June 2016) as well as reimbursement of other moving and relocation expenses up to $25,000, and Mr. Johnson is entitled to receive reimbursement of temporary housing expenses up to $2,500 per month for the first twelve months of employment (i.e., through September 2016) as well as reimbursement of other moving and relocation expenses up to $35,000. In the event of either such named executive officer’s voluntary departure from the Company within the first twelve months of employment, he will be required to repay such relocation reimbursements.

We believe the perquisites described above are necessary and appropriate to provide a competitive compensation package to our named executive officers.

No Tax Gross-Ups

We do not make gross-up payments to cover our named executive officers’ personal income taxes that may pertain to any of the compensation or perquisites paid or provided by us.

Equity Compensation

Our equity award program is the primary vehicle for offering long-term incentives to our executives. We believe that equity awards provide our executives with a strong link to our long-term performance, create an ownership culture and help to align the interests of our executives and our stockholders. To date, we have used stock option grants for this purpose because we believe they are an effective means by which to align the long-term interests of our executive officers with those of our stockholders. The use of options also can provide tax and other advantages to our executive officers relative to other forms of equity compensation. We believe that our equity awards are an important retention tool for our executive officers, as well as for our other employees.

We award stock options broadly to our employees, including to our non-executive employees. Grants to our executives and other employees are made at the discretion of our board or President and

 

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are not made at any specific time period during a fiscal year. All of our named executive officers have received stock option grants under our 2008 Plan, which is described below. Our board intends to adopt a new equity incentive plan described under “—Equity Compensation Plans” below, effective upon the closing of this offering, and has determined not to grant any additional awards under our 2008 Plan after the effectiveness of such plan. Our new 2016 Plan will afford our compensation committee continued flexibility in making a wide variety of equity awards.

Initial option grants to our executive officers are generally set forth in their employment agreements. These initial grants are the product of negotiation with the executive officer, but we generally seek to establish equity ownership levels that we believe are commensurate with the equity stakes held by executive officers serving in similar roles at comparable biopharmaceutical companies. In addition, from time to time in connection with corporate finance transactions and at other times as our compensation committee and board deem appropriate, we provide subsequent option grants to those executive officers determined to be performing well.

The majority of the stock option grants we have made to our executive officers vest over three years. However, from time to time, our board has approved grants with different and sometimes shorter vesting provisions. Our historical practice has been to provide for 100% acceleration of vesting of outstanding stock options in the event of a change of control. Additional information regarding the effect of accelerated vesting upon a change in control with respect to our named executive officers is discussed below under “—Arrangements with our Named Executive Officer.”

The following table sets forth certain information regarding equity awards granted to our named executive officers that remain outstanding as of December 31, 2015.

Outstanding Equity Awards at Fiscal Year-End

 

Name

  Grant
Date
     Number of
Securities
Underlying
Unexercised
Options (#)
Exercisable
     Number of
Securities
Underlying
Unexercised
Options (#)
Unexercisable
     Option
Exercise
Price

($)
     Option
Expiration
Date
 

Nathan Stasko

    12/29/14         36,000         18,000         0.93         11/30/24   

Richard Peterson

    10/21/15         30,000         60,000         10.21         09/27/25   

Brian Johnson

    10/21/15         9,998         50,002         10.21         09/15/25   

Arrangements with our Named Executive Officers

We have entered into employment agreements with our named executive officers which set forth certain terms and conditions of their employment, including base salary and employee benefits.

Amended and Restated Employment Agreement with Nathan Stasko

Dr. Stasko serves as our President and Chief Executive Officer pursuant to an amended and restated employment agreement, dated as of April 13, 2016, or the Stasko Employment Agreement, pursuant to which, he receives an annual base salary of $360,000 and is eligible to receive a discretionary annual bonus with a target bonus equal to 60% of his base salary, annual stock option awards, as well as performance-based equity awards as determined by the board. The Stasko Employment Agreement also provides Dr. Stasko with eligibility to participate in standard benefit plans as well as an executive life insurance plan and reimbursement of reasonable business expenses.

 

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In the event of Dr. Stasko’s “separation from service” by us without “cause” or by Dr. Stasko for “good reason,” each as defined in the Stasko Employment Agreement, then in addition to any accrued amounts and subject to Dr. Stasko timely delivering an effective release of claims in our favor, Dr. Stasko will be entitled to receive (i) payment of an amount equal to 12 months of his base salary, paid in installments over 12 months in accordance with standard payroll practices, and (ii) reimbursement of Dr. Stasko’s applicable COBRA premiums for up to 12 months after the separation date. Upon separation from service by Dr. Stasko other than for good reason or due to death or disability, or by us for cause, Dr. Stasko will not be entitled to any additional compensation beyond any accrued amounts.

Notwithstanding the foregoing, the Stasko Employment Agreement further provides that, in the event such separation from service of Dr. Stasko by us without cause or by Dr. Stasko for good reason within 6 months after the occurrence of a “change in control” as defined in the Stasko Employment Agreement, all of Dr. Stasko’s unvested stock options will vest and become immediately exercisable and any restricted stock granted to Dr. Stasko will be released from our repurchase rights.

Employment Agreement with Richard Peterson

Mr. Peterson serves as our Chief Financial Officer pursuant to an Employment Agreement with us dated as of April 13, 2016, or the Peterson Employment Agreement, pursuant to which he receives an annual base salary of $350,400 and is eligible to receive a discretionary annual bonus with a target bonus equal to 45% of his base salary, and is eligible to participate in standard benefit plans as well as an executive life insurance plan and reimbursement of reasonable business expenses. In addition, under the terms of the Peterson Employment Agreement, Mr. Peterson is entitled to a relocation allowance of up to $25,000, and reimbursement for the costs of up to nine round trip tickets to and from Phoenix, Arizona to Research Triangle Park, and reimbursement of up to $2,500 per month for temporary housing expenses for nine months following the commencement of his employment on September 28, 2015, which we collectively refer to as the Peterson Relocation Benefits.

The Peterson Employment Agreement provides that, in the event of Mr. Peterson’s “separation from service” by us without “cause” or by Mr. Peterson for “good reason,” each as defined in the Peterson Employment Agreement, then in addition to any accrued amounts and subject to Mr. Peterson timely delivering an effective release of claims in our favor, Mr. Peterson will be entitled to receive (i) payment in an amount equal to the sum of (x) 12 months of his base salary and (y) a pro-rata portion of his target annual bonus for the year of such separation from service (calculated at 100% achievement of Mr. Peterson’s annual objectives) and based on the percentage of the calendar year actually worked by Mr. Peterson, paid in installments over 12 months in accordance with our standard payroll practices, (ii) vesting of any stock options that would have vested in the vesting year of such separation from service, and (iii) reimbursement of Mr. Peterson’s applicable COBRA premiums for up to 18 months after the separation date or, at our election, to avoid any penalty or excise tax being imposed on us, a lump sum payment in lieu thereof. The Peterson Employment Agreement further provides that, notwithstanding the foregoing, in the event such separation from service by us without cause or by Mr. Peterson for good reason occurs within six months after a “change in control,” as defined in the Peterson Employment Agreement, Mr. Peterson’s cash severance (described in (i) above) will include the full-year target bonus, instead of a pro-rata portion thereof, and Mr. Peterson will be entitled to accelerated vesting of all unvested stock options held by Mr. Peterson on the separation date. Upon separation from service by Mr. Peterson other than for good reason or due to death or disability, or by us for cause, Mr. Peterson will not be entitled to any additional compensation beyond any accrued amounts.

Employment Agreement with Brian Johnson

Mr. Johnson serves as our Chief Commercial Officer pursuant to an Employment Agreement with us dated as of April 13, 2016, or the Johnson Employment Agreement, pursuant to which he will receive an annual base salary of $326,400 and is eligible to receive a discretionary annual bonus with

 

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a target bonus equal to 35% of his base salary and is eligible to participate in standard benefit plans as well as an executive life insurance plan and reimbursement of reasonable business expenses. The Johnson Employment Agreement provides Mr. Johnson with the right to receive a one-time lump sum bonus, or the IPO bonus, payable within 30 days of the closing of this offering, of $50,000. In addition, under the terms of the Johnson Employment Agreement, Mr. Johnson is entitled to a relocation allowance of up to $35,000, reimbursement for the costs of up to 12 round trip tickets to and from Dallas/Fort Worth, Texas to Research Triangle Park and reimbursement of up to $2,500 per month for temporary housing expenses for 12 months following commencement of his employment on September 16, 2015, which we collectively refer to as the Johnson Relocation Benefits.

The Johnson Employment Agreement provides that, in the event of Mr. Johnson’s “separation from service” by us without “cause” or by Mr. Johnson for “good reason,” each as defined in the Johnson Employment Agreement, then in addition to any accrued amounts and subject to Mr. Johnson timely delivering an effective release of clams in our favor, Mr. Johnson will be entitled to receive (i) payment in an amount equal to 12 months of his base salary, paid in installments over 12 months in accordance with our standard payroll practices, (ii) vesting of any stock options that would have vested in the vesting year of such separation from service and (iii) reimbursement of Mr. Johnson’s applicable COBRA premiums for up to 18 months after the separation date or, at our election, to avoid any penalty or excise tax being imposed on us, a lump sum payment in lieu thereof. The Johnson Employment Agreement provides that, notwithstanding the foregoing, in the event such separation from service by us without cause or by Mr. Johnson for good reason occurs within six months after a “change in control,” as defined in the Johnson Employment Agreement, Mr. Johnson will be entitled to accelerated vesting of all unvested stock options held by Mr. Johnson on the separation date. Upon separation from service by Mr. Johnson other than for good reason or due to death or disability, or by us for cause, Mr. Johnson will not be entitled to any additional compensation beyond any accrued amounts.

Director Compensation

The following table sets forth information concerning the compensation of our non-employee directors for the year ended December 31, 2015.

 

Name

  Fees Earned or
Paid in Cash
    Option Awards
(1)
    All Other
Compensation
    Total  

F. Neal Hunter(2)

  $ 62,500      $ 206,141             $ 268,641   

W. Kent Geer

           94,216               94,216   

Robert Ingram

                           

G. Kelly Martin

                           

Sean Murphy

                           

John Palmour

                           

Mark Schoenfisch(2)

                $ 87,500 (3)    $ 87,500   

 

(1) Amounts reflect the grant-date Black-Scholes value of stock awards and stock options granted during 2015 computed in accordance with ASC Topic 718, rather than the amounts paid to or realized by the named individual. We provide information regarding the assumptions used to calculate the value of all stock awards and option awards made to our directors in the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
(2) Resigned from our board of directors in February 2016.
(3) Amount reflects aggregate consideration for consulting services provided in calendar year 2015. See “Certain Relationships and Related Person Transactions — Consulting Agreement” for a description of this agreement.

 

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The table below shows the aggregate numbers of option awards (exercisable and unexercisable) held as of December 31, 2015 by each non-employee director who was serving as of December 31, 2015. No director held any other equity awards.

 

Name

  Options Outstanding at Fiscal
Year End
     Unvested Restricted Shares
Outstanding at Fiscal Year End
 

F. Neal Hunter

    36,191           

W. Kent Geer

    18,300           

Robert Ingram

    36,000           

G. Kelly Martin

              

Sean Murphy

              

John Palmour

              

Mark Schoenfisch

              

On April 13, 2016, we approved the Novan, Inc. Non-Employee Director Compensation Policy, or the Director Compensation Policy, for our non-employee directors that consists of annual retainer fees and equity awards that will be paid or made automatically and without further action by our Board. Pursuant to the Director Compensation Policy, subject to continued service on our Board each non-employee director will receive an annual cash retainer of $35,000 and each non-employee director serving as a committee chair will receive an additional annual retainer between $10,000 and $15,000, each non-employee director serving as a committee member will receive an additional annual retainer between $5,000 and $7,500, and the non-employee chairman of our Board will receive an additional annual retainer of $25,000. The Director Compensation Policy also provides each non-employee director with an annual equity award, subject to continued service on the Board, with a grant date fair value of $100,000 (and each non-employee director who is initially elected or appointed on any date other than the date of the annual meeting will receive a pro-rated portion of such annual equity award for the year of such election or appointment). Additionally, each non-employee director who serves on the Board as of the pricing date of this offering, and will continue to serve as a director following the pricing date, will be automatically granted an option to purchase the number of shares of common stock that have an aggregate fair value of $100,000 on the pricing date. Each director equity award will vest and become exercisable in four equal quarterly installments, such that each such award shall be fully vested and exercisable on the first anniversary of the date of grant, subject to the director’s continued service on the Board through each applicable vesting date.