10-Q 1 otic-10q_20180630.htm 10-Q otic-10q_20180630.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, 2018

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 August 3, 2018 was 30,630,125.

 

 


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

16

 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

26

 

 

Item 4. Controls and Procedures

27

 

 

PART II. OTHER INFORMATION

28

 

 

Item 1. Legal Proceedings

28

 

 

Item 1A. Risk Factors

28

 

 

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

57

 

 

Item 3. Default Upon Senior Securities

57

 

 

Item 4. Mine Safety Disclosures

57

 

 

Item 5. Other Information

57

 

 

Item 6. Exhibits

58

 

 

 


 

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,

 

 

2018

 

 

2017

 

 

(unaudited)

 

 

 

 

 

Assets

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

Cash and cash equivalents

$

19,024

 

 

$

18,456

 

Short-term investments

 

80,984

 

 

 

101,548

 

Accounts receivable, net

 

14

 

 

 

107

 

Prepaid and other current assets

 

2,398

 

 

 

2,334

 

Total current assets

 

102,420

 

 

 

122,445

 

Restricted cash

 

1,160

 

 

 

1,158

 

Property and equipment, net

 

4,529

 

 

 

4,679

 

Other long-term assets

 

82

 

 

 

82

 

Total assets

$

108,191

 

 

$

128,364

 

Liabilities and Stockholders' Equity

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

Accounts payable

$

877

 

 

$

961

 

Accrued expenses

 

2,645

 

 

 

3,881

 

Accrued compensation

 

1,943

 

 

 

3,307

 

Current portion of deferred rent

 

39

 

 

 

42

 

Total current liabilities

 

5,504

 

 

 

8,191

 

Deferred rent, net of current portion

 

2,951

 

 

 

2,894

 

Total liabilities

 

8,455

 

 

 

11,085

 

Commitments and Contingencies

 

 

 

 

 

 

 

Stockholders' equity:

 

 

 

 

 

 

 

Preferred stock, $0.001 par value; 10,000,000 shares authorized at June 30, 2018

   and December 31, 2017; no shares issued or outstanding at June 30, 2018 and

   December 31, 2017

 

 

 

 

 

Common stock, $0.001 par value; 200,000,000 shares authorized at June 30, 2018

   and December 31, 2017; 30,630,125 and 30,558,726 shares issued and outstanding

   at June 30, 2018 and December 31, 2017, respectively

 

31

 

 

 

31

 

Additional paid-in capital

 

489,578

 

 

 

482,198

 

Accumulated other comprehensive loss

 

(46

)

 

 

(100

)

Accumulated deficit

 

(389,827

)

 

 

(364,850

)

Total stockholders' equity

 

99,736

 

 

 

117,279

 

Total liabilities and stockholders' equity

$

108,191

 

 

$

128,364

 

 

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,

 

 

2018

 

 

2017

 

 

2018

 

 

2017

 

 

 

 

 

 

(unaudited)

 

 

 

 

 

Product sales, net

$

123

 

 

$

326

 

 

$

424

 

 

$

684

 

Costs and operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of product sales

 

241

 

 

 

397

 

 

 

513

 

 

 

860

 

Research and development

 

8,225

 

 

 

12,714

 

 

 

13,875

 

 

 

25,899

 

Selling, general and administrative

 

5,619

 

 

 

10,747

 

 

 

11,776

 

 

 

24,839

 

Total costs and operating expenses

 

14,085

 

 

 

23,858

 

 

 

26,164

 

 

 

51,598

 

Loss from operations

 

(13,962

)

 

 

(23,532

)

 

 

(25,740

)

 

 

(50,914

)

Interest income

 

409

 

 

 

311

 

 

 

763

 

 

 

615

 

Net loss

$

(13,553

)

 

$

(23,221

)

 

$

(24,977

)

 

$

(50,299

)

Net loss per share, basic and diluted

$

(0.44

)

 

$

(0.77

)

 

$

(0.82

)

 

$

(1.66

)

Weighted-average shares used to compute net loss per share, basic and diluted

 

30,594,288

 

 

 

30,269,190

 

 

 

30,581,481

 

 

 

30,263,042

 

 

See accompanying notes.

 

 

-3-


 

Otonomy, Inc.

Condensed Statements of Comprehensive Loss

(in thousands)

 

 

Three Months Ended June 30,

 

 

Six Months Ended June 30,

 

 

2018

 

 

2017

 

 

2018

 

 

2017

 

 

(unaudited)

 

Net loss

$

(13,553

)

 

$

(23,221

)

 

$

(24,977

)

 

$

(50,299

)

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized gain (loss) on available for sale securities

 

50

 

 

 

(9

)

 

 

54

 

 

 

(78

)

Comprehensive loss

$

(13,503

)

 

$

(23,230

)

 

$

(24,923

)

 

$

(50,377

)

 

See accompanying notes.

 

 

-4-


 

Otonomy, Inc.

Condensed Statements of Cash Flows

(in thousands)

 

 

Six Months Ended June 30,

 

 

2018

 

 

2017

 

 

(unaudited)

 

Cash flows from operating activities:

 

 

 

 

 

 

 

Net loss

$

(24,977

)

 

$

(50,299

)

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

 

 

 

 

 

 

 

Depreciation

 

594

 

 

 

592

 

Stock-based compensation

 

7,151

 

 

 

7,217

 

Amortization of discount or premium on short-term investments

 

(169

)

 

 

307

 

Deferred rent

 

54

 

 

 

1,488

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

Accounts receivable, net

 

93

 

 

 

15

 

Inventory

 

 

 

 

244

 

Prepaid and other assets

 

(64

)

 

 

930

 

Accounts payable

 

(184

)

 

 

 

Accrued expenses

 

(1,237

)

 

 

(4,258

)

Accrued compensation

 

(1,364

)

 

 

(1,501

)

Net cash used in operating activities

 

(20,103

)

 

 

(45,265

)

Cash flows from investing activities:

 

 

 

 

 

 

 

Purchases of short-term investments

 

(54,213

)

 

 

(73,662

)

Maturities of short-term investments

 

75,000

 

 

 

117,299

 

Purchases of property and equipment

 

(343

)

 

 

(681

)

Net cash provided by investing activities

 

20,444

 

 

 

42,956

 

Cash flows from financing activities:

 

 

 

 

 

 

 

Proceeds from exercise of stock options

 

32

 

 

 

58

 

Proceeds from issuance of common stock

 

197

 

 

 

427

 

Net cash provided by financing activities

 

229

 

 

 

485

 

Net change in cash, cash equivalents and restricted cash

 

570

 

 

 

(1,824

)

Cash, cash equivalents and restricted cash at beginning of period

 

19,614

 

 

 

24,853

 

Cash, cash equivalents and restricted cash at end of period

$

20,184

 

 

$

23,029

 

 

 

 

 

 

 

 

 

Cash and cash equivalents at end of period

$

19,024

 

 

$

22,332

 

Restricted cash at end of period

 

1,160

 

 

 

697

 

Cash, cash equivalents and restricted cash at end of period

$

20,184

 

 

$

23,029

 

 

 

 

 

 

 

 

 

Supplemental disclosure of non-cash investing activities:

 

 

 

 

 

 

 

Purchase of property and equipment in accounts payable and accrued expenses

$

166

 

 

$

36

 

 

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. (Otonomy or the Company) was incorporated in the state of Delaware on May 6, 2008. Otonomy is a biopharmaceutical company dedicated to the development of innovative therapeutics for otology. The Company pioneered the application of drug delivery technology to the ear in order to develop products that achieve sustained drug exposure from a single local administration. OTIVIDEXTM is a steroid formulation that has completed two Phase 3 trials for the treatment of Ménière’s disease, with a third Phase 3 trial recently initiated to support a submission for U.S. registration. OTO-313 is a formulation of the potent and selective N-Methyl-D-Aspartate (NMDA) receptor antagonist gacyclidine that is in development for the treatment of tinnitus. Otonomy is also advancing three preclinical-stage programs that address different pathologies of hearing loss: (i) OTO-413 is a formulation of brain-derived neurotrophic factor (BDNF) for the repair of cochlear synaptopathy and the treatment of speech-in-noise hearing difficulties; (ii) OTO-5XX is an otoprotectant for the prevention of cisplatin-induced hearing loss; and (iii) OTO-6XX induces hair cell regeneration for the treatment of severe hearing loss.

In addition, the Company developed, received U.S. Food and Drug Administration (FDA) approval and commercially launched OTIPRIO® (ciprofloxacin otic suspension) for use during tympanostomy tube placement (TTP) surgery in pediatric patients. OTIPRIO was also approved by the FDA for the treatment of acute otitis externa (AOE). The Company recently announced the initiation of a partnership with privately held Mission Pharmacal (Mission) to support the promotion of OTIPRIO for the treatment of AOE in pediatric and primary care physician offices as well as urgent care clinics.

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, 2018, the Company had cash, cash equivalents and short-term investments of $100.0 million and an accumulated deficit of $389.8 million. The Company anticipates that it will continue to incur net losses into the foreseeable future as it: (i) develops and seeks regulatory approvals for OTIVIDEX and its other potential product candidates; and (ii) works to develop additional product candidates through research and development programs. When 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 the Company’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, 2017 included in the Company’s Form 10-K, as filed with the SEC on March 8, 2018. 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.

 

2. Summary of Significant Accounting Policies

Use of Estimates

The preparation of financial statements in conformity with GAAP requires the Company 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.

-6-


 

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, Cash Equivalents and Restricted Cash

Cash and cash equivalents consist of cash in readily available checking, savings and money market accounts, 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.

The Company’s restricted cash consists of cash maintained in separate deposit accounts to secure a letter of credit issued by a bank to the landlord under a lease agreement for the Company’s corporate headquarters and to secure the Company’s credit cards.

Short-term Investments

The Company carries short-term investments classified as available-for-sale debt securities 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 7 – Fair Value).

Realized gains or losses of available-for-sale debt 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 debt 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 on available-for-sale debt securities as a component of other comprehensive loss within the statements of comprehensive loss and as a separate component of stockholders’ equity on the condensed balance sheets.

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.

Accounts Receivable

Accounts receivable are recorded net of customer allowances for chargebacks, distributor fees and any allowance for doubtful accounts. The Company estimates the allowance for doubtful accounts based on existing contractual payment terms, actual payment patterns of its customers and individual customer circumstances. To date, the Company has determined that an allowance for doubtful accounts is not required.

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.

-7-


 

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, the Company believes that future cash flows to be received support the carrying value of its long-lived assets. The Company had no impairments or disposals of long-lived assets during the six months ended June 30, 2018. 

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

Effective January 1, 2018, the Company adopted Accounting Standards Concepts (ASC) 606, Revenue from Contracts with Customers using the full retrospective approach. The Company’s accounting for revenue under ASC 606 is materially consistent with the accounting for revenue under ASC 605, Revenue Recognition, and therefore the cumulative effect of adoption was immaterial.

To determine revenue recognition for arrangements within the scope of ASC 606, the Company performs the following five steps: (i) identify the contract(s) with a customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations in the contract, and (v) recognize revenue when (or as) we satisfy a performance obligation. The Company only applies the five-step model to arrangements that meet the definition of a contract with a customer under ASC 606 and when it is probable the Company will collect the consideration exchanged for the goods or services transferred to the customer. At contract inception, the Company assesses the goods or services promised within each contract and determines those that are performance obligations, and then it assesses whether each promised good or service is distinct. The Company recognizes as revenue the amount of the transaction price that is allocated to the respective performance obligation when the performance obligation is satisfied.

OTIPRIO is sold to a limited number of specialty wholesale distributors. The Company recognizes revenue when its customers obtain control of OTIPRIO, typically upon delivery by the Company to these distributors. The Company has determined the delivery of OTIPRIO to its customers constitutes a single performance obligation and no other performance obligations are present. The Company’s customer contracts have standard payment terms. The Company does not offer prompt pay discounts or financing on sales and has not identified any credit risk issues.

Hospitals, ambulatory surgery centers and physician offices order OTIPRIO from the Company’s 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. To date, product returns have been immaterial.

Sales commissions and other incremental costs of obtaining customer contracts are expensed as incurred as the amortization periods would be less than one year or the amount is immaterial.

-8-


 

Transaction Price and Reserves for Variable Consideration

Revenue from product sales are recorded at the net sales price (transaction price), which includes estimates of variable consideration for which reserves are established. Components of variable consideration include trade discounts and allowances, government chargebacks, discounts and rebates and other fee for service amounts that are detailed within customer contracts relating to the sale of OTIPRIO. These reserves, as detailed below, are based on the amounts earned or accrued on our sales. Variable consideration is estimated using the most likely method, which is the single most likely outcome under the Company’s contracts and takes into consideration contractual fees, historical chargeback activity and historical Medicaid rebates. Overall, these reserves reflect the Company’s best estimates of the amount of consideration to which the Company is entitled based on the terms of the respective underlying contracts.

The amount of variable consideration included in the transaction price may be constrained and is included in the net sales price only to the extent that it is probable a significant reversal in the amount of the cumulative revenue recognized under the contract will not occur in a future period. The Company’s analyses also contemplate application of the constraint in accordance with the guidance, under which the Company determined a material reversal of revenue would not occur in a future period. Reserves are established for these discounts and allowances upon delivery 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. Actual amounts of consideration ultimately received may differ from the Company’s estimates. If actual results in the future vary from original estimates, the Company will adjust these estimates, which would affect net product revenue and earnings in the period such variances become known.

Trade Discounts and Allowances. The Company’s customers are specialty wholesale distributors with whom the Company has contracted to pay a fee based on a percentage of wholesale acquisition cost for sales order management, data, and distribution services. The Company determined such services received to date are not distinct from the sale of products to customers and, therefore, these payments have been recorded as a reduction of revenue within the statement of operations. This fee for service is recorded as an allowance against accounts receivable at the time of sale based on the contracted percentage.

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 the wholesale acquisition cost and the discounted price at which eligible purchasers purchased from the distributors. At the time of sale, estimated chargebacks are recorded based on historical chargeback activity, the projected payer mix, patient population industry data and the identification of entities purchasing OTIPRIO that 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, which provides a rebate to participating states based on covered purchases of OTIPRIO. At the time of sale, estimated Medicaid rebates are recorded based on historical government rebate activity, the projected payer mix and Medicaid patient population industry data.

Concentration of Major Customers

The Company sells OTIPRIO to specialty wholesale distributor customers. The following table summarizes the Company’s sales to its largest customers for each of the periods presented:

 

 

 

Three Months Ended June 30,

 

 

Six Months Ended June 30,

 

 

 

2018

 

 

2017

 

 

2018

 

 

2017

 

First largest

 

 

69

%

 

 

40

%

 

 

47

%

 

 

33

%

Second largest

 

 

27

%

 

 

31

%

 

 

31

%

 

 

33

%

Third largest

 

*

 

 

 

26

%

 

 

21

%

 

 

32

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

* represents less than 10%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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.

-9-


 

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. Forfeitures are recognized as incurred. For awards subject to time-based vesting conditions, stock-based compensation expense is recognized using the straight-line method.  For performance-based awards to employees, (i) the fair value of the award is determined on the grant date, (ii) we assess the probability of the individual performance milestones under the award being achieved and (iii) the fair value of the shares subject to the milestone is expensed over the implicit service period commencing once management believes the performance criteria is probable of being met.

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.

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,

 

 

2018

 

 

2017

 

Warrants to purchase common stock

 

 

 

 

141,060

 

Options to purchase common stock

 

5,146,089

 

 

 

5,537,575

 

 

 

5,146,089

 

 

 

5,678,635

 

 

-10-


 

Recent Accounting Pronouncements

Not Yet Adopted

In February 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 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 by recognizing a cumulative effect adjustment to the opening balance of retained earnings as of that date. The effect of adoption on the Company's financial statements will depend on the leases in effect and the Company's borrowing rates at that time, but based on the Company's existing leases, adoption is expected to result in a significant increase in assets and liabilities on the balance sheet, and no significant change to operating expenses.

In June 2018, the FASB issued ASU No. 2018-07, Compensation – Stock Compensation (Topic 718) – Improvements to Nonemployee Share-Based Payment Accounting (ASU 2018-07). The amendments in ASU 2018-07 expand the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from nonemployees. An entity should apply the requirements of Topic 718 to nonemployee awards for specific guidance on inputs to an option pricing model, the period of time over which share-based payment awards vest and the pattern of cost recognition over that period. The amendments also clarify that Topic 718 does not apply to share-based payments used to effectively provide (1) financing to the issuer or (2) awards granted in conjunction with selling goods or services to customers as part of a contracted accounted for under Topic 606, Revenue from Contracts with Customers. ASU 2018-07 is effective for the Company in January 2020, with early adoptions permitted, but no earlier than the Company’s adoption date of Topic 606. The Company does not expect the adoption of ASU 2018-07 to have a material impact on its financial position, results of operations or cash flows.

3. Available-for-Sale Securities

The Company invests in available-for-sale debt securities consisting of money market funds, certificates of deposit, U.S. Treasury securities and U.S. government sponsored enterprise securities. Available-for-sale debt securities are classified as part of either cash and cash equivalents or short-term investments in the condensed balance sheets. Available-for-sale debt securities with maturities of three months or less from the date of purchase have been classified as cash equivalents, and were $15.8 million and $10.5 million as of June 30, 2018 and December 31, 2017 respectively. Available-for-sale debt securities with maturities of more than three months from the date of purchase have been classified as short-term investments, and were as follows (in thousands):

 

 

Amortized Cost

 

 

Unrealized Gain

 

 

Unrealized Loss

 

 

Market Value

 

June 30, 2018:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury securities

$

61,050

 

 

$

 

 

$

(30

)

 

$

61,020

 

U.S. government sponsored enterprise securities

 

19,980

 

 

 

 

 

 

(16

)

 

 

19,964

 

 

$

81,030

 

 

$

 

 

$

(46

)

 

$

80,984

 

December 31, 2017:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury securities

$

39,209

 

 

$

 

 

$

(44

)

 

$

39,165

 

U.S. government sponsored enterprise securities

 

62,439

 

 

 

 

 

 

(56

)

 

 

62,383

 

 

$

101,648

 

 

$

 

 

$

(100

)

 

$

101,548

 

 

As of June 30, 2018, the Company had 38 securities in a gross unrealized loss position, all which have been in such position for less than twelve months. At each reporting date, the Company performs an evaluation of impairment to determine if the unrealized losses are other-than-temporary. Factors considered in determining whether a loss is other-than-temporary include the length of time and extent to which fair value has been less than the cost basis, the financial condition of the issuer, and the Company’s intent and ability to hold the investment until recovery of its amortized cost basis. Otonomy intends and has the ability, to hold its investments in unrealized loss positions until their amortized cost basis has been recovered. The Company determined there were no other-than-temporary declines in the value of any available-for-sale securities as of June 30, 2018. All the Company’s available-for-sale debt securities mature within one year.

 

-11-


 

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,

 

 

2018

 

 

2017

 

Prepaid clinical trial costs

$

313

 

 

$

729

 

Other

 

2,085

 

 

 

1,605

 

Total

$

2,398

 

 

$

2,334

 

 

Property and Equipment, Net

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

 

 

June 30,

 

 

December 31,

 

 

2018

 

 

2017

 

Laboratory equipment

$

3,760

 

 

$

3,457

 

Manufacturing equipment

 

1,002

 

 

 

871

 

Computer equipment and software

 

737

 

 

 

731

 

Leasehold improvements

 

736

 

 

 

733

 

Office furniture

 

1,548

 

 

 

1,581

 

 

 

7,783

 

 

 

7,373

 

Less: accumulated depreciation

 

(3,254

)

 

 

(2,694

)

Total

$

4,529

 

 

$

4,679

 

 

Accrued Expenses

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

 

 

June 30,

 

 

December 31,

 

 

2018

 

 

2017

 

Accrued clinical trial costs

$

330

 

 

$

1,112

 

Accrued other

 

2,315

 

 

 

2,769

 

Total

$

2,645

 

 

$

3,881

 

 

 

5. Restructuring Charges

In November 2017, the Company initiated a restructuring plan to focus resources on its development programs and eliminate the cash burn associated with OTIPRIO promotional support. The actions associated with the restructuring were substantially completed in December 2017 and, as a result, the Company recorded a restructuring charge of $3.8 million to selling, general and administrative expense. Restructuring costs primarily include severance costs, including severance payments and outplacement services, health insurance coverage and $1.0 million in stock-based compensation expense associated with accelerated vesting pursuant to the original terms of the Company’s employment agreement with its Chief Medical Officer. As of June 30, 2018 and December 31, 2017, accrued and unpaid severance costs totaled approximately $0.1 million and $1.5 million, respectively. During the six months ended June 30, 2018, the Company paid approximately $1.4 million in severance costs.

6. 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.

-12-


 

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

$

1,600

 

Regulatory

 

10,275

 

Commercialization

 

1,000

 

Total

$

12,875

 

 

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, 2018, 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.

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-313. Under this license agreement, the Company is obligated to pay Ipsen low single-digit royalties on annual net sales of OTO-313 by the Company or its affiliates or sublicensees, up to a maximum cumulative royalty totaling $10.0 million.

 

7. 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.

-13-


 

As of June 30, 2018 and December 31, 2017 the Company held no assets or liabilities measured at fair value on a nonrecurring basis and no liabilities measured at fair value on a recurring basis. The following fair value hierarchy table presents the Company’s assets measured at fair value on a recurring basis (in thousands):

 

 

Fair Value Measurement at Reporting Date Using

 

 

Total

 

 

Level 1

 

 

Level 2

 

 

Level 3

 

June 30, 2018:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Money market funds

$

15,845

 

 

$

15,845

 

 

$

 

 

$

 

U.S. Treasury securities

 

61,020

 

 

 

61,020

 

 

 

 

 

 

 

U.S. government sponsored enterprise securities

 

19,964

 

 

 

 

 

 

19,964

 

 

 

 

 

$

96,829

 

 

$

76,865

 

 

$

19,964

 

 

$

 

December 31, 2017:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Money market funds

$

10,494

 

 

$

10,494

 

 

$

 

 

$

 

U.S. Treasury securities

 

39,165

 

 

 

39,165

 

 

 

 

 

 

 

U.S. government sponsored enterprise securities

 

62,383

 

 

 

 

 

 

62,383

 

 

 

 

 

$

112,042

 

 

$

49,659

 

 

$

62,383

 

 

$

 

 

 

8. Stockholders’ Equity

Common Stock Reserved for Future Issuance

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

 

 

June 30,

 

 

December 31,

 

 

2018

 

 

2017

 

Common stock options issued and outstanding

 

5,146,089

 

 

 

4,599,252

 

Common stock options available for future grant

 

4,365,896

 

 

 

3,403,597

 

Common stock reserved for issuance under ESPP

 

1,698,108

 

 

 

1,292,327

 

Total common stock reserved for future issuance

 

11,210,093

 

 

 

9,295,176

 

 

 

9. 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 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, 2018 (share amounts in thousands):

 

 

 

Options

 

 

Weighted-

Average

Exercise

Price

 

Outstanding as of December 31, 2017

 

 

4,599

 

 

$

14.28

 

Granted

 

 

3,634

 

 

$

5.69

 

Exercised

 

 

(19

)

 

$

1.69

 

Forfeited

 

 

(3,068

)

 

$

18.42

 

Outstanding as of June 30, 2018

 

 

5,146

 

 

$

5.79

 

-14-


 

Performance-based Awards

In February 2018, the Company granted its chief executive officer a stock option for the purchase of 250,000 shares of the Company’s common stock which is subject to time-based vesting and certain performance-based conditions. Specifically, subject to continued service the option will vest upon achievement of a clinical development milestone. On the grant date, the Company determined the fair value of the award and determined achievement of the milestone was probable of occurrence. The Company is recognizing stock-based compensation expense, based upon the grant date fair value, over the implicit service period. If the Company determines the achievement of the milestone is not probable, it will reverse all previously recognized expense.

Option Exchange

On December 20, 2017, the Company commenced an option exchange program (Option Exchange) which allowed eligible employees to exchange certain outstanding stock options (Eligible Options), whether vested or unvested, with an exercise price greater than $12.00 per share (Exchange Offer), for new stock options.  Non-employee members of our Board of Directors were not eligible to participate in the Option Exchange. The Program expired on January 19, 2018, with a closing price of $5.675 per share.  

Pursuant to the terms and condition of the Exchange Offer, the Company accepted for exchange Eligible Options to purchase a total of 1,992,000 shares of the Company’s common stock, representing approximately 81.51% of the total shares of common stock underlying the Eligible Options. All surrendered options were canceled effective as of the expiration of the Exchange Offer and in exchange the Company granted new options to purchase an aggregate of 1,570,328 shares of the Company’s common stock pursuant to the terms of the Exchange Offer and the Company’s 2014 Equity Incentive Plan.  

These new options vest over one to three years, subject to the terms of the Option Exchange and expire eight years from the date of grant. The Company determined this option exchange was an option modification. The exchange of these stock options was treated as a modification for accounting purposes. The difference in the fair value of the canceled options immediately prior to the cancellation and the fair value of the modified options resulted in incremental value, of approximately $0.6 million, which was calculated using the Black-Scholes-Merton option pricing model. Total stock-based compensation expense to be recognized over the requisite service period is equal to remaining unrecognized expense for the exchanged option, as of the exchange date, plus the incremental value of the modification to the award.  

During the financial statement close process for the three and six months ended June 30, 2018 the Company identified and corrected an immaterial error related to the first quarter of 2018. The adjustment related to an error in the timing of recognition of the stock-based compensation associated with the Option Exchange and had the impact of understating stock-based compensation, additional paid in capital and net loss in the first quarter of 2018 by $1.2 million. Management evaluated the effect of the adjustment on the previously issued interim financial statements in accordance with SAB No. 99 and SAB No. 108 and concluded that it was qualitatively and quantitatively immaterial to the interim period and the trend of earnings. Management also concluded that correcting the error in the second quarter of 2018 would not have a material impact on the second quarter results for 2018.  As a result, we corrected the error in our condensed statement of operations for the three months ended June 30, 2018.  There was no impact to the condensed balance sheet as of June 30, 2018 or our condensed statement of operations for the six months ended June 30, 2018.

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,

 

 

 

2018

 

 

2017

 

 

2018

 

 

2017

 

Cost of product sales

 

$

2

 

 

$

6

 

 

$

6

 

 

$

12

 

Research and development

 

 

1,698

 

 

 

1,359

 

 

 

2,335

 

 

 

2,344

 

Selling, general and administrative

 

 

2,738

 

 

 

2,126

 

 

 

4,810

 

 

 

4,861

 

Total stock-based compensation

 

$

4,438

 

 

$

3,491

 

 

$

7,151

 

 

$

7,217

 

 

10. Subsequent Event

On August 2, 2018, the Company entered into a co-promotion agreement (the "Co-Promotion Agreement”) with privately held Mission Pharmacal Company (“Mission”), pursuant to which Mission will exclusively promote OTIPRIO for AOE in the United States to pediatrician and primary care physician offices and urgent care clinics. In partial consideration of the OTIPRIO support activities provided by the Company, and as reimbursement for certain expenses incurred by the Company to obtain and maintain FDA approval for use of OTIPRIO in AOE, Mission will make non-refundable, non-creditable payments to the Company during each of the first five years of the Co-Promotion Agreement. In addition, Mission will reimburse the Company for a proportion of product support expenses as agreed upon by both parties and the Company will retain a share of gross profits from the sale of OTIPRIO to Mission’s accounts. The Company retains all commercial rights for other customer segments for AOE and for use of OTIPRIO in all other indications. The initial term of the Co-Promotion Agreement is five years with provisions for extension and early termination.

-15-


 

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 OTIPRIO promotional partnership;

 

our expectations regarding our clinical development of OTIVIDEX, including availability of top-line results from the recently initiated additional Phase 3 trial in the first half of 2020;

 

our expectations regarding the clinical development of OTO-313, including but not limited to our plans to initiate a Phase 1/2 clinical trial in tinnitus patients in the first half of 2019;

 

our expectations regarding the clinical development of OTO-413, including but not limited to our plans to initiate a Phase 1/2 clinical trial in hearing loss patients in the first half of 2019;

 

the timing or likelihood of regulatory filings and approvals;

 

our expectations regarding the future development of other product candidates, including but not limited to our plans to select a candidate for clinical development for both the OTO-5XX and OTO-6XX programs by the end of 2018;

 

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

 

our expectations and statements regarding the pricing, market size, opportunity and growth potential for OTIVIDEX, OTO-313, OTO-413 and our other product candidates, if approved for commercial use;

 

our expectations and statements regarding the adoption and use of OTIPRIO and OTIVIDEX, OTO-313 and OTO-413, if approved, by ear, nose and throat physicians (ENTs);

 

our expectations regarding potential coverage and reimbursement relating to OTIPRIO, and OTIVIDEX, OTO-313 and OTO-413, 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 establish and manage our own sales and marketing capabilities, or seek and establish collaborative partners, to commercialize our products;

 

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.

-16-


 

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-313, 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 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 dedicated to the development of innovative therapeutics for otology. We pioneered the application of drug delivery technology to the ear in order to develop products that achieve sustained drug exposure from a single local administration. This approach is covered by a broad patent estate and is being utilized to develop a pipeline of products addressing important unmet medical needs including Ménière’s disease, hearing loss and tinnitus.

OTIVIDEX is a steroid in development for the treatment of Ménière’s disease. Two Phase 3 trials in Ménière’s disease patients were completed in the second half of 2017. The AVERTS-2 trial, conducted in Europe, achieved its primary endpoint (p value = 0.029) while the AVERTS-1 trial, conducted in the United States, did not (p value = 0.62). Based on a Type C meeting with the FDA, we believe that one additional successful pivotal trial is sufficient to support the U.S. registration of OTIVIDEX in Ménière’s disease, and recently announced the initiation of such trial.  We expect top-line results from this trial in the first half of 2020.

OTO-313 is a formulation of the potent and selective NMDA receptor antagonist gacyclidine that is in development for the treatment of tinnitus. A Phase 1 clinical safety trial has been successfully completed using OTO-311, a poloxamer-based formulation of gacyclidine, with no safety concerns observed. We have shifted development to OTO-313, an alternative formulation of gacyclidine that has improved properties compared to OTO-311. We expect to initiate a Phase 1/2 clinical trial for OTO-313 in tinnitus patients in the first half of 2019.

We are advancing three distinct hearing loss programs that address different pathologies and broad patient populations. OTO-413 is a sustained exposure formulation of BDNF in development for the repair of cochlear synaptopathy and the treatment of speech-in-noise hearing difficulties. We have initiated nonclinical studies and manufacturing for OTO-413 to support an Investigational New Drug Application, with a Phase 1/2 clinical trial in hearing loss patients expected to begin in the first half of 2019. OTO-5XX is an otoprotectant in development for the prevention of cisplatin induced hearing loss. OTO-6XX induces hair cell regeneration in a nonclinical proof-of-concept model and is being developed for the treatment of severe hearing loss. We expect to select a candidate for clinical development for both the OTO-5XX and OTO-6XX programs by the end of 2018.

-17-


 

In addition, we developed, received FDA approval for and commercially launched OTIPRIO (ciprofloxacin otic suspension) for use during tympanostomy tube placement (TTP) surgery in pediatric patients. OTIPRIO was also approved by the FDA for the treatment of acute otitis externa (AOE). In November 2017, we announced the discontinuation of promotional support for OTIPRIO in order to significantly reduce operating expenses related to the product. The Company recently announced the initiation of a partnership with privately held Mission Pharmacal (Mission) to support the promotion of OTIPRIO for the treatment of AOE in pediatric and primary care physician offices as well as urgent care clinics. 

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, 2018, we had cash, cash equivalents and short-term investments of $100.0 million.

We have never been profitable, and as of June 30, 2018, we had an accumulated deficit of $389.8 million. Our net losses were $13.6 million and $23.2 million for the three months ended June 30, 2018 and 2017, respectively, and $25.0 million and $50.3 million for the six months ended June 30, 2018 and 2017, respectively. Substantially all our net losses have resulted from research and development expenses related to our 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 develop, seek regulatory approval, and, if approved, commercialize our product candidates. In the near term, we anticipate our expenses will continue to be substantial as we:

 

conduct clinical development of OTIVIDEX;

 

conduct nonclinical development of OTO-313 and OTO-413;

 

contract to manufacture our product candidates;

 

evaluate opportunities for development of additional product candidates;

 

maintain and expand our intellectual property portfolio;

 

hire additional staff as necessary to execute our product development plan; and

 

operate as a public company.

We will require additional financing to complete the development of and, if approved, commercialize, OTIVIDEX, OTO-313, OTO-413 and any other product candidates. We believe we will continue to expend substantial resources for the foreseeable future for the development of OTIVIDEX, OTO-313, OTO-413 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 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 the revenue generated by OTIPRIO and our other product candidates, if approved. When additional financing is required, we anticipate 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 our existing cash and cash equivalents and short-term investments will be sufficient to fund our currently planned operations for a period of at least twelve months from the date of this report.

In November 2008, we entered into an exclusive license agreement with the Regents of the University of California (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 and regulatory 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.

-18-


 

In April 2013, we entered into an exclusive license agreement with DURECT Corporation (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 covering our OTO-313 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 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 (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 users of OTIPRIO for use during TTP surgery. In November 2017, we announced the discontinuation of our promotional support for OTIPRIO. The product has continued to be available for purchase by customers while we evaluated commercial partnering options.

We recognize revenue on sales of OTIPRIO upon delivery to our distributors. Product sales are recorded net of estimated chargebacks, government rebates and distributor fees.

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, including third-party manufacturing costs, allocation of overhead costs and royalty payments based on OTIPRIO sales. In 2017, OTIPRIO inventory values were written down due to the discontinuation of promotional support for the product indicating our expectation that the useful life and ability to recover inventory costs have decreased. Similarly, OTIPRIO manufacturing equipment was impaired.

Research and development expenses

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

 

 

2018

 

 

2017

 

 

2018

 

 

2017

 

Third-party development costs:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

OTIPRIO

$

52

 

 

$

1,258

 

 

$

98

 

 

$

2,431

 

OTIVIDEX

 

928

 

 

 

4,387

 

 

 

1,306

 

 

 

10,013

 

OTO-311/OTO-313

 

973

 

 

 

19

 

 

 

1,179

 

 

 

20

 

OTO-413

 

874

 

 

 

 

 

1,807

 

 

 

Total third-party development costs

 

2,827

 

 

 

5,664

 

 

 

4,390

 

 

 

12,464

 

Other unallocated internal research and development

   costs

 

5,398

 

 

 

7,050

 

 

 

9,485

 

 

 

13,435

 

Total research and development costs

$

8,225

 

 

$

12,714

 

 

$

13,875

 

 

$

25,899

 

 

We expect our research and development expenses to continue to be substantial for the foreseeable future as we advance our 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 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 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 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 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 employee-related expenses, including salaries, benefits, travel and stock-based compensation expense, as well as 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 support activities for OTIPRIO and commercial preparation activities for our product candidates.

-20-


 

We expect our selling, general and administrative expenses to decrease due to the discontinuation of promotional support for OTIPRIO, but continue to be substantial as we support 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.

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, we evaluate our estimates and assumptions, including those related to net product sales, accrued expenses and stock-based compensation. We base our estimates on our historical experience, known trends and events and various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

We believe 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, 2017, as filed with the SEC on March 8, 2018, have the greatest potential impact on our financial statements, so we consider them to be our critical accounting policies and estimates. Updates to these critical accounting policies and estimates are described below.  In addition, effective January 1, 2018, the Company adopted ASC 606, as described below. ASC 606 replaces the Company’s previous method of revenue recognition described.

Stock-based compensation 

We recognize non-cash expense for the fair value of all stock options and other share-based awards. We use the Black-Scholes option valuation model to calculate the fair value of stock options, using the single-option award approach and straight-line attribution method. For options granted to employees and directors, we recognize the resulting fair value as expense on a straight-line basis over the vesting period of each respective stock option, generally four years.

We have granted stock options that vest upon achievement of certain performance criteria, or Performance Awards. For performance-based awards to employees, (i) the fair value of the award is determined on the grant date, (ii) we assess the probability of the individual performance milestones under the award being achieved and (iii) the fair value of the shares subject to the milestone is expensed over the implicit service period commencing once management believes the performance criteria is probable of being met.

In January 2018 we completed an option exchange program (Option Exchange) which allowed eligible employees to exchange certain outstanding stock options (Eligible Options), whether vested or unvested, with an exercise price greater than $12.00 per share (Exchange Offer), for new stock options.  These new options vest over one to three years, subject to the terms of the Option Exchange and expire eight years from the date of grant. The Company determined this option exchange was an option modification. The exchange of these stock options was treated as a modification for accounting purposes. The difference in the fair value of the canceled options immediately prior to the cancellation and the fair value of the modified options resulted in incremental value, of approximately $0.6 million, which was calculated using the Black-Scholes-Merton option pricing model. Total stock-based compensation expense to be recognized over the requisite service period is equal to remaining unrecognized expense for the exchanged option, as of the exchange date, plus the incremental value of the modification to the award.

Revenue Recognition

Our accounting for revenue under ASC 606 is materially consistent with the accounting for revenue under ASC 605 and therefore the cumulative effect of adoption was immaterial.

-21-


 

To determine revenue recognition for arrangements within the scope of ASC 606, we perform the following five steps: (i) identify the contract(s) with a customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations in the contract, and (v) recognize revenue when (or as) we satisfy a performance obligation. We only apply the five-step model to arrangements that meet the definition of a contract with a customer under ASC 606 and when it is probable we will collect the consideration exchanged for the goods or services transferred to the customer. At contract inception, we assess the goods or services promised within each contract and determine those that are performance obligations, and then we assess whether each promised good or service is distinct. We recognize as revenue the amount of the transaction price that is allocated to the respective performance obligation when the performance obligation is satisfied.

OTIPRIO is sold to a limited number of specialty wholesale distributors. We recognize revenue when our customer obtains control of our product, typically upon delivery to these distributors. We have determined the delivery of OTIPRIO to our customers constitutes a single performance obligation and no other performance obligations are present. Our customer contracts have standard payment terms. We do not offer prompt pay discounts or financing on our sales and have not identified any credit risk issues.

Hospitals, ambulatory surgery centers and physician offices order OTIPRIO from our distributors and are the end users of OTIPRIO. We permit 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. To date, returns have been immaterial.

Sales commissions and other incremental costs of obtaining customer contracts are expensed as incurred as the amortization periods would be less than one year or the amount is immaterial.

Transaction Price and Reserves for Variable Consideration

Revenues from product sales are recorded at the net sales price (transaction price), which includes estimates of variable consideration for which reserves are established. Components of variable consideration include trade discounts and allowances, government chargebacks, discounts and rebates, and other fee for service amounts that are detailed within our contracts with our customers relating to the sale of OTIPRIO. These reserves, as detailed below, are based on the amounts earned or accrued on our sales. Variable consideration is estimated using the most likely method, which is the single most likely outcome under our contracts and takes into consideration contractual fees, historical chargeback activity and historical Medicaid rebates. Overall, these reserves reflect our best estimates of the amount of consideration to which we are entitled based on the terms of the respective underlying contracts.

The amount of variable consideration included in the transaction price may be constrained and is included in the net sales price only to the extent that it is probable a significant reversal in the amount of the cumulative revenue recognized under the contract will not occur in a future period. Our analyses also contemplate application of the constraint in accordance with the guidance, under which we determined a material reversal of revenue would not occur in a future period. Reserves are established for these discounts and allowances upon delivery 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. Actual amounts of consideration ultimately received may differ from our estimates. If actual results in the future vary from our original estimates, we will adjust these estimates, which would affect net product revenue and earnings in the period such variances become known.

Trade Discounts and Allowances. Our customers are specialty wholesale distributors with whom we have contracted to pay a fee based on a percentage of wholesale acquisition cost for sales order management, data, and distribution services. We have determined such services received to date are not distinct from our sale of products to our customers and, therefore, these payments have been recorded as a reduction of revenue within the statement of operations. This fee for service is recorded as an allowance against accounts receivable at the time of sale based on the contracted percentage.

Chargebacks. We estimate allowances against accounts receivable for chargebacks related to agreements with group purchasing organizations and federal contracts. Under these agreements, we credit distributors a chargeback amount which represents the difference between the wholesale acquisition cost and the discounted price at which eligible purchasers purchased from the distributors. At the time of sale, estimated chargebacks are recorded based on historical chargeback activity, the projected payer mix, patient population industry data and the identification of entities purchasing OTIPRIO which are eligible for discounted pricing.

Government Rebates. We estimate a rebate liability in connection with a Medicaid Drug Rebate Agreement with the Centers for Medicare & Medicaid Services, which provides a rebate to participating states based on covered purchases of OTIPRIO. At the time of sale, estimated Medicaid rebates are recorded based on historical government rebate activity, the projected payer mix, and Medicaid patient population industry data.

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Results of Operations

Comparison of the Three Months Ended June 30, 2018 and 2017

The following table sets forth the significant components of our results of operations for the periods presented (in thousands):

 

 

Three Months Ended June 30,

 

 

 

 

 

 

2018

 

 

2017

 

 

Change

 

Product sales, net

$

123

 

 

$

326

 

 

$

(203

)

Cost of product sales

 

241

 

 

 

397

 

 

 

(156

)

Research and development

 

8,225

 

 

 

12,714

 

 

 

(4,489

)

Selling, general and administrative

 

5,619

 

 

 

10,747

 

 

 

(5,128

)

 

Product sales, net. OTIPRIO is sold in the United States upon delivery 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 use during TTP surgery. For the three months ended June 30, 2018 and 2017, our net product sales represent revenues for OTIPRIO sold to our distributors during this period. Product sales are recorded net of estimated chargebacks, government rebates and distributor fees. On March 2, 2018, OTIPRIO was approved for use in the treatment of AOE which will be administered in physician offices.

Cost of product sales. Cost of product sales decreased primarily due to lower product sales. 

Research and development expenses. The decrease of $4.5 million in research and development expenses was primarily due to a net $3.5 million decrease in OTIVIDEX clinical trial and development costs due to the completion and early termination of our OTIVIDEX clinical trials in 2017; a $1.2 million decrease in OTIPRIO clinical trial and regulatory expenses associated with the label expansion for AOE; a $0.6 million decrease in personnel-related costs due to a reduction in headcount, and a decrease of $0.8 million in other research and development costs. These decreases were partially offset by a $1.0 million increase in development expenses related to OTO-313 and a $0.6 million increase in research costs for our sensorineural hearing loss programs.

Selling, general and administrative expenses. The decrease of $5.1 million in selling, general and administrative expenses was primarily related to reduced employee-related expenses of approximately $3.0 million, resulting from reductions in personnel during 2017 and 2018, and a $2.1 million decrease in outside services and other operating expenses due to the discontinuation of promotional support for OTIPRIO.

Comparison of the Six Months Ended June 30, 2018 and 2017

The following table sets forth the significant components of our results of operations for the periods presented (in thousands):

 

 

Six Months Ended June 30,

 

 

 

 

 

 

2018

 

 

2017

 

 

Change

 

Product sales, net

$

424

 

 

$

684

 

 

$

(260

)

Cost of product sales

 

513

 

 

 

860

 

 

 

(347

)

Research and development

 

13,875

 

 

 

25,899

 

 

 

(12,024

)

Selling, general and administrative

 

11,776

 

 

 

24,839

 

 

 

(13,063

)

Product sales, net. OTIPRIO is sold in the United States upon delivery 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 use during TTP surgery. For the six months ended June 30, 2018 and 2017, our net product sales represent revenues for OTIPRIO sold to our distributors during this period. Product sales are recorded net of estimated chargebacks, government rebates and distributor fees. On March 2, 2018, OTIPRIO was approved for use in the treatment of AOE which will be administered in physician offices.

Cost of product sales. Cost of product sales decreased $0.3 million primarily due to lower sales volumes during the six months ended June 30, 2018 and a write-down of excess inventory during the six months ended June 30, 2017 of $0.2 million. There were no write-downs of inventory in 2018.

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Research and development expenses. The decrease of $12.0 million in research and development expenses was primarily due to a net $8.7 million decrease in OTIVIDEX clinical trial and development costs due to the completion and early termination of our OTIVIDEX clinical trials in 2017; a $2.3 million decrease in OTIPRIO clinical trial and regulatory expenses associated with the label expansion for AOE; a $1.9 million decrease in personnel-related costs due to a reduction in headcount, and a decrease of $1.5 million in other research and development costs. These decreases were partially offset by a $1.2 million increase in development expenses related to OTO-313 and an increase of $1.2 million in research costs for our sensorineural hearing loss programs.

Selling, general and administrative expenses. The decrease of $13.1 million in selling, general and administrative expenses was primarily related to reduced employee-related expenses of approximately $10.7 million, resulting from reductions in personnel during 2017 and 2018 and a $4.0 million decrease in outside services and other operating expenses due to the discontinuation of promotional support for OTIPRIO. These decreases were partially offset by one-time termination benefits including one-time stock compensation expense, totaling approximately $1.6 million incurred during the six months ended June 30, 2018.

Liquidity and Capital Resources

We have incurred significant losses and negative cash flows from operations since our inception. As of June 30, 2018, we had an accumulated deficit of $389.8 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 will 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, 2018, we had cash, cash equivalents and short-term investments of $100.0 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.

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

 

 

2018

 

 

2017

 

Net cash (used in) provided by:

 

 

 

 

 

 

 

Operating activities

$

(20,103

)

 

$

(45,265

)

Investing activities

 

20,444

 

 

 

42,956

 

Financing activities

 

229

 

 

 

485

 

Net increase (decrease) in cash

$

570

 

 

$

(1,824

)

 

Operating activities. For both periods presented, the primary uses of cash were to fund development activities for our product candidates and in 2017 to support the commercialization of OTIPRIO.

During the six months ended June 30, 2018, we used cash in operating activities of $20.1 million, while our net loss was $25.0 million. The difference consisted of $7.7 million of non-cash adjustments, primarily comprised of stock-based compensation expense and depreciation expense, which was partially offset by a $2.8 million net change in our operating assets and liabilities.

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.

Investing activities. Net cash provided by investing activities was $20.4 million during the six months ended June 30, 2018. $75.0 million was provided by maturities of short-term investments, which was partially offset by $54.2 million used to purchase short-term investments and $0.4 million used for capital expenditures.

Net cash provided by investing activities was $43.0 million 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.

Financing activities. Net cash provided by financing activities was $0.2 million for the six months ended June 30, 2018. During the six months ended June 30, 2018, net cash provided by financing activities was for shares issued for stock option exercises and under our employee stock purchase plan.

-24-


 

Net cash provided by financing activities was $0.5 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.

Funding Requirements

We expect to continue to incur significant losses for the foreseeable future as we: (i) develop and seek regulatory approvals for our product candidates OTIVIDEX, OTO-313 and OTO-413; and (ii) work to develop additional product candidates through research and development programs. We are subject to all 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 for a period of at least twelve months from the date of this report.

We will require additional financing to complete the development of and, if approved, commercialize OTIVIDEX, OTO-313, OTO-413 and any other product candidates. When 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 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 costs related to manufacturing commercial supplies of OTIPRIO;

 

the timing and costs of completing the remaining clinical development and obtaining regulatory approval for OTIVIDEX in Ménière’s disease;