Organization and Significant Accounting Policies

Business Description and Basis of Presentation

Novan, Inc. (“Novan” and together with its subsidiaries, the “Company”), is a North Carolina-based clinical development-stage biotechnology company focused on leveraging nitric oxide’s naturally occurring anti-viral, anti-bacterial, anti-fungal and immunomodulatory mechanisms of action to treat a range of diseases with significant unmet needs. Novan was incorporated in January 2006 under the state laws of Delaware. Its wholly-owned subsidiary, Novan Therapeutics, LLC was organized in 2015 under the state laws of North Carolina. On March 14, 2019, the Company completed registration of a wholly-owned Ireland-based subsidiary, Novan Therapeutics, Limited.

The accompanying condensed consolidated financial statements of the Company have been prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”). The December 31, 2019 year-end condensed consolidated balance sheet data was derived from audited financial statements but does not include all disclosures required by U.S. GAAP. Additionally, the Company’s independent registered public accounting firm report for the December 31, 2019 financial statements included an explanatory paragraph indicating that there is substantial doubt about the Company’s ability to continue as a going concern.

Basis of Consolidation

The accompanying condensed consolidated financial statements reflect the operations of the Company and its wholly owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.

Liquidity and Ability to Continue as a Going Concern

The Company’s condensed consolidated financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business. The accompanying condensed 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 uncertainty related to the Company’s ability to continue as a going concern.

The Company has evaluated principal conditions and events that may raise substantial doubt about its ability to continue as a going concern within one year from the date that these financial statements are issued. The Company identified the following conditions:


•	The Company has reported a net loss in all fiscal periods since inception and, as of March 31, 2020, the Company had an accumulated deficit of $226,151.

•

As described below, in March 2020 the Company completed a public offering of its common stock (or pre-funded warrants to purchase common stock in lieu thereof) and common warrants to purchase common stock pursuant to the Company’s then effective shelf registration statement (the “March 2020 Public Offering”). Net proceeds from the offering were approximately $5,158 after deducting underwriting discounts and commissions and offering expenses of approximately $791. The Company has also received proceeds from the exercises of common warrants issued in the March 2020 Public Offering of approximately $2,880 through March 31, 2020.

•

Also described below, in March 2020 the Company completed a registered direct offering of its common stock (or pre-funded warrants to purchase common stock in lieu thereof) pursuant to the Company’s then effective shelf registration statement (the “March 2020 Registered Direct Offering”). Net proceeds from the offering were approximately $7,225 after deducting fees and commissions and offering expenses of approximately $774.


•	As of March 31, 2020, the Company had a total cash and cash equivalents balance of $21,785.


•	The Company has concluded that the prevailing conditions and ongoing liquidity risks faced by the Company raise substantial doubt about its ability to continue as a going concern.

The Company believes that its existing cash and cash equivalents balance, including (i) the net proceeds of approximately $15,263 related to the March 2020 offerings and related warrant exercises, and (ii) expected contractual payments to be received in connection with existing licensing agreements, will provide it with adequate liquidity to fund its operating needs into the second half of 2021, excluding costs associated with the execution of the Company’s late-stage clinical development programs, which will require additional funding or strategic partnering in order to complete. Specifically, this operating forecast and related cash projection excludes the potential costs associated with an additional confirmatory Phase 3 trial for SB206 as a treatment for molluscum beyond the initial start-up phase, along with any other new clinical stage development programs. Further advancement of the additional confirmatory Phase 3 trial for molluscum beyond the trial start-up phase and into the enrollment initiation phase, or advancement of any other late-stage clinical development program across our platform, is subject to additional funding or strategic partnering, and has been and may be further impacted by the COVID-19 pandemic.

If the Company is unable to secure the additional capital necessary to advance its late-stage clinical development programs, including funding necessary to complete an additional confirmatory Phase 3 trial for SB206, the Company expects that it would align its operations accordingly to support conduct of its early stage research and development programs, while also continuing to evaluate strategic alternatives.

The failure of the Company to obtain additional funding on acceptable terms could have a material adverse effect on the Company’s business and cause the Company to alter or reduce its planned operating activities, including but not limited to delaying, reducing, terminating or eliminating planned product candidate development activities, to conserve its cash and cash equivalents. The Company needs and intends to secure additional capital from non-dilutive sources, including partnerships, collaborations, licensing, grants or other strategic relationships, or through equity or debt financings. Any issuance of equity or debt that could be convertible into equity would result in significant dilution to our existing stockholders. Alternatively, the Company may seek to engage in one or more potential transactions, such as the sale of the Company, or sale or divestiture of some of its assets, such as a sale of its dermatology platform assets, but there can be no assurance that the Company will be able to enter into such a transaction or transactions on a timely basis or at all on terms that are favorable to the Company. Under these circumstances, the Company may instead determine to dissolve and liquidate its assets or seek protection under the bankruptcy laws. If the Company decides to dissolve and liquidate its assets or to seek protection under the bankruptcy laws, it is unclear to what extent the Company will be able to pay its obligations, and, accordingly, it is further unclear whether and to what extent any resources will be available for distributions to stockholders.

March 2020 Public Offering

On February 27, 2020, the Company entered into an underwriting agreement with H.C. Wainwright & Co., LLC (“H.C. Wainwright”), as underwriter, relating to the offering, issuance and sale of 14,000,000 shares of common stock, pre-funded warrants to purchase 4,333,334 shares of common stock, and accompanying common warrants to purchase up to an aggregate of 18,333,334 shares of common stock. The Company also granted H.C. Wainwright, as underwriter, a 30-day option to purchase up to 2,750,000 additional shares of common stock and/or common warrants to purchase up to an aggregate of 2,750,000 shares of common stock, which H.C. Wainwright partially exercised on March 2, 2020 to purchase 1,498,602 shares of common stock and common warrants to purchase 2,750,000 shares of common stock. The March 2020 Public Offering closed on March 3, 2020. At closing, the Company also issued to designees of H.C. Wainwright, as underwriter, warrants to purchase an aggregate of up to 594,958 shares of common stock representing 3.0% of the aggregate number of shares of common stock sold and shares of common stock underlying the pre-funded warrants sold in this offering.

The shares issued as part of the March 2020 Public Offering, and upon exercises of common warrants and pre-funded warrants issued as part of the March 2020 Public Offering, increased the number of shares outstanding, which impacts the comparability of the Company’s reported net loss per share calculations between 2020 and 2019 periods.

See Note 9—Stockholders’ Equity (Deficit) for further information regarding the March 2020 Public Offering.

March 2020 Registered Direct Offering

On March 24, 2020, the Company entered into a securities purchase agreement with several institutional and accredited investors, pursuant to which the Company agreed to sell and issue, in a registered direct offering priced at the market, an aggregate of 10,550,000 shares of the Company’s common stock and pre-funded warrants to purchase 8,054,652 shares of common stock. The March 2020 Registered Direct Offering closed on March 26, 2020. At closing, the Company also issued to designees of H.C. Wainwright, as placement agent, warrants to purchase an aggregate of up to 558,140 shares of common stock representing 3.0% of the aggregate number of shares of common stock and shares of common stock underlying the pre-funded warrants sold in this offering.

The shares issued as part of the March 2020 Registered Direct Offering, and upon exercises of pre-funded warrants issued as part of the March 2020 Registered Direct Offering, increased the number of shares outstanding, which impacts the comparability of the Company’s reported net loss per share calculations between 2020 and 2019 periods.

See Note 9—Stockholders’ Equity (Deficit) for further information regarding the March 2020 Registered Direct Offering.

COVID-19

In December 2019, the novel strain of a virus named SARS-CoV-2 (severe acute respiratory syndrome coronavirus 2), which causes novel coronavirus disease 2019 (“COVID-19”) was reported in China, and in March 2020, the World Health Organization declared it a pandemic. The extent to which COVID-19 and global efforts to contain its spread will impact the Company’s business including its operations, preclinical studies, clinical trials, and financial condition will depend on future developments, which are highly uncertain and cannot be predicted at this time, and include the duration, severity and scope of the pandemic and the actions taken by other parties, such as governmental authorities, to contain and treat COVID-19. The timetable for development of the Company’s product candidates has been impacted and may face further disruption and the Company’s business could be further adversely affected by the outbreak of COVID-19. At this time, the extent to which COVID-19 may impact the Company’s financial condition or results of operations is uncertain. In particular, COVID-19 has impacted the trial execution plans of the Company’s B-SIMPLE4 Phase 3 trial for SB206, and the Company is assessing any further impact of COVID-19 on the B-SIMPLE4 Phase 3 trial for SB206, which is also subject to additional funding, including delay, postponement or other impacts to the trial.

Classification of Warrants Issued in Connection with Offerings of Common Stock

The Company accounts for common stock warrants as either equity-classified or liability-classified instruments based on an assessment of the warrant’s specific terms and applicable authoritative guidance in Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 480, Distinguishing Liabilities from Equity (“ASC 480”) and ASC 815, Derivatives and Hedging (“ASC 815”). The assessment considers whether the warrants are freestanding financial instruments pursuant to ASC 480, meet the definition of a liability pursuant to ASC 480, and whether the warrants meet all of the requirements for equity classification under ASC 815, including whether the warrants are indexed to the Company’s own common stock and whether the warrant holders could potentially require “net cash settlement” in a circumstance outside of the Company’s control, among other conditions for equity classification. This assessment, which requires the use of professional judgment, is conducted at the time of warrant issuance and as of each subsequent quarterly period end date while the warrants are outstanding.

For issued or modified warrants that meet all of the criteria for equity classification, the warrants are required to be recorded as a component of additional paid-in capital at the time of issuance. For issued or modified warrants that do not meet all the criteria for equity classification, the warrants are required to be recorded at their initial fair value on the date of issuance, and remeasured each balance sheet date thereafter. Changes in the estimated fair value of liability-classified warrants are recognized as a non-cash gain or loss on the consolidated statements of operations and comprehensive loss.

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. Actual results could differ from these estimates.

Unaudited Interim Condensed Consolidated Financial Statements

The accompanying interim condensed consolidated financial statements and the related footnote disclosures are unaudited. These unaudited condensed consolidated financial statements have been prepared in accordance with U.S. GAAP and applicable rules and regulations of the Securities and Exchange Commission’s (“SEC”) Rule 10-01 of Regulation S-X for interim financial information. The condensed consolidated financial statements were prepared on the same basis as the audited consolidated financial statements and in the opinion of management, reflect all adjustments (consisting of adjustments of a normal, recurring nature and the impact of the Company’s restatement of its consolidated financial statements for the Affected Periods (as defined below)) that are necessary for the fair statement of the Company’s financial position and its results of operations and cash flows. The results of operations for interim periods are not necessarily indicative of the results expected for the full fiscal year or any future period. These interim financial statements should be read in conjunction with the financial statements and notes for the year ended December 31, 2019 set forth in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019, as amended, filed with the SEC as discussed below.

Restatement of Previously Issued Financial Statements

On May 14, 2020, the Company revised its prior position on accounting for warrants and concluded that its previously issued consolidated financial statements for the year ended December 31, 2018, and all quarterly periods of 2019 and 2018 (the “Affected Periods”) should not be relied upon because of a misapplication in the guidance on warrant accounting. On May 20, 2020, the Company restated its consolidated financial statements for all Affected Periods in its Annual Report on Form 10-K/A (Amendment No. 1) for the fiscal year ended December 31, 2019. As such, the comparative information provided for the three months ended March 31, 2019 contained in the preceding condensed consolidated financial statements and the accompanying footnotes reflect these previously restated amounts.

Restricted Cash

Restricted cash as of March 31, 2020 and December 31, 2019 includes funds maintained in a separate deposit account to secure a letter of credit for the benefit of the lessor of facility space leased by the Company.

Impairment of Long-Lived Assets

Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized for an amount by which the carrying amount of the asset exceeds the fair value of the asset.

During the three months ended March 31, 2020 and 2019, respectively, the Company concluded there were no such events or changes in circumstances requiring review of the carrying amount of the Company’s long-lived assets.

Net Loss Per Share

Basic net loss per share attributable to common stockholders is computed by dividing the net loss attributable to common stockholders by the weighted average number of shares of common stock outstanding for the period. Basic shares outstanding includes the weighted average effect of the Company’s outstanding pre-funded warrants, the exercise of which requires little or no consideration for the delivery of shares of common stock.

Diluted net loss per share is calculated by adjusting weighted average shares outstanding for the dilutive effect of common stock equivalents outstanding for the period. Diluted net loss per share is the same as basic net loss per share, since the effects of potentially dilutive securities are anti-dilutive for all periods presented.

The following securities, presented on a common stock equivalent basis, have been excluded from the calculation of weighted average common shares outstanding for the three months ended March 31, 2020 and 2019 because the effect is anti-dilutive due to the net loss reported in each of those periods. All share amounts presented in the table below represent the total number outstanding as of the end of each period.



	March 31,
	2020	2019
Warrants to purchase common stock associated with January 2018 public offering (Note 9)	10,000,000	10,000,000
Warrants to purchase common stock associated with March 2020 public offering (Note 9)	12,078,292	—
Warrants to purchase common stock associated with March 2020 registered direct offering (Note 9)	558,140	—
Stock options outstanding under the 2008 and 2016 Plans (Note 10)	2,010,603	1,544,857
Stock appreciation rights outstanding under the 2016 Plan (Note 10)	600,000	—
Inducement options outstanding (Note 10)	96,167	100,500

Segment and Geographic Information

The Company has determined that it operates in one segment. The Company uses its nitric oxide-based technology to develop product candidates. The Chief Executive Officer, who is the Company’s chief operating decision maker, reviews financial information on an aggregate basis for purposes of allocating resources and evaluating financial performance. The Company has only had limited revenue since its inception, but substantially all revenue was derived from licensing agreements originating in the United States. All of the Company’s long-lived assets are maintained in the United States.

Although all operations are based in the United States, the Company generated revenue from its licensing partner in Japan of $1,024, or approximately 84% of total revenue, and $1,100 or 100% of total revenue, during the three months ended March 31, 2020 and 2019, respectively.

Recently Issued Accounting Standards

Accounting Pronouncements Adopted

In August 2018, the FASB issued Accounting Standards Update (“ASU”) No. 2018-13 Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement. This guidance is intended to improve the effectiveness of disclosure requirements on fair value measurements in Topic 820. The new standard modifies certain disclosure requirements and is effective for annual reporting periods beginning after December 15, 2019. This ASU was effective for the Company as of January 1, 2020. The adoption of this new accounting guidance did not have a material impact on the Company’s condensed consolidated financial statements.

In October 2018, the FASB issued ASU No. 2018-17 Consolidation (Topic 810): Targeted Improvements to Related Party Guidance for Variable Interest Entities. This guidance is intended to improve the accounting for variable interest entities and whether the entity should be consolidated. This guidance is effective for annual reporting periods beginning after December 15, 2019, including interim reporting periods within those annual reporting periods, with early adoption permitted. This ASU was effective for the Company as of January 1, 2020. The adoption of this new accounting guidance did not have a material impact on the Company’s condensed consolidated financial statements.

In November 2018, the FASB issued ASU No. 2018-18 Collaborative Arrangements (Topic 808): Clarifying the Interaction between Topic 808 and Topic 606. This guidance is intended to reduce diversity in practice and clarify the interaction between Topic 808, Collaborative Arrangements, and Topic 606, Revenue from Contracts with Customers. This ASU provided guidance on whether certain transactions between collaborative arrangement participants should be accounted for with revenue under Topic 606. This guidance is effective for annual reporting periods beginning after December 15, 2019, including interim reporting periods within those annual reporting periods, with early adoption permitted. This ASU was effective for the Company as of January 1, 2020. The adoption of this new accounting guidance did not have a material impact on the Company’s condensed consolidated financial statements.

Accounting Pronouncements Being Evaluated

In December 2019, the FASB issued ASU No. 2019-12 Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. This guidance is intended to improve consistent application and simplify the accounting for income taxes. This ASU removes certain exceptions to the general principles in Topic 740 and clarifies and amends existing guidance. This standard is effective for annual reporting periods beginning after December 15, 2020, including interim reporting periods within those annual reporting periods, with early adoption permitted. The Company is currently evaluating the impact of adoption of this ASU and does not expect the adoption of this new standard to have a material impact on its consolidated financial statements.