10-Q 1 otic-10q_20170630.htm 10-Q otic-10q_20170630.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

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

For the quarterly period ended June 30, 2017

OR

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

For the transition period from                      to                     

Commission file number: 001-36591

 

Otonomy, Inc.

(Exact name of registrant as specified in its charter)

 

Delaware

 

26-2590070

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification Number)

4796 Executive Drive

San Diego, California 92121

(619) 323-2200

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

 

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes      No  

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

 

Large accelerated filer

 

  

Accelerated filer

 

 

 

 

 

Non-accelerated filer

 

  (Do not check if a small reporting company)

  

Smaller reporting company

 

 

 

 

 

 

 

 

Emerging growth company

 

 

 

 

 

 

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

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

The number of shares of the registrant’s common stock, par value $0.001, outstanding as of July 28, 2017 was 30,303,410.

 

 


TABLE OF CONTENTS

 

 

Page

PART I. FINANCIAL INFORMATION

2

 

 

Item 1. Financial Statements

2

 

 

Condensed Balance Sheets

2

 

 

Condensed Statements of Operations

3

 

 

Condensed Statements of Comprehensive Loss

4

 

 

Condensed Statements of Cash Flows

5

 

 

Notes to Condensed Financial Statements

6

 

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

15

 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

24

 

 

Item 4. Controls and Procedures

24

 

 

PART II. OTHER INFORMATION

25

 

 

Item 1. Legal Proceedings

25

 

 

Item 1A. Risk Factors

25

 

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

54

 

 

Item 3. Default Upon Senior Securities

54

 

 

Item 4. Mine Safety Disclosures

54

 

 

Item 5. Other Information

54

 

 

Item 6. Exhibits

54

 

 

 


 

PART I. FINANCIAL INFORMATION

Item 1.

Financial Statements

Otonomy, Inc.

Condensed Balance Sheets

(in thousands, except share and per share data)

 

 

June 30,

 

 

December 31,

 

 

2017

 

 

2016

 

 

(unaudited)

 

 

 

 

 

Assets

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

Cash and cash equivalents

$

22,332

 

 

$

24,156

 

Short-term investments

 

128,200

 

 

 

172,222

 

Accounts receivable, net

 

76

 

 

 

91

 

Inventory

 

1,191

 

 

 

1,435

 

Prepaid and other current assets

 

3,538

 

 

 

4,316

 

Total current assets

 

155,337

 

 

 

202,220

 

Restricted cash

 

697

 

 

 

697

 

Property and equipment, net

 

5,102

 

 

 

4,977

 

Other long-term assets

 

550

 

 

 

702

 

Total assets

$

161,686

 

 

$

208,596

 

Liabilities and Stockholders' Equity

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

Accounts payable

$

1,303

 

 

$

1,292

 

Accrued expenses

 

4,831

 

 

 

9,064

 

Accrued compensation

 

3,338

 

 

 

4,839

 

Current portion of deferred rent

 

38

 

 

 

38

 

Total current liabilities

 

9,510

 

 

 

15,233

 

Deferred rent, net of current portion

 

2,114

 

 

 

626

 

Total liabilities

 

11,624

 

 

 

15,859

 

Commitments and Contingencies

 

 

 

 

 

 

 

Stockholders' equity:

 

 

 

 

 

 

 

Preferred stock, $0.001 par value, 10,000,000 shares authorized at June 30, 2017

   and December 31, 2016; no shares issued or outstanding at June 30, 2017 and

   December 31, 2016

 

 

 

 

 

Common stock, $0.001 par value; 200,000,000 shares authorized at June 30, 2017

   and December 31, 2016; 30,297,463 and 30,255,339 shares issued and outstanding

   at June 30, 2017 and December 31, 2016, respectively

 

30

 

 

 

30

 

Additional paid-in capital

 

475,170

 

 

 

467,468

 

Accumulated other comprehensive loss

 

(119

)

 

 

(41

)

Accumulated deficit

 

(325,019

)

 

 

(274,720

)

Total stockholders' equity

 

150,062

 

 

 

192,737

 

Total liabilities and stockholders' equity

$

161,686

 

 

$

208,596

 

 

See accompanying notes.

 

 

-2-


 

Otonomy, Inc.

Condensed Statements of Operations

(in thousands, except share and per share data)

 

 

Three Months Ended June 30,

 

 

Six Months Ended June 30,

 

 

2017

 

 

2016

 

 

2017

 

 

2016

 

 

(unaudited)

 

Product sales, net

$

326

 

 

$

76

 

 

$

684

 

 

$

89

 

Costs and operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of product sales

 

397

 

 

 

395

 

 

 

860

 

 

 

404

 

Research and development

 

12,714

 

 

 

16,742

 

 

 

25,899

 

 

 

30,614

 

Selling, general and administrative

 

10,747

 

 

 

12,846

 

 

 

24,839

 

 

 

25,841

 

Total costs and operating expenses

 

23,858

 

 

 

29,983

 

 

 

51,598

 

 

 

56,859

 

Loss from operations

 

(23,532

)

 

 

(29,907

)

 

 

(50,914

)

 

 

(56,770

)

Other income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

311

 

 

 

231

 

 

 

615

 

 

 

332

 

Other expense

 

 

 

 

 

 

 

 

 

 

(1

)

Total other income

 

311

 

 

 

231

 

 

 

615

 

 

 

331

 

Net loss

$

(23,221

)

 

$

(29,676

)

 

$

(50,299

)

 

$

(56,439

)

Net loss per share, basic and diluted

$

(0.77

)

 

$

(0.98

)

 

$

(1.66

)

 

$

(1.90

)

Weighted-average shares used to compute net loss

   per share, basic and diluted

 

30,269,190

 

 

 

30,128,150

 

 

 

30,263,042

 

 

 

29,728,477

 

 

See accompanying notes.

 

 

-3-


 

Otonomy, Inc.

Condensed Statements of Comprehensive Loss

(in thousands)

 

 

Three Months Ended June 30,

 

 

Six Months Ended June 30,

 

 

2017

 

 

2016

 

 

2017

 

 

2016

 

 

(unaudited)

 

Net loss

$

(23,221

)

 

$

(29,676

)

 

$

(50,299

)

 

$

(56,439

)

Other comprehensive (loss) income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized (loss) gain on available for sale

   securities, net of tax

 

(9

)

 

 

52

 

 

 

(78

)

 

 

52

 

Comprehensive loss

$

(23,230

)

 

$

(29,624

)

 

$

(50,377

)

 

$

(56,387

)

 

See accompanying notes.

 

 

-4-


 

Otonomy, Inc.

Condensed Statements of Cash Flows

(in thousands)

 

 

Six Months Ended June 30,

 

 

2017

 

 

2016

 

 

(unaudited)

 

Cash flows from operating activities:

 

 

 

 

 

 

 

Net loss

$

(50,299

)

 

$

(56,439

)

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

 

 

 

 

 

 

 

Depreciation

 

592

 

 

 

320

 

Stock-based compensation

 

7,217

 

 

 

5,962

 

Amortization of discount or premium on short-term investments

 

307

 

 

 

206

 

Deferred rent

 

1,488

 

 

 

84

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

Accounts receivable, net

 

15

 

 

 

(2

)

Inventory

 

244

 

 

 

(913

)

Prepaid and other assets

 

930

 

 

 

(1,938

)

Accounts payable

 

 

 

 

(2,749

)

Accrued expenses

 

(4,258

)

 

 

872

 

Accrued compensation

 

(1,501

)

 

 

921

 

Deferred product sales, net

 

 

 

 

79

 

Net cash used in operating activities

 

(45,265

)

 

 

(53,597

)

Cash flows from investing activities:

 

 

 

 

 

 

 

Purchases of short-term investments

 

(73,662

)

 

 

(189,695

)

Maturities of short-term investments

 

117,299

 

 

 

23,262

 

Purchases of property and equipment

 

(681

)

 

 

(400

)

Increase in restricted cash

 

 

 

 

(1

)

Net cash provided by (used in) investing activities

 

42,956

 

 

 

(166,834

)

Cash flows from financing activities:

 

 

 

 

 

 

 

Proceeds from issuance of common stock, net of transaction costs

 

427

 

 

 

108,198

 

Proceeds from exercise of stock options

 

58

 

 

 

138

 

Net cash provided by financing activities

 

485

 

 

 

108,336

 

Net change in cash

 

(1,824

)

 

 

(112,095

)

Cash and cash equivalents at beginning of period

 

24,156

 

 

 

158,664

 

Cash and cash equivalents at end of period

$

22,332

 

 

$

46,569

 

Supplemental disclosure of non-cash investing activities:

 

 

 

 

 

 

 

Purchase of property and equipment in accounts payable and accrued expenses

$

36

 

 

$

304

 

 

See accompanying notes.

 

 

-5-


 

Otonomy, Inc.

Notes to Condensed Financial Statements

(unaudited)

 

1. Description of Business and Basis of Presentation

Description of Business

Otonomy, Inc. (the Company) was incorporated in the state of Delaware on May 6, 2008. The Company is a biopharmaceutical company focused on the development and commercialization of innovative therapeutics for diseases and disorders of the ear. OTIPRIO® (ciprofloxacin otic suspension) is approved in the United States for use during tympanostomy tube placement (TTP) surgery in pediatric patients. The Company has filed a Supplemental New Drug Application (sNDA) for OTIPRIO in acute otitis externa (AOE) with the United States Food and Drug Administration (FDA) and has been assigned a Prescription Drug User Fee Act (PDUFA) action date of March 2, 2018. The Company has also completed a successful End-of-Phase 2 review with the FDA for OTIPRIO in patients with acute otitis media with tympanostomy tubes (AOMT). OTIVIDEXTM (formerly OTO-104) is a steroid in development for the treatment of Ménière’s disease and other balance and hearing disorders. Two Phase 3 trials in Ménière’s disease patients are ongoing, AVERTS-1 in the United States and AVERTS-2 in Europe, with AVERTS-1 results expected in September 2017 and AVERTS-2 results expected by the end of 2017. In addition, a Phase 2 trial of OTIVIDEX is ongoing in patients at risk for cisplatin-induced hearing loss. OTO-311 is a N-Methyl-D-Aspartate (NMDA) receptor antagonist for the treatment of tinnitus that has completed a Phase 1 clinical safety trial with a Phase 2 trial expected to be initiated by the end of 2017. A fourth program targeting sensorineural hearing loss including age-related hearing loss is in preclinical development. OTIPRIO and the Company’s current product candidates utilize the Company’s proprietary formulation technology that combines a thermosensitive gel with drug microparticles to enable a single dose treatment by a physician.

In January 2016, the Company completed a public offering of 5,750,000 shares of its common stock, which includes the exercise in full by the underwriters of their option to purchase 750,000 shares of common stock, at an offering price of $20.00 per share. Proceeds from the public offering were approximately $107.6 million, net of underwriting discounts, commissions and offering-related transaction costs.

Basis of Presentation

The accompanying condensed financial statements have been prepared assuming the Company will continue as a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The Company has incurred operating losses and negative cash flows from operating activities since inception. As of June 30, 2017, the Company had cash, cash equivalents and short-term investments of $150.5 million and an accumulated deficit of $325.0 million. The Company anticipates that it will continue to incur net losses into the foreseeable future as it: (i) commercializes OTIPRIO and continues its development for additional indications; (ii) develops and seeks regulatory approvals for its product candidates OTIVIDEX and OTO-311; and (iii) works to develop additional product candidates through research and development programs. If additional financing is required, the Company anticipates that it will seek additional funding through future debt and/or equity financings or other sources, such as potential collaboration agreements. If the Company is not able to secure adequate additional funding, if or when necessary, the Company may be forced to make reductions in spending, extend payment terms with suppliers, liquidate assets where possible, and/or suspend or curtail planned programs. Any of these actions could materially harm the Company’s business, results of operations, and future prospects.

Unaudited Interim Financial Information

The accompanying interim condensed financial statements are unaudited. These unaudited interim condensed financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) and following the requirements of the United States Securities and Exchange Commission (SEC) for interim reporting. As permitted under those rules, certain footnotes or other financial information that are normally required by GAAP can be condensed or omitted. In management’s opinion, the unaudited interim condensed financial statements have been prepared on the same basis as the audited financial statements and include all adjustments, which include only normal recurring adjustments necessary for the fair presentation of the Company’s financial position, results of operations and cash flows for the periods presented. These statements do not include all disclosures required by GAAP and should be read in conjunction with the Company’s audited financial statements and accompanying notes for the year ended December 31, 2016 included in the Company’s Form 10-K, as filed with the SEC on March 2, 2017. The results presented in these unaudited condensed financial statements are not necessarily indicative of the results expected for the full fiscal year or any other interim period or any future year or period.

 

 

-6-


 

2. Summary of Significant Accounting Policies

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of product sales and expense during the reporting period. Although these estimates are based on the Company’s knowledge of current events and actions it may undertake in the future, actual results may ultimately materially differ from these estimates and assumptions.

Segment Reporting

Operating segments are identified as components of an enterprise about which separate discrete financial information is available for evaluation by the chief operating decision-maker in making decisions regarding resource allocation and assessing performance. The Company views its operations and manages its business in one operating segment.

Concentrations of Credit Risk

Financial instruments that potentially subject the Company to significant concentrations of credit risk consist primarily of cash, cash equivalents and short-term investments. The Company maintains deposits in federally insured financial institutions in excess of federally insured limits. The Company has not experienced any losses in such accounts and believes it is not exposed to significant risk on its cash balances due to the financial position of the depository institution in which those deposits are held. Additionally, the Company established guidelines regarding approved investments and maturities of investments, which are designed to maintain safety and liquidity.

Cash and Cash Equivalents

Cash and cash equivalents consist of cash and highly liquid investments with original maturities of three months or less at the date of purchase. The carrying amounts approximate fair value due to the short maturities of these instruments. Cash and cash equivalents include cash in readily available checking, savings and money market accounts, as well as certificates of deposit.

Short-Term Investments

The Company carries short-term investments classified as available-for-sale at fair value as determined by prices for identical or similar securities at the balance sheet date. Short-term investments consist of both Level 1 and Level 2 financial instruments in the fair value hierarchy (see Note 6).

Realized gains or losses of available-for-sale securities are determined using the specific identification method and net realized gains and losses are included in interest income. The Company periodically reviews available-for-sale securities for other-than temporary declines in fair value below the cost basis, and whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company records unrealized gains and losses as a component of other comprehensive loss within the condensed statements of comprehensive loss and as a separate component of stockholders’ equity on the condensed balance sheet.

Fair Value of Financial Instruments

The carrying value of the Company’s cash and cash equivalents, short-term investments, prepaid expenses and other current assets, other assets, accounts payable, accrued liabilities, and accrued compensation approximate fair value due to the short-term nature of these items.

Restricted Cash

The Company’s restricted cash consists of cash maintained in a separate deposit account to secure a letter of credit issued by a bank to the landlord under a lease agreement for the Company’s new corporate headquarters. The Company has classified the restricted cash as noncurrent on the condensed balance sheet.

-7-


 

Inventory

Inventory, which is stated at the lower of cost or market (net realizable value), is based on actual cost in a manner that approximates the first-in, first-out method. Inventories consist of OTIPRIO finished goods and work in process, as well as raw materials used in the manufacture of OTIPRIO. If inventory costs exceed expected market value due to obsolescence, expiry or quantities in excess of expected demand, write downs are recorded for the difference between cost and market value, less cost to sell.  

Property and Equipment

Property and equipment generally consist of manufacturing equipment, furniture and fixtures, computers, and scientific and office equipment and are recorded at cost and depreciated using the straight-line method over the estimated useful lives of the assets (generally two to ten years). Leasehold improvements are stated at cost and are depreciated on a straight-line basis over the lesser of the remaining term of the related lease or the estimated useful lives of the assets. Repairs and maintenance costs are charged to expense as incurred.

Impairment of Long-Lived Assets

The Company assesses the value of its long-lived assets, which consist of property and equipment, for impairment on an annual basis and whenever events or changes in circumstances and the undiscounted cash flows generated by those assets indicate that the carrying amount of such assets may not be recoverable. While the Company’s current and historical operating losses and negative cash flows are indicators of impairment, management believes that future cash flows to be received support the carrying value of its long-lived assets. No impairment of long-lived assets was recorded during the six months ended June 30, 2017 and 2016.

Clinical Trial Expense Accruals

As part of the process of preparing the Company’s financial statements, the Company is required to estimate expenses resulting from the Company’s obligations under contracts with vendors, clinical research organizations and consultants and under clinical site agreements in connection with conducting clinical trials. The financial terms of these contracts are subject to negotiations, which vary from contract to contract and may result in payment flows that do not match the periods over which materials or services are provided under such contracts.

The Company’s objective is to reflect the appropriate clinical trial expenses in its financial statements by recording those expenses in the period in which services are performed and efforts are expended. The Company accounts for these expenses according to the progress of the trial as measured by patient progression and the timing of various aspects of the trial. The Company determines accrual estimates through financial models taking into account discussion with applicable personnel and outside service providers as to the progress or state of its trials. During the course of a clinical trial, the Company adjusts its clinical expense if actual results differ from its estimates.

Revenue Recognition

The Company recognizes revenue when all of the following four criteria are met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services have been rendered; (3) the fee is fixed or determinable; and (4) collectability is reasonably assured. Determination of criteria (3) and (4) are based on management’s judgments regarding the nature of the fee charged for products delivered and the collectability of those fees. If the revenue recognition criteria are not met, the Company defers the recognition of revenue by recording deferred revenue until such time that all criteria are met.

The Company began selling OTIPRIO during March 2016. The Company sells OTIPRIO to a limited number of specialty wholesale distributors, and title and risk of loss transfer upon receipt by these distributors. Hospitals and ambulatory surgery centers order OTIPRIO from these distributors, and are the end users of OTIPRIO. The Company permits product returns from the distributors only if the product is damaged or is shipped or ordered in error. Product returns based on expiry are not permitted. Product sales are recorded net of estimated chargebacks, government rebates and distributor fees.

The Company establishes reserves for chargebacks, government rebates and distributor fees utilizing a variety of information including specific contractual terms of agreements with customers, historical rebates and chargebacks, the Company’s historical and projected payer mix, industry data, sell-through and inventory on-hand information received from the Company’s distributors and changes in the overall marketplace. Reserves are established for these discounts and allowances upon receipt of OTIPRIO by the distributor and are classified as: (i) an allowance against accounts receivable if the amount is payable to the distributor or (ii) an accrued liability if the amount is payable to a party other than the distributor. Allowances against accounts receivable relate to chargebacks and distributor fees and accruals relate primarily to government rebates. Such reserves result in a reduction to revenue.

-8-


 

Chargebacks. The Company estimates allowances against accounts receivable for chargebacks related to agreements with group purchasing organizations and federal contracts. Under these agreements, the Company credits distributors a chargeback amount which represents the difference between wholesale acquisition cost (WAC) and the discounted price at which eligible purchasers purchased from the distributors. At the time of sale, the Company records estimated chargebacks based on the Company’s historical chargeback activity, the projected payer mix and the identification of entities that purchase OTIPRIO which are eligible for discounted pricing.

Government Rebates. The Company estimates a rebate liability in connection with a Medicaid Drug Rebate Agreement with the Centers for Medicare & Medicaid Services (CMS), which provides a rebate to participating states based on covered purchases of OTIPRIO. At the time of sale, the Company records estimated Medicaid rebates based on the Company’s historical rebate activity, projected payer mix and Medicaid patient population industry data.

Distributor Fees. The Company’s customers are specialty wholesale distributors with whom the Company has contracted to pay a fee for service based on a percentage of gross product sales. This fee for service is recorded as an allowance against accounts receivable at the time of sale based on the contracted percentage.

Research and Development

Research and development expenses include the costs associated with the Company’s research and development activities, including salaries, benefits and occupancy costs. Also included in research and development expenses are third-party costs incurred in conjunction with contract manufacturing for the Company’s research and development programs and clinical trials, including the cost of clinical trial drug supply, costs incurred by contract research organizations and regulatory expenses. Research and development costs are expensed as incurred.

Patent Expenses

The Company expenses all costs as incurred in connection with patent applications (including direct application fees, and the legal and consulting expenses related to making such applications) and such costs are included in selling, general and administrative expenses in the accompanying condensed statements of operations.

Stock-Based Compensation

The Company accounts for stock-based compensation expense related to stock options and employee stock purchase plan (ESPP) rights by estimating the fair value on the date of grant using the Black-Scholes-Merton option pricing model net of estimated forfeitures. For awards subject to time-based vesting conditions, stock-based compensation expense is recognized using the straight-line method.

Income Taxes

The accounting guidance for uncertainty in income taxes prescribes a recognition threshold and measurement attribute criteria for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more likely than not to be sustained upon examination by taxing authorities based on the technical merits of the position.

The Company uses the liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial reporting and the tax reporting basis of assets and liabilities and are measured using the enacted tax rates and laws that are expected to be in effect when the differences are expected to reverse. The Company provides a valuation allowance against net deferred tax assets unless, based upon the available evidence, it is more likely than not that the deferred tax assets will be realized. When the Company establishes or reduces the valuation allowance against its deferred tax assets, its provision for income taxes will increase or decrease, respectively, in the period such determination is made.

Comprehensive Loss

Comprehensive loss is defined as the change in equity during a period from transactions and other events and/or circumstances from non-owner sources.

-9-


 

Net Loss Per Share

Basic net loss per common share is calculated by dividing the net loss attributable to common stockholders by the weighted-average number of common shares outstanding during the period, without consideration for potentially dilutive securities. Diluted net loss per share is computed by dividing the net loss attributable to common stockholders by the weighted-average number of common shares and potentially dilutive securities outstanding for the period determined using the treasury-stock and if-converted methods. For purposes of the diluted net loss per share calculation, potentially dilutive securities are excluded from the calculation of diluted net loss per share because their effect would be anti-dilutive and therefore, basic and diluted net loss per share were the same for all periods presented.

Potentially dilutive securities excluded from the calculation of diluted net loss per share are as follows:

 

 

Three and Six Months

Ended June 30,

 

 

2017

 

 

2016

 

Warrants to purchase common stock

 

141,060

 

 

 

141,060

 

Options to purchase common stock

 

5,537,575

 

 

 

4,760,723

 

 

 

5,678,635

 

 

 

4,901,783

 

 

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2014-09, “Revenue from Contracts with Customers” (ASU 2014-09). ASU 2014-09 supersedes nearly all existing revenue recognition guidance under U.S. GAAP and requires revenue to be recognized when promised goods or services are transferred to customers in an amount that reflects the consideration that is expected to be received for those goods or services. Additionally, qualitative and quantitative disclosures are required about customer contracts, significant judgments and changes in judgments, and assets recognized from the costs to obtain or fulfill a contract. The FASB has also recently issued several amendments to ASU 2014-09, including clarification on accounting for licenses of intellectual property and identifying performance obligations.

ASU 2014-09 is effective for the Company beginning in the first quarter of 2018 using one of two prescribed transition methods: retrospectively to each prior reporting period presented (full retrospective method), or retrospectively with the cumulative effect of initially applying the guidance recognized at the date of initial application (the cumulative catch-up transition method). The Company expects to adopt ASU 2014-09 in the first quarter of 2018 using the full retrospective method to restate each prior reporting period presented.

The Company is currently evaluating the effect that the updated standard and transition method will have on its internal processes, financial statements and related disclosures. The Company has used internal resources and third-party service providers to assist in the evaluation. While the Company continues to assess all potential impacts under ASU 2014-09, recognition of the Company’s revenue under the new standard is expected to be materially consistent with the Company’s current revenue recognition policy. The new standard is not expected to materially impact the timing or amounts of revenue recognized.

In February 2016, the FASB issued Accounting Standards Update No. 2016-02, "Leases" (ASU 2016-02). ASU 2016-02 provides accounting guidance for both lessee and lessor accounting models. Among other things, lessees will recognize a right-of-use asset and a lease liability for leases with a duration of greater than one year. For statement of operations purposes, ASU 2016-02 will require leases to be classified as either operating or finance. Operating leases will result in straight-line expense while finance leases will result in a front-loaded expense pattern. The new standard will be effective for the Company on January 1, 2019 and will be adopted using a modified retrospective approach which will require application of the new guidance at the beginning of the earliest comparative period presented. The Company is currently evaluating the effect that ASU 2016-02 will have on its financial statements and related disclosures.

 

 

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3. Available-for-Sale Securities

The Company invests in available-for-sale securities consisting of money market funds, certificates of deposit, U.S. Treasury securities and U.S. government sponsored enterprise securities. Available-for-sale securities are classified as part of either cash and cash equivalents or short-term investments in the condensed balance sheets. Available-for-sale securities with maturities of three months or less from the date of purchase have been classified as cash equivalents, and were $13.1 million and $18.5 million as of June 30, 2017 and December 31, 2016, respectively. Available-for-sale securities with maturities of more than three months from the date of purchase have been classified as short-term investments, and were as follows as of June 30, 2017 and December 31, 2016 (in thousands):

 

 

Amortized Cost

 

 

Unrealized Gain

 

 

Unrealized Loss

 

 

Market Value

 

June 30, 2017:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury securities

$

32,517

 

 

$

 

 

$

(34

)

 

$

32,483

 

U.S. government sponsored enterprise securities

 

95,802

 

 

 

 

 

 

(85

)

 

 

95,717

 

 

$

128,319

 

 

$

 

 

$

(119

)

 

$

128,200

 

December 31, 2016:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury securities

$

45,625

 

 

$

 

 

$

(26

)

 

$

45,599

 

U.S. government sponsored enterprise securities

 

121,694

 

 

 

4

 

 

 

(19

)

 

 

121,679

 

Certificates of deposit

 

4,944

 

 

 

 

 

 

 

 

 

4,944

 

 

$

172,263

 

 

$

4

 

 

$

(45

)

 

$

172,222

 

 

The Company determined that there were no other-than-temporary declines in the value of any available-for-sale securities as of June 30, 2017. All of the Company’s available-for-sale investment securities mature within one year.

The Company obtains the fair value of its available-for-sale securities from a professional pricing service. The fair values of available-for-sale securities are validated by comparing the fair values reported by the professional pricing service to quoted market prices or to fair values obtained from the custodian bank.

 

 

4. Balance Sheet Details

Prepaid and Other Current Assets

Prepaid and other current assets are comprised of the following (in thousands):

 

 

June 30,

 

 

December 31,

 

 

2017

 

 

2016

 

Prepaid clinical trial costs

$

1,860

 

 

$

2,161

 

Other

 

1,678

 

 

 

2,155

 

Total

$

3,538

 

 

$

4,316

 

 

Inventory

Inventory is comprised of the following (in thousands):

 

 

June 30,

 

 

December 31,

 

 

2017

 

 

2016

 

Raw materials

$

366

 

 

$

214

 

Work in process

 

622

 

 

 

916

 

Finished goods

 

203

 

 

 

305

 

Total

$

1,191

 

 

$

1,435

 

 

During the three and six months ended June 30, 2017, the Company recorded inventory write downs of $0.1 million and $0.2 million, respectively, for inventory nearing expiration that was in excess of current expected customer demand. No inventory write downs were recorded for the three and six months ended June 30, 2016.

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Property and Equipment, Net

Property and equipment, net is comprised of the following (in thousands):

 

 

June 30,

 

 

December 31,

 

 

2017

 

 

2016

 

Laboratory equipment

$

3,221

 

 

$

2,910

 

Manufacturing equipment

 

1,102

 

 

 

870

 

Computer equipment and software

 

744

 

 

 

733

 

Leasehold improvements

 

710

 

 

 

830

 

Office furniture

 

1,581

 

 

 

1,474

 

 

 

7,358

 

 

 

6,817

 

Less: accumulated depreciation

 

(2,256

)

 

 

(1,840

)

Total

$

5,102

 

 

$

4,977

 

 

Accrued Expenses

Accrued expenses are comprised of the following (in thousands):

 

 

June 30,

 

 

December 31,

 

 

2017

 

 

2016

 

Accrued clinical trial costs

$

2,008

 

 

$

4,352

 

Accrued other

 

2,823

 

 

 

4,712

 

Total

$

4,831

 

 

$

9,064

 

 

 

5. Commitments and Contingencies

Intellectual Property Licenses

The Company has acquired exclusive rights to develop patented rights, information rights and related know-how for OTIPRIO, OTIVIDEX and OTO-311 and potential future product candidates under licensing agreements with third parties. The licensing rights obligate the Company to make payments to the licensors for license fees, milestones and royalties. The Company is also responsible for patent prosecution costs, in the event such costs are incurred.

Under one of these agreements, the Company has achieved six development milestones and one regulatory milestone, totaling $2.8 million, related to its clinical trials for OTIPRIO, OTIVIDEX and OTO-311. The Company may be obligated to make additional milestone payments under the Company’s intellectual property license agreements as follows (in thousands):

 

Development

$

2,100

 

Regulatory

 

10,150

 

Commercialization

 

1,000

 

Total

$

13,250

 

 

In addition, the Company is obligated to pay royalties of less than five percent on net sales of OTIPRIO and on sales of any other commercial products developed using these licensed technologies. Such royalty expense for OTIPRIO is recorded to cost of product sales. The Company may also be obligated to pay to the licensors a percentage of fees received if and when the Company sublicenses the technology. As of June 30, 2017, the Company has not entered into any sublicense agreements for the licensed technologies.

 

Other Royalty Arrangements

The Company entered into an agreement related to OTIPRIO under which the Company is obligated to pay a one-time milestone payment of $0.5 million upon the first commercial sale of OTIPRIO and to pay royalties of less than one percent on net product sales of OTIPRIO. This milestone payment was paid during March 2016 and both this milestone payment and the royalties are recorded as selling, general and administrative expense. The royalties are payable until the later of: (i) the expiration of the last to expire patent owned by the Company in such country covering OTIPRIO; or (ii) 10 years after the first commercial sale of OTIPRIO after receipt of regulatory approval for OTIPRIO in such country.

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During October 2014, the Company entered into an exclusive license agreement with Ipsen that enables the Company to use clinical and non-clinical gacyclidine data generated by Ipsen to support worldwide development and regulatory filings for OTO-311. Under this license agreement, the Company is obligated to pay Ipsen low single-digit royalties on annual net sales of OTO-311 by the Company or its affiliates or sublicensees, up to a maximum cumulative royalty totaling $10.0 million.

 

 

6. Fair Value

The accounting guidance defines fair value, establishes a consistency framework for measuring fair value and expands disclosure for each major asset and liability category measured at fair value on either a recurring basis or nonrecurring basis. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants on the measurement date. Accounting guidance establishes a three-tier fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. These tiers are based on the source of the inputs and are as follows:

Level 1: Observable inputs such as quoted prices in active markets for identical assets or liabilities.

Level 2: Inputs other than quoted prices in active markets that are observable either directly or indirectly.

Level 3: Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.

The Company held no liabilities measured at fair value on a recurring basis as of June 30, 2017 and December 31, 2016. The following fair value hierarchy table presents the Company’s assets measured at fair value on a recurring basis as of June 30, 2017 and December 31, 2016 (in thousands):

 

 

Fair Value Measurement at Reporting Date Using

 

 

Total

 

 

Level 1

 

 

Level 2

 

 

Level 3

 

June 30, 2017:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Money market funds

$

13,110

 

 

$

13,110

 

 

$

 

 

$

 

U.S. Treasury securities

 

32,483

 

 

 

32,483

 

 

 

 

 

 

 

U.S. government sponsored enterprise securities

 

95,717

 

 

 

 

 

 

95,717

 

 

 

 

 

$

141,310

 

 

$

45,593

 

 

$

95,717

 

 

$

 

December 31, 2016:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Money market funds

$

18,476

 

 

$

18,476

 

 

$

 

 

$

 

U.S. Treasury securities

 

45,599

 

 

 

45,599

 

 

 

 

 

 

 

U.S. government sponsored enterprise securities

 

121,679

 

 

 

 

 

 

121,679

 

 

 

 

Certificates of deposit

 

4,944

 

 

 

 

 

 

4,944

 

 

 

 

 

$

190,698

 

 

$

64,075

 

 

$

126,623

 

 

$

 

 

 

7. Stockholders’ Equity

Common Stock Reserved for Future Issuance

Shares of common stock reserved for future issuance are as follows:

 

 

June 30,

 

 

December 31,

 

 

2017

 

 

2016

 

Warrants for the purchase of common stock

 

141,060

 

 

 

141,060

 

Common stock options issued and outstanding

 

5,537,575

 

 

 

5,149,973

 

Common stock options available for future grant

 

2,651,637

 

 

 

1,531,216

 

Common stock reserved for issuance under ESPP

 

1,335,018

 

 

 

918,569

 

Total common stock reserved for future issuance

 

9,665,290

 

 

 

7,740,818

 

 

 

8. Stock-Based Compensation

The 2014 Plan permits the grant of incentive stock options to the Company’s employees and the grant of nonstatutory stock options, restricted stock, restricted stock units, stock appreciation rights, performance units and performance shares to the Company’s

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employees, directors and consultants. Options granted under the 2014 Plan are generally scheduled to vest over four years, subject to continued service, and subject to certain acceleration of vesting provisions, expire no later than 10 years from the date of grant. Options granted under the 2014 Plan must have a per share exercise price equal to at least 100% of the fair market value of a shares of the common stock as of the date of grant.

The following table summarizes stock option activity for the six months ended June 30, 2017 (share amounts in thousands):

 

 

Options

 

 

Weighted-

Average

Exercise Price

 

Outstanding as of December 31, 2016

 

5,150

 

 

$

15.01

 

Granted

 

1,430

 

 

$

14.29

 

Exercised

 

(5

)

 

$

12.10

 

Forfeited

 

(1,037

)

 

$

18.65

 

Outstanding as of June 30, 2017

 

5,538

 

 

$

14.15

 

 

Total non-cash stock-based compensation expense recognized in the accompanying condensed statements of operations is as follows (in thousands):

 

 

Three Months Ended June 30,

 

 

Six Months Ended June 30,

 

 

2017

 

 

2016

 

 

2017

 

 

2016

 

Cost of product sales

$

6

 

 

$

4

 

 

$

12

 

 

$

4

 

Research and development

 

1,359

 

 

 

778

 

 

 

2,344

 

 

 

1,425

 

Selling, general and administrative

 

2,126

 

 

 

2,444

 

 

 

4,861

 

 

 

4,533

 

Total stock-based compensation

$

3,491

 

 

$

3,226

 

 

$

7,217

 

 

$

5,962

 

 

 

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ITEM 2.

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

The following discussion and analysis of our financial condition and results of operations should be read together with our financial statements and the other financial information appearing elsewhere in this Quarterly Report on Form 10-Q. These statements generally relate to future events or to our future financial performance and involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. The following discussion and analysis contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Our actual results and the timing of events may differ materially from those discussed in our forward-looking statements as a result of various factors, including those discussed below and those discussed in the section titled “Risk Factors” included in this Quarterly Report on Form 10-Q.

Forward-looking statements include, but are not limited to, statements about:

 

our expectations regarding our clinical development and commercialization of OTIPRIO;

 

our expectations regarding our clinical development of OTIVIDEX, including but not limited to the timing of results for the AVERTS-1 and AVERTS-2 Phase 3 clinical trials;

 

our expectations regarding our clinical development of OTIVIDEX for a second indication;

 

our expectations regarding the clinical development of OTO-311, including but not limited to our plans to initiate a Phase 2 clinical trial in tinnitus patients;

 

our expectations regarding our future development of our product candidates for additional indications;

 

the timing or likelihood of regulatory filings and approvals;

 

our expectations regarding the future development of other product candidates;

 

our expectations regarding the multiple-dose clinical safety requirement for U.S. regulatory approval of OTIVIDEX in the United States in patients with Ménière’s disease;

 

the potential for commercialization of our product candidates, if approved;

 

our expectations and statements regarding the pricing, market size, opportunity and growth potential for OTIPRIO, and OTIVIDEX and OTO-311, if approved for commercial use;

 

our expectations and statements regarding the adoption and use of OTIPRIO, and OTIVIDEX and OTO-311, if approved, by ear, nose and throat physicians (ENTs);

 

our expectations regarding potential coverage and reimbursement relating to OTIPRIO, and OTIVIDEX and OTO-311, if approved, or any other approved product candidates;

 

our plans regarding the use of contract manufacturers for the production of our product candidates for clinical trials and, if approved, commercial use;

 

our plans and ability to effectively expand and manage our own sales and marketing capabilities, or seek and establish collaborative partners, to commercialize our products;

 

our expectations regarding the financial and other impact of the changes to our sales organization;

 

our ability to advance product candidates into, and successfully complete, clinical trials;

 

the implementation of our business model, strategic plans for our business, products and technology;

 

the initiation, timing, progress and results of future nonclinical studies and clinical trials;

 

the scope of protection we are able to establish and maintain for intellectual property rights covering our products and technology;

 

estimates of our expenses, future revenue, capital requirements and our needs for additional financing;

 

our financial performance;

 

accounting principles, policies and estimates;

 

developments and projections relating to our competitors and our industry; and

 

our expectations regarding the period during which we qualify as an emerging growth company under the JOBS Act.

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These forward-looking statements are subject to a number of risks, uncertainties, and assumptions, including but not limited to: our limited operating history and our expectation that we will incur significant losses for the foreseeable future; our ability to obtain additional financing; our dependence on the commercial success of OTIPRIO and the regulatory success and advancement of additional product candidates, such as OTIVIDEX and OTO-311, and label expansion indications for OTIPRIO; the uncertainties inherent in the clinical drug development process, including, without limitation, our ability to adequately demonstrate the safety and efficacy of our product candidates, the nonclinical and clinical results for our product candidates, which may not support further development, and challenges related to patient enrollment in clinical trials; our ability to obtain regulatory approval for our product candidates; side effects or adverse events associated with our product candidates; competition in the biopharmaceutical industry; our dependence on third parties to conduct nonclinical studies and clinical trials; the timing and outcome of hospital pharmacy and therapeutics reviews and other facility reviews; the impact of coverage and reimbursement decisions by third-party payors on the pricing and market acceptance of OTIPRIO; our dependence on third parties for the manufacture of OTIPRIO and product candidates; our dependence on a small number of suppliers for raw materials; our ability to protect our intellectual property related to OTIPRIO and our product candidates in the United States and throughout the world; expectations regarding potential market size, opportunity and growth; our ability to manage operating expenses; implementation of our business model and strategic plans for our business, products and technology; and other risks. In some cases, you can identify these statements by terms such as “anticipate,” “believe,” “could,” “estimate,” “expects,” “intend,” “may,” “plan,” “potential,” “predict,” “project,” “should,” “will,” “would” or the negative of those terms, and similar expressions that convey uncertainty of future events or outcomes. These forward-looking statements reflect our beliefs and views with respect to future events and are based on estimates and assumptions as of the date of this Quarterly Report on Form 10-Q and are subject to risks and uncertainties. We discuss many of these risks in greater detail in the section titled “Risk Factors” included in Part II, Item 1A and elsewhere in this report. Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time. It is not possible to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. Given these uncertainties, you should not place undue reliance on these forward-looking statements. We qualify all of the forward-looking statements in this Quarterly Report on Form 10-Q by these cautionary statements. Except as required by law, we assume no obligation to update these forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in any forward-looking statements, whether as a result of new information, future events or otherwise.

Otonomy, the Otonomy logo, OTIPRIO, OTIVIDEX and other trademarks or service marks of Otonomy appearing in this report are the property of Otonomy. Trade names, trademarks and service marks of other companies appearing in this report are the property of their respective holders. We have generally omitted the ®, ™ and other designations, as applicable, in this report.

Overview

We are a biopharmaceutical company focused on the development and commercialization of innovative therapeutics for diseases and disorders of the ear. OTIPRIO® (ciprofloxacin otic suspension) is approved in the United States for use during tympanostomy tube placement (TTP) surgery in pediatric patients. We have filed a Supplemental New Drug Application (sNDA) for OTIPRIO in acute otitis externa (AOE) with the United States Food and Drug Administration (FDA) and been assigned a Prescription Drug User Fee Act (PDUFA) action date of March 2, 2018. We have also completed a successful End-of-Phase 2 review with the FDA for OTIPRIO in patients with acute otitis media with tympanostomy tubes (AOMT). OTIVIDEXTM (formerly known as OTO-104) is a steroid in development for the treatment of Ménière’s disease and other balance and hearing disorders. Two Phase 3 trials in Ménière’s disease patients are ongoing, AVERTS-1 in the United States and AVERTS-2 in Europe, with AVERTS-1 results expected in September 2017 and AVERTS-2 results expected by the end of 2017. In addition, a Phase 2 trial of OTIVIDEX is ongoing in patients at risk for cisplatin-induced hearing loss. OTO-311 is a N-Methyl-D-Aspartate (NMDA) receptor antagonist for the treatment of tinnitus that has completed a Phase 1 clinical safety trial with a Phase 2 trial expected to be initiated by the end of 2017. A fourth program targeting sensorineural hearing loss including age-related hearing loss is in preclinical development. OTIPRIO and our current product candidates utilize our proprietary formulation technology that combines a thermosensitive gel with drug microparticles to enable a single dose treatment by a physician.

In the first quarter of 2017, we realigned our sales territories to optimize the coverage of accounts with current or near-term potential for OTIPRIO utilization, enabling us to reduce the size of the sales force from 40 to 20 sales representatives. As part of refocusing our commercial effort, we hired a new vice president of sales and our chief commercial officer left the Company. In the second quarter of 2017, we replaced nearly all of the remaining 20 sales representatives with individuals having significant sales experience in the ENT field with products routinely used in the hospital operating room setting. We estimate that during 2017 we will save cash of at least $3 million as a result of these changes, net of the termination benefits we paid out in cash during the first half of 2017.

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We have a limited operating history. Since our inception in 2008, we have devoted substantially all our efforts to developing and commercializing OTIPRIO, developing our current product candidates, and providing general and administrative support for these operations. As of June 30, 2017, we had cash, cash equivalents and short-term investments of $150.5 million.

We have never been profitable, and as of June 30, 2017, we had an accumulated deficit of $325.0 million. Our net losses were $23.2 million and $29.7 million for the three months ended June 30, 2017 and 2016, respectively, and $50.3 million and $56.4 million for the six months ended June 30, 2017 and 2016, respectively. Substantially all our net losses have resulted from research and development expenses related to our ongoing clinical trials and product development activities, commercialization expenses to launch OTIPRIO in the U.S. market, and other general and administrative expenses.

We expect to continue to incur significant expenses and operating losses for the foreseeable future as we continue to commercialize and develop OTIPRIO, and develop, seek regulatory approval, and, if approved, commercialize our product candidates. In the near term, we anticipate that our expenses will continue to be substantial as we:

 

commercialize OTIPRIO in the United States;

 

conduct clinical development and seek regulatory approval in additional indications for OTIPRIO;

 

conduct clinical development of OTIVIDEX and OTO-311;

 

conduct nonclinical development of our product candidates;

 

contract to manufacture our product candidates;

 

evaluate opportunities for development of additional product candidates;

 

maintain and expand our intellectual property portfolio;

 

hire additional staff, including clinical, scientific, medical, operational, financial, sales and marketing and management personnel, to execute our business plan; and

 

operate as a public company.

We may require additional financing to commercialize OTIPRIO and continue its development for additional indications, and to complete the development of and, if approved, commercialize, OTIVIDEX, OTO-311 and any other product candidates. We believe that we will continue to expend substantial resources for the foreseeable future for the commercialization of OTIPRIO and the development of OTIVIDEX, OTO-311 and any other product candidates we may choose to pursue. These expenditures will include costs associated with marketing and selling any products approved for sale, manufacturing, preparing regulatory submissions, and conducting nonclinical studies and clinical trials. The amount and timing of our future funding requirements, if any, will depend on many factors, including the pace and results of our clinical development efforts, the timing and nature of the regulatory approval process for our product candidates, and our ability to effectively commercialize OTIPRIO. If additional financing is required, we anticipate that we will seek funding through public or private equity or debt financings or other sources, such as potential collaboration arrangements. We may not be able to raise capital on terms acceptable to us, or at all. Our failure to raise capital as and when needed could have a negative impact on our financial condition and our ability to pursue our business strategies. We believe that our existing cash and cash equivalents and short-term investments will be sufficient to fund our currently planned operations through at least the next 24 months.

In November 2008, we entered into an exclusive license agreement with the Regents of the University of California, or UC. Under the license agreement, UC granted us an exclusive license under their rights to patents and applications that are co-developed and co-owned with us for the treatment of human otic diseases. Our financial obligations under the license agreement include development milestone payments of up to $2.7 million per licensed product, of which $1.9 million has been paid for OTIPRIO, $0.8 million has been paid for OTIVIDEX, and $0.1 million has been paid for OTO-311 (but such milestone payments are reduced by 75% for any orphan indication product), and a low single-digit royalty on net sales by us or our affiliates of licensed products. In addition, for each sublicense we grant we are obligated to pay UC a fixed percentage of all royalties as well as a sliding-scale percentage of non-royalty sublicense fees received by us under such sublicense, with such percentage depending on the licensed product’s stage of development when sublicensed to such third party. We have the right to offset a certain amount of third-party royalties, milestone fees or sublicense fees against the foregoing financial obligations, provided such third-party royalties or fees are paid by us in consideration for intellectual property rights necessary to commercialize a licensed product.

In April 2013, we entered into an exclusive license agreement with DURECT Corporation, or Durect, as part of an asset transfer agreement between us and IncuMed LLC, an affiliate of the NeuroSystec Corporation. Under this license agreement, Durect granted us an exclusive, worldwide, royalty-bearing license under Durect’s rights to certain patents and applications that cover our OTO-311 product candidate, as well as certain related know-how. Under this license agreement and the asset transfer agreement, we are obligated to make one-time milestone payments of up to $7.5 million for the first licensed product. Upon commercializing a licensed

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product, we are obligated to pay Durect tiered, low single-digit royalties on annual net sales by us or our affiliates or sublicensees of the licensed products, and we have the right to offset a certain amount of third-party license fees or royalties against such royalty payments to Durect. In addition, each sublicense we grant to a third party is subject to payment to Durect of a low double-digit percentage of all non-royalty payments we receive under such sublicense. Additionally, we are also obligated to pay the Institut National de la Sante et de la Recherche Medicale, or INSERM, on behalf of Durect, for a low single-digit royalty payment on net sales by us or our affiliates or sublicensees upon commercialization of the licensed product. The foregoing royalty payment obligation to Durect would continue on a product-by-product and country-by-country basis until expiration or determination of invalidity of the last valid claim within the licensed patents that cover the licensed product, and the payment obligation to INSERM would continue so long as Durect’s license from INSERM remains in effect.

Financial Operations Overview

Revenue

In December 2015, OTIPRIO was approved by the FDA for the treatment of pediatric patients with bilateral otitis media with effusion undergoing TTP surgery. In March 2016, we began sales of OTIPRIO in the United States to our network of specialty distributors who fill orders received from hospitals and ambulatory surgery centers who are the primary end user customers of OTIPRIO for the approved indication. We are commercializing OTIPRIO using an internal sales force.

Product sales are recorded net of estimated chargebacks, government rebates and distributor fees. We expect revenues to increase in the future due to increased OTIPRIO sales.

Prior to March 2016 we had not generated revenue. We do not expect to generate any revenue from any of our product candidates unless and until we obtain regulatory approval and commercialize our products or enter into collaborative agreements with third parties.

Operating Expenses

Cost of product sales

Cost of product sales consists primarily of direct and indirect costs related to the manufacturing of OTIPRIO incurred following the receipt of regulatory approval, including third party manufacturing costs, allocation of overhead costs and royalty payments based on OTIPRIO sales. Costs incurred to manufacture OTIPRIO commercial supply following the receipt of FDA approval in December 2015 were capitalized to inventory during the three months ended March 31, 2016, when those costs were incurred. No commercial supply of OTIPRIO was manufactured prior to regulatory approval.

Research and development expenses

Our research and development expenses primarily consist of costs associated with the continued clinical development of OTIPRIO for additional indications, and nonclinical and clinical development of our product candidates. Our research and development expenses include:

 

employee-related expenses, including salaries, benefits, travel and stock-based compensation expense;

 

external development expenses incurred under arrangements with third parties, such as fees paid to contract research organizations (CROs) in connection with nonclinical studies and clinical trials, costs of acquiring and evaluating clinical trial data such as investigator grants, patient screening fees, laboratory work and statistical compilation and analysis, and fees paid to consultants and our scientific advisory board;

 

costs to acquire, develop and manufacture clinical trial materials, including fees paid to contract manufacturers;

 

payments related to licensed product candidates and technologies;

 

costs related to compliance with drug development regulatory requirements; and

 

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

We expense our internal and third-party research and development expenses as incurred.

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The following table summarizes our research and development expenses (in thousands) for OTIPRIO and our current product candidates:

 

 

Three Months Ended June 30,

 

 

Six Months Ended June 30,

 

 

2017

 

 

2016

 

 

2017

 

 

2016

 

Third-party development costs:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

OTIPRIO

$

1,258

 

 

$

5,523

 

 

$

2,431

 

 

$

8,832

 

OTIVIDEX

 

4,387

 

 

 

5,875

 

 

 

10,013

 

 

 

10,862

 

OTO-311

 

19

 

 

 

475

 

 

 

20

 

 

 

1,122

 

Total third-party development costs

 

5,664

 

 

 

11,873

 

 

 

12,464

 

 

 

20,816

 

Other unallocated internal research and development costs

 

7,050

 

 

 

4,869

 

 

 

13,435

 

 

 

9,798

 

Total research and development costs

$

12,714

 

 

$

16,742

 

 

$

25,899

 

 

$

30,614

 

 

We expect our research and development expenses to continue to be substantial for the foreseeable future as we pursue expanded indications for OTIPRIO and advance our other product candidates through their respective development programs. The process of conducting nonclinical studies and clinical trials necessary to obtain regulatory approval is costly and time consuming. We may never succeed in achieving regulatory approval for expanded indications for OTIPRIO or for our product candidates. The probability of success will be affected by numerous factors, including nonclinical data, clinical data, competition, manufacturing capability and commercial viability. We are responsible for all of the research and development costs for our programs.

Completion dates and completion costs can vary significantly for each of our clinical development programs and are difficult to predict. We therefore cannot estimate with any degree of certainty the costs we will incur in connection with development of OTIPRIO and our product candidates. We anticipate that we will make determinations as to which programs and product candidates to pursue and how much funding to direct to each program and product candidate on an ongoing basis in response to the results of ongoing and future clinical trials, regulatory developments, and our ongoing assessments as to each current or future product candidate’s commercial potential. We may need to raise substantial additional capital in the future to commercialize OTIPRIO and continue its development for additional indications and complete the development of and, if approved, commercialize, our product candidates. We may enter into collaborative agreements in the future in order to conduct clinical trials and gain regulatory approval of our product candidates, particularly in markets outside of the United States. We cannot forecast which programs or product candidates may be subject to future collaborations, when such arrangements will be secured, if at all, and to what degree such arrangements would affect our development plans and overall capital requirements.

The costs of clinical trials may vary significantly over the life of a program owing to the following:

 

per patient trial costs;

 

the number of sites included in the trials;

 

the countries in which the trials are conducted;

 

the length of time required to enroll eligible patients;

 

the number of patients that participate in the trials;

 

the number of doses that patients receive;

 

the drop-out or discontinuation rates of patients;

 

potential additional safety monitoring or other studies requested by regulatory agencies;

 

the duration of patient follow-up;

 

the phase of development of the product candidate; and

 

the efficacy and safety profile of the product candidate.

Selling, general and administrative expenses

Our selling, general and administrative expenses consist primarily of salaries, benefits, travel and stock-based compensation expense, and other related costs for our employees and consultants in executive, commercial, administrative, finance and human resource functions. Other general and administrative expenses include facility-related costs not otherwise included in research and development and professional fees for accounting, auditing, tax and legal fees, and other costs associated with obtaining and maintaining our patent portfolio, commercial activities for OTIPRIO and commercial preparation activities for our product candidates.

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We expect our selling, general and administrative expenses to continue to be substantial as we support commercialization of OTIPRIO and development of our product candidates, and as we incur ongoing expenses related to audit, legal, regulatory, and tax-related services associated with maintaining compliance with stock exchange listing and SEC requirements, director’s and officer’s liability insurance premiums, and investor relations-related expenses. As discussed above, we estimate that during 2017 we will save cash of at least $3 million as a result of these commercial personnel changes, net of the termination benefits we paid out in cash during the first half of 2017.

Other Income

Other income primarily consists of interest income earned on cash and cash equivalents and short-term investments.

Critical Accounting Policies and Significant Judgments and Estimates

Our management’s discussion and analysis of our financial condition and results of operations is based on our condensed financial statements. Our financial statements are prepared in accordance with generally accepted accounting principles in the United States of America. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, and expenses and the disclosure of contingent assets and liabilities in our financial statements. On an ongoing basis, actual results may differ significantly from our estimates.

We believe that the estimates, assumptions and judgments involved in the accounting policies described in the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2016, as filed with the SEC on March 2, 2017, have the greatest potential impact on our financial statements, so we consider them to be our critical accounting policies and estimates. There were no material changes to our critical accounting policies and estimates during the six months ended June 30, 2017.

Results of Operations

Comparison of the Three Months Ended June 30, 2017 and 2016

The following table sets forth the significant components of our results of operations for the three months ended June 30, 2017 and 2016 (in thousands):

 

 

Three Months Ended June 30,

 

 

 

 

 

 

2017

 

 

2016

 

 

Change

 

Product sales, net

$

326

 

 

$

76

 

 

$

250

 

Cost of product sales

 

397

 

 

 

395

 

 

 

2

 

Research and development

 

12,714

 

 

 

16,742

 

 

 

(4,028

)

Selling, general and administrative

 

10,747

 

 

 

12,846

 

 

 

(2,099

)

Interest income

 

311

 

 

 

231

 

 

 

80

 

 

Product sales, net. OTIPRIO was launched in March 2016. The increase of $0.3 million was a result of our commercial efforts since launch.    

Cost of product sales. Cost of product sales for the three months ended June 30, 2017 is greater than net product sales for this period primarily due to the write down of $0.1 million of excess inventory. 

Research and development expenses. The decrease of $4.0 million in research and development expenses was primarily due to: (i) a $4.8 million decrease in OTIPRIO clinical trial and development expenses mainly due to the completion of the OTIPRIO label expansion trial in AOE; (ii) a $1.6 million decrease in OTIVIDEX clinical trial and development expenses; and (iii) a $0.5 million decrease in development expenses related to OTO-311 due to the completion of the Phase 1 safety trial. These decreases were partially offset by a $1.9 million increase in facilities and personnel costs, including stock-based compensation expense, due to additional headcount, and a $1.0 million increase in OTIPRIO regulatory costs related to the filing of the sNDA for AOE.

Selling, general and administrative expenses. The decrease of $2.1 million in selling, general and administrative expenses was primarily related to reduced personnel costs, including stock compensation expense, resulting from the commercial personnel changes discussed above. These reduced personnel costs are net of one-time termination benefits expense.

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Interest income. Interest income consists primarily of interest earned on our available-for-sale securities. The increase of $0.1 million in interest income was primarily the result of increased available-for-sale securities balances during the three months ended June 30, 2017 compared to the three months ended June 30, 2016.

Comparison of the Six Months Ended June 30, 2017 and 2016

The following table sets forth the significant components of our results of operations for the six months ended June 30, 2017 and 2016 (in thousands):

 

 

Six Months Ended June 30,

 

 

 

 

 

 

2017

 

 

2016

 

 

Change

 

Product sales, net

$

684

 

 

$

89

 

 

$

595

 

Cost of product sales

 

860

 

 

 

404

 

 

 

456

 

Research and development

 

25,899

 

 

 

30,614

 

 

 

(4,715

)

Selling, general and administrative

 

24,839

 

 

 

25,841

 

 

 

(1,002

)

Interest income

 

615

 

 

 

332

 

 

 

283

 

 

Product sales, net. OTIPRIO was launched in March 2016. The increase of $0.6 million was a result of our commercial efforts since launch and due to the full six months of sales during the six months ended June 30, 2017.

Cost of product sales. The increase of $0.5 million in cost of product sales was primarily due to the increase in sales volume and the write down of $0.2 million of excess inventory during the six months ended June 30, 2017. Cost of product sales for the six months ended June 30, 2017 is greater than net product sales for this period primarily due to the write down of $0.2 million of excess inventory.

Research and development expenses. The decrease of $4.7 million in research and development expenses was primarily due to: (i) a $7.3 million decrease in OTIPRIO clinical trial and development expenses mainly due to the completion of the label expansion trials in AOE and AOMT; (ii) a $1.1 million decrease in development expenses related to OTO-311 due to the completion of the Phase 1 safety trial; and (iii) a $0.7 million decrease in OTIVIDEX clinical trial and development expenses. These decreases were partially offset by a $3.2 million increase in facilities and personnel costs, including stock-based compensation expense, due to additional headcount, and a $1.2 million increase in OTIPRIO regulatory costs related to the filing of the sNDA for AOE.

Selling, general and administrative expenses. The decrease of $1.0 million in selling, general and administrative expenses was primarily related to reduced personnel costs, including stock compensation expense, of approximately $1.8 million resulting from the commercial personnel changes discussed above. These reduced personnel costs are net of one-time termination benefits expense, including one-time stock compensation expense. This decrease was partially offset by a $0.8 million increase in facilities expense primarily due to the lease of our new headquarters facility which began in December 2016.

Interest income. Interest income consists primarily of interest earned on our available-for-sale securities. The increase of $0.3 million in interest income was primarily the result of increased available-for-sale securities balances during the six months ended June 30, 2017 compared to the six months ended June 30, 2016.

Liquidity and Capital Resources

We have incurred significant losses and negative cash flows from operations since our inception. As of June 30, 2017, we had an accumulated deficit of $325.0 million and we expect to continue to incur significant losses for the foreseeable future. We expect our research and development and selling, general and administrative expenses to continue to be substantial for the foreseeable future and, as a result, we may need additional capital to fund our operations, which we may obtain through one or more public or private equity or debt financings, or other sources such as potential collaboration arrangements.

As of June 30, 2017, we had cash, cash equivalents and short-term investments of $150.5 million. We have principally financed our operations through sales and issuances of our equity securities as well as private placements of redeemable convertible preferred stock and convertible notes.

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The following table sets forth a summary of the primary sources and uses of cash for the six months ended June 30, 2017 and 2016 (in thousands):

 

 

Six Months Ended June 30,

 

 

2017

 

 

2016

 

Net cash (used in) provided by:

 

 

 

 

 

 

 

Operating activities

$

(45,265

)

 

$

(53,597

)

Investing activities

 

42,956

 

 

 

(166,834

)

Financing activities

 

485

 

 

 

108,336

 

Net increase (decrease) in cash

 

(1,824

)

 

 

(112,095

)

 

Operating activities. For both periods presented, the primary uses of cash were to fund development activities for our product candidates and to support the commercialization of OTIPRIO, which activities and uses of cash we expect to continue for the foreseeable future.

During the six months ended June 30, 2017, we used cash in operating activities of $45.3 million, while our net loss was $50.3 million. The difference consisted of $9.6 million of non-cash adjustments, primarily comprised of stock-based compensation expense and deferred rent expense, which was partially offset by a $4.6 million net change in our operating assets and liabilities.

During the six months ended June 30, 2016, we used cash in operating activities of $53.6 million, while our net loss was $56.4 million. The difference consisted of $6.5 million of non-cash adjustments, primarily comprised of stock-based compensation expense, together with a $3.7 million net change in our operating assets and liabilities.

Investing activities. Net cash provided by investing activities was $43.0 million during the six months ended June 30, 2017. During the six months ended June 30, 2017, $117.3 million was provided by maturities of short-term investments, which was partially offset by $73.6 million used to purchase short-term investments and $0.7 million used for capital expenditures.

Net cash used in investing activities was $166.8 million during the six months ended June 30, 2016. During the six months ended June 30, 2016, $189.7 million was used to purchase short-term investments and $0.4 million was used for capital expenditures, which were partially offset by $23.3 million provided by maturities of short-term investments.

Financing activities. Net cash provided by financing activities was $0.5 million for the six months ended June 30, 2017. During the six months ended June 30, 2017, net cash provided by financing activities was for shares issued for stock option exercises and under our employee stock purchase plan.

Net cash provided by financing activities was $108.3 million for the six months ended June 30, 2016. During the six months ended June 30, 2016, proceeds from our public offering of common stock completed in January 2016 were $107.6 million after deducting underwriting discounts, commissions and offering-related transaction costs, and other proceeds from financing activities were $0.7 million for shares issued for stock option exercises and under our employee stock purchase plan.

Funding Requirements

We expect to continue to incur significant losses for the foreseeable future as we: (i) commercialize OTIPRIO and continue its development for additional indications; (ii) develop and seek regulatory approvals for our product candidates OTIVIDEX and OTO-311; and (iii) work to develop additional product candidates through research and development programs. We are subject to all of the risks incident in the development of new therapeutic products, and we may encounter unforeseen expenses, difficulties, complications, delays and other unknown factors that may adversely affect our business.

We believe that our existing cash and cash equivalents and short-term investments will be sufficient to fund our currently planned operations through at least the next 24 months.

We may require additional financing to commercialize OTIPRIO and continue its development for additional indications, and to complete the development of and, if approved, commercialize OTIVIDEX, OTO-311 and any other product candidates. If additional financing is required, we anticipate that we will seek funding through public or private equity or debt financings or other sources, such as potential collaboration arrangements. We may not be able to raise capital on terms acceptable to us, or at all. If we are unable to raise additional capital in sufficient amounts or on terms acceptable to us, we may have to significantly delay, scale back or discontinue the development or commercialization of one or more of our product candidates. If we raise additional funds through the issuance of additional debt or equity securities, it could result in dilution to our existing stockholders, increased fixed payment

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obligations and the existence of securities with rights that may be senior to those of our common stock. If we incur indebtedness, we could become subject to covenants that would restrict our operations and potentially impair our competitiveness, such as limitations on our ability to incur additional debt, limitations on our ability to acquire, sell or license intellectual property rights and other operating restrictions that could adversely impact our ability to conduct our business. Any collaboration agreements we enter into may provide capital in the near-term but limit our potential cash flow and revenue in the future. Any of the foregoing could significantly harm our business, financial condition and prospects.

Our forecast of the period of time through which our financial resources will be adequate to support our operations is a forward-looking statement and involves risks and uncertainties, and actual results could vary as a result of a number of factors. We have based this estimate on assumptions that may prove to be wrong, and we could utilize our available capital resources sooner than we currently expect. The amount and timing of future funding requirements, both near- and long-term, will depend on many factors, including:

 

the revenue generated by OTIPRIO and our product candidates, if approved;

 

the cost of commercialization activities for OTIPRIO and our other products that may be approved for sale, if any, including marketing, sales and distribution costs and related facilities expansion costs;

 

the timing of, and the costs involved in, clinical development and obtaining regulatory approval for OTIPRIO in label expansion indications;

 

the timing of, and the costs involved in, nonclinical and clinical development and obtaining regulatory approvals for OTIVIDEX, OTO-311 or any future product candidates;

 

the cost of manufacturing OTIPRIO and our product candidates;

 

the number and characteristics of any other product candidates we develop or acquire;

 

our ability to establish and maintain strategic collaborations, licensing or other commercialization arrangements and the terms and timing of such arrangements;

 

the degree and rate of market acceptance of OTIPRIO and any other approved products;

 

the emergence, approval, availability, perceived advantages, relative cost, relative safety and relative efficacy of other products or treatments;

 

the expenses needed to attract and retain skilled personnel;

 

the costs associated with being a public company;

 

the costs involved in preparing, filing, prosecuting, maintaining, defending and enforcing patent claims and other intellectual property rights, including litigation costs and the outcome of such litigation;

 

the extent to which we are required to pay milestone or other payments under our in-license agreements and the timing of such payments; and

 

the cost of litigation, including any product liability or other lawsuits related to our products.

If we cannot expand our operations or otherwise capitalize on our business opportunities because we lack sufficient capital, our business, financial condition and results of operations could be materially adversely affected.

Off-Balance Sheet Arrangements

During the periods presented we did not have, nor do we currently have, any off-balance sheet arrangements as defined under the applicable rules of the SEC.

Contractual Obligations and Commitments

During the six months ended June 30, 2017, there were no material changes, outside of the ordinary course of business, in our contractual obligations from those disclosed in the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2016, as filed with the SEC on March 2, 2017.

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ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rate Sensitivity

As of June 30, 2017, we had cash and cash equivalents and short-term investments of $150.5 million which are comprised of cash in checking and savings accounts, money market funds and U.S. Treasury securities. The primary objective of our investment activities is to preserve principal and liquidity while maximizing income without significantly increasing risk. We do not enter into investments for trading or speculative purposes. We do not believe that an immediate 10% increase in interest rates would have a material effect on the fair market value of our portfolio, and therefore, we do not expect our operating results or cash flows to be materially affected to any degree by a sudden change in market interest rates.

Foreign Currency Exchange Rate Risk

To date, the vast majority of our contractual obligations have been denominated in U.S. dollars; however, we have contracts with CROs and investigational sites in countries within the European Union and are subject to fluctuations in foreign currency rates in connection with such contracts. In the future, we may contract with other CROs and investigational sites in foreign countries. We do not hedge our foreign currency exchange rate risk. To date, we have not incurred any material effects from foreign currency changes in connection with such contracts.

Inflation

Inflation generally affects us by increasing our cost of labor and clinical trial costs. We do not believe that inflation has had a material effect on our business, financial condition or results of operations during the periods presented.

ITEM 4.

CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Management, with the participation of our Chief Executive Officer and our Chief Financial and Business Officer, evaluated the effectiveness of our disclosure controls and procedures as of June 30, 2017. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of June 30, 2017, our Chief Executive Officer and our Chief Financial and Business Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting identified in connection with the evaluation required by Rule 13a-15(d) and 15d-15(d) of the Exchange Act that occurred during the quarter ended June 30, 2017 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Inherent Limitations of Disclosure Controls and Internal Control over Financial Reporting

Because of their inherent limitations, our disclosure controls and procedures and our internal control over financial reporting may not prevent material errors or fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. The effectiveness of our disclosure controls and procedures and our internal control over financial reporting is subject to risks, including that the controls may become inadequate because of changes in conditions or that the degree of compliance with our policies or procedures may deteriorate.

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