10-Q 1 zsan-20190630x10q.htm 10-Q Document

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________________________
FORM 10-Q
_______________________________
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2019
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 001-36570
___________________________
ZOSANO PHARMA CORPORATION
(Exact name of registrant as specified in its charter)
____________________________
Delaware
 
45-4488360
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
34790 Ardentech Court
Fremont, CA 94555
(Address of principal executive offices) (Zip Code)
(510) 745-1200
(Registrant’s telephone number, including area code)
___________________________________
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock, 0.0001 par value
ZSAN
The Nasdaq Stock Market
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  x    No  ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  x    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
x
 
Smaller reporting company
x
 
 
 
 
 
 
 
 
Emerging growth company
x



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.  x
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  x
As of August 8, 2019, the registrant had a total of 17,723,039 shares of its common stock, $0.0001 par value per share, outstanding.
 



Zosano Pharma Corporation
Quarterly Report on Form 10-Q
INDEX

1




PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
ZOSANO PHARMA CORPORATION
CONDENSED BALANCE SHEETS
(in thousands, except par value and share amounts)
 
June 30,
2019
 
December 31,
2018
 
(unaudited)
 
 
ASSETS
Current assets:
 
 
 
Cash and cash equivalents
$
14,252

 
$
9,140

Marketable securities at fair value
3,488

 
13,862

Prepaid expenses and other current assets
991

 
358

Total current assets
18,731

 
23,360

Restricted cash
455

 
455

Property and equipment, net
20,568

 
11,916

Operating lease right-of-use assets
6,016

 

Other long-term assets
17

 
49

Total assets
$
45,787

 
$
35,780

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
 
 
 
Accounts payable
$
5,985

 
$
4,450

Accrued compensation
1,459

 
2,092

Build-to-suit obligation, current portion
3,147

 
2,326

Operating lease liabilities, current portion
1,026

 

Other accrued liabilities
3,678

 
2,419

Total current liabilities
15,295

 
11,287

Build-to-suit obligation, long-term portion, net of debt issuance costs and discount
5,091

 
4,478

Operating lease liabilities, long-term portion
6,369

 

Other liabilities
25

 
18

Deferred rent

 
1,287

Total liabilities
26,780

 
17,070

Commitments and contingencies (note 8)

 

Stockholders’ equity:
 
 
 
Preferred stock, $0.0001 par value; 5,000,000 shares authorized; none issued and outstanding as of June 30, 2019 and December 31, 2018

 

Common stock, $0.0001 par value; 250,000,000 shares authorized; 17,723,039 and 11,973,039 shares issued and outstanding as of June 30, 2019 and December 31, 2018, respectively
2

 
1

Additional paid-in capital
299,023

 
279,946

Accumulated deficit
(280,018
)
 
(261,232
)
Accumulated other comprehensive loss

 
(5
)
Total stockholders’ equity
19,007

 
18,710

Total liabilities and stockholders’ equity
$
45,787

 
$
35,780

The accompanying notes are an integral part of these condensed financial statements.

2


ZOSANO PHARMA CORPORATION
CONDENSED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(in thousands, except share and per share amounts)
(unaudited)
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2019
 
2018
 
2019
 
2018
Revenue
$

 
$

 
$

 
$

Operating expenses:
 
 
 
 
 
 
 
Research and development
6,640

 
6,533

 
13,256

 
12,339

General and administrative
2,767

 
2,272

 
5,638

 
4,532

Total operating expenses
9,407

 
8,805

 
18,894

 
16,871

Loss from operations
(9,407
)
 
(8,805
)
 
(18,894
)
 
(16,871
)
Other income (expense):
 
 
 
 
 
 
 
Interest income
82

 
79

 
162

 
94

Interest expense
(35
)
 
(112
)
 
(76
)
 
(268
)
Other income, net

 
2

 
22

 
3

Loss before provision for income taxes
(9,360
)
 
(8,836
)
 
(18,786
)
 
(17,042
)
Provision for income taxes

 

 

 

Net loss
$
(9,360
)
 
$
(8,836
)
 
$
(18,786
)
 
$
(17,042
)
Unrealized gain (loss) on marketable securities, net of tax
(1
)
 

 
5

 

Comprehensive loss
$
(9,361
)
 
$
(8,836
)
 
$
(18,781
)
 
$
(17,042
)
 
 
 
 
 
 
 
 
Net loss per common share – basic and diluted
$
(0.55
)
 
$
(0.75
)
 
$
(1.30
)
 
$
(2.47
)
Weighted-average shares used in computing net loss per common share – basic and diluted
16,868,643

 
11,753,259

 
14,434,365

 
6,890,166

The accompanying notes are an integral part of these condensed financial statements.

3


ZOSANO PHARMA CORPORATION
CONDENSED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(in thousands, except share amounts)
(unaudited)

 
Common Stock
 
Additional
Paid-In Capital
 
  Accumulated  
Deficit
 
Accumulated
Other
  Comprehensive Income (Loss)
 
Total
Stockholders’
  Equity  (Deficit)
 
Shares
 
Amount
 
Balance at January 1, 2018
1,973,039

 
$

 
$
232,922

 
$
(225,874
)
 
$

 
$
7,048

Stock-based compensation

 

 
139

 

 

 
139

Net loss

 

 

 
(8,206
)
 

 
(8,206
)
Balance at March 31, 2018
1,973,039

 

 
233,061

 
(234,080
)
 

 
(1,019
)
Issuance of common stock in connection with public offering
10,000,000

 
1

 
45,604

 

 

 
45,605

Stock-based compensation

 

 
330

 

 

 
330

Net loss

 

 

 
(8,836
)
 

 
(8,836
)
Balance at June 30, 2018
11,973,039

 
$
1

 
$
278,995

 
$
(242,916
)
 
$

 
$
36,080

 
 
Common Stock
 
Additional
Paid-In Capital
 
  Accumulated  
Deficit
 
Accumulated
Other
  Comprehensive Income (Loss)
 
Total
Stockholders’
  Equity  
 
Shares
 
Amount
 
Balance at January 1, 2019
11,973,039

 
$
1

 
$
279,946

 
$
(261,232
)
 
$
(5
)
 
$
18,710

Stock-based compensation

 

 
361

 

 

 
361

Unrealized gain on marketable securities

 

 

 

 
6

 
6

Net loss

 

 

 
(9,426
)
 

 
(9,426
)
Balance at March 31, 2019
11,973,039

 
1

 
280,307

 
(270,658
)
 
1

 
9,651

Issuance of common stock in connection with public offering
5,750,000

 
1

 
18,330

 

 

 
18,331

Stock-based compensation

 

 
386

 

 

 
386

Unrealized loss on marketable securities

 

 

 

 
(1
)
 
(1
)
Net loss

 

 

 
(9,360
)
 

 
(9,360
)
Balance at June 30, 2019
17,723,039

 
$
2

 
$
299,023

 
$
(280,018
)
 
$

 
$
19,007

The accompanying notes are an integral part of these condensed financial statements.


4


ZOSANO PHARMA CORPORATION
CONDENSED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
 
Six Months Ended June 30,
 
2019
 
2018
Cash flows from operating activities:
 
 
 
Net loss
$
(18,786
)
 
$
(17,042
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
Stock-based compensation
747

 
469

Amortization of operating lease right-of-use assets
399

 

Depreciation
361

 
391

Deferred rent

 
515

Other
42

 
45

Change in operating assets and liabilities:
 
 
 
Prepaid expenses and other assets
(657
)
 
635

Accounts payable
635

 
615

Accrued compensation and other accrued liabilities
(904
)
 
(21
)
Operating lease liabilities
(451
)
 

Net cash used in operating activities
(18,614
)
 
(14,393
)
Cash flows from investing activities:
 
 
 
Proceeds from maturities of marketable securities
13,900

 
16,000

Purchases of marketable securities
(3,476
)
 
(37,475
)
Purchases of property and equipment
(6,213
)
 
(2,106
)
Net cash provided by (used in) investing activities
4,211

 
(23,581
)
Cash flows used in financing activities:
 
 
 
Proceeds from public offering of securities, net of underwriting commissions and offering costs
18,472

 
45,603

Proceeds from build-to-suit obligation, net of issuance costs
2,277

 

Principal payments on financing obligations
(1,234
)
 
(3,083
)
Net cash provided by financing activities
19,515

 
42,520

Net increase in cash, cash equivalents and restricted cash
5,112

 
4,546

Cash, cash equivalents and restricted cash at beginning of period
9,595

 
11,686

Cash, cash equivalents and restricted cash at end of period
$
14,707

 
$
16,232

 
 
 
 
Supplemental cash flow information:
 
 
 
Cash paid for interest
$
365

 
$
203

Cash paid for taxes
$
1

 
$

Non-cash investing and financing activities:
 
 
 
Acquisition of property and equipment under accounts payable and other accrued liabilities
$
5,795

 
$
264

Accrued offering costs
$
142

 
$
98

Right-of-use assets acquired under finance lease obligations
$
22

 
$

The accompanying notes are an integral part of these condensed financial statements.

5


Zosano Pharma Corporation
Notes to Condensed Financial Statements
(unaudited)
1.
Organization and Basis of Presentation
The Company
Zosano Pharma Corporation (the “Company”) is a clinical stage biopharmaceutical company focused on providing rapid systemic administration of therapeutics to patients using its proprietary Adhesive Dermally-Applied Microarray, or ADAM™, technology.
Basis of Presentation
The condensed financial statements have been prepared in accordance with United States generally accepted accounting principles (“U.S. GAAP”) for interim financial information, the instructions to Form 10-Q and Regulation S-X. They do not include all the information and notes required by U.S. GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and six months ended June 30, 2019 are not necessarily indicative of the results that may be expected for the year ending December 31, 2019, or any other subsequent period. These financial statements should be read in conjunction with the Company’s audited financial statements for the year ended December 31, 2018, included in the Company’s annual report on Form 10-K and filed with the United States Securities and Exchange Commission (“SEC”) on March 25, 2019.
Use of Estimates
The preparation of the accompanying condensed financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the condensed financial statements, and the reported amounts of expenses during the periods reported. Actual results could differ from those estimates.
Liquidity and Substantial Doubt in Going Concern
Since inception, the Company has incurred recurring operating losses and negative cash flows from operating activities, and as of June 30, 2019, had an accumulated deficit of $280.0 million. As of June 30, 2019, the Company had approximately $17.7 million in cash, cash equivalents and marketable securities. Presently, the Company does not have sufficient cash, cash equivalents and marketable securities to enable it to fund its anticipated level of operations and meet its obligations as they become due within twelve months following the date of issuance of this Quarterly Report on Form 10-Q. The aforementioned factors raise substantial doubt about the Company’s ability to continue as a going concern for a period of one year from the issuance of these financial statements. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
On April 11, 2019, the Company closed a public offering of 5,000,000 shares of common stock at a price to the underwriter of $3.29 per share. On May 8, 2019, the underwriter purchased an additional 750,000 shares at a price to the underwriter of $3.29 per share pursuant to the exercise of the underwriter's option to purchase additional shares. The aggregate net proceeds were approximately $18.3 million, after deducting underwriting costs and estimated offering expenses.
The Company plans to raise additional funding through financing, a capital offering, a license or collaboration agreement or a combination of such sources of capital. However, there are no assurances that additional funding will be achieved and that the Company will succeed in its future operations. The Company’s inability to obtain required funding in the near future or its inability to obtain funding on favorable terms will have a material adverse effect on its operations and strategic development plan for future growth. If the Company cannot successfully raise additional capital and implement its strategic development plan, its liquidity, financial condition and business prospects will be materially and adversely affected, and it may have to cease operations.
The Company will continue to evaluate its timelines, strategic needs, and working capital requirements. There can be no assurance that if the Company attempts to raise additional capital, it will be successful in doing so on terms acceptable to the Company, or at all. Further, there can be no assurance that it will be able to gain access and/or be able to execute on securing new sources of funding, new development opportunities, successfully obtain regulatory approvals for and commercialize new products, achieve significant product revenues from its products (if approved), or achieve or sustain profitability in the future.


6


2.
Summary of Significant Accounting Policies
Significant Accounting Policies
The Company’s significant accounting policies are included in “Part II - Item 8 - Financial Statements and Supplementary Data - Note 2 - Summary of Significant Accounting Policies” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018. As discussed in the Company's Annual Report, the Company adopted the new leases standard in the first quarter of 2019. In the second quarter of 2019, the Company made an accounting policy election to recognize the impact of stock option forfeitures on stock compensation expense in the period the award is forfeited as permitted under ASC2016-09, Compensation-Stock Compensation (Topic 718). Previously, the Company estimated the effects of stock option forfeitures at the initial grant date and reduced stock compensation expense for the estimated effect of forfeitures over the requisite service period. There have been no other changes to the Company's significant accounting policies.
Leases
ASC Topic 842, Leases, requires lessees to recognize right-of-use assets and lease liabilities for most leases on the balance sheet and to provide expanded disclosures about leasing arrangements. The Company adopted Topic 842 effective January 1, 2019 using the optional transition method and did not restate comparative periods. There was no effect on accumulated deficit at adoption.

The Company has elected the package of practical expedients to (i) not reassess whether expired or existing contracts are or contain leases, (ii) not reassess the lease classification for any expired or existing leases and (iii) not reassess the accounting for initial direct costs.
The adoption of the new leases standard resulted in the following adjustments to the Company's balance sheet as of January 1, 2019:
 
December 31, 2018
 
Adoption Impact
 
January 1, 2019
 
(in thousands)
 
(unaudited; in thousands)
Operating lease right-of-use assets
$

 
$
6,415

 
$
6,415

Operating lease liabilities, current portion
$

 
$
945

 
$
945

Other accrued liabilities
$
2,414

 
$
(143
)
 
$
2,271

Operating lease liabilities, long-term portion
$

 
$
6,900

 
$
6,900

Deferred rent
$
1,287

 
$
(1,287
)
 
$

As of December 31, 2018, the short-term portion of deferred rent was recorded in other accrued liabilities. The adoption impact was a non-cash operating activity for the six months ended June 30, 2019.
At the inception of an arrangement, the Company determines whether the arrangement is or contains a lease based on the unique facts and circumstances present. Operating lease liabilities and their corresponding right-of-use assets are recorded based on the present value of lease payments over the expected lease term. If the interest rate implicit in the Company's lease contracts is not readily determinable, the Company utilizes its incremental borrowing rate, which is the rate incurred to borrow on a collateralized basis over a similar term, an amount equal to the lease payments in a similar economic environment. Certain adjustments to the right-of-use asset may be required for items such as initial direct costs paid or incentives received.
Cash, Cash Equivalents, and Restricted Cash
The Company considers all highly liquid investments with an original maturity of 90 days or less to be cash equivalents.
As of June 30, 2019 and December 31, 2018, the Company had restricted cash of approximately $0.5 million consisting of deposits of $0.3 million to secure its building lease until the end of the lease term, a deposit of approximately $0.1 million to a utility provider and $35,000 to secure corporate purchasing cards.

7


The following table provides a reconciliation of cash, cash equivalents and restricted cash to amounts shown in the statement of cash flows:
 
June 30, 2019
 
June 30, 2018
 
(unaudited; in thousands)
Cash and cash equivalents
$
14,252

 
$
16,197

Restricted cash
455

 
35

Total
$
14,707

 
$
16,232

Marketable Securities
Marketable securities generally consist of debt securities with original maturities greater than 90 days and remaining maturities of less than one year. Marketable securities with an original maturity greater than one year, if any, would be considered long-term investments. All of the Company's investments are classified as available-for-sale and carried at fair value based upon quoted market price. The change in unrealized gains and losses related to fixed maturity debt securities is reported as a separate component of other comprehensive income (loss) on the statements of operations and comprehensive loss and as a separate component of stockholders' equity on the balance sheets. Interest income includes interest, dividends, amortization and accretion of purchase premiums and discounts and realized gains and losses on sales of securities, if any. The cost of securities sold is based on the specific-identification method.
The Company monitors its investment portfolio for potential impairment on a quarterly basis. If the carrying amount of an investment in marketable securities exceeds its fair value and the decline in value is determined to be other-than-temporary, the carrying amount of the security is reduced to fair value and a loss is recognized in operating results for the amount of such decline. In order to determine whether a decline in value is other-than-temporary, the Company evaluates, among other factors, the cause of the impairment, including the creditworthiness of the security issuers, the number of securities in an unrealized loss position, the severity and duration of the unrealized losses, and its intent and ability to hold the security to maturity or expected recovery.
Fair Value Instruments
The Company records its financial assets and liabilities at fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the reporting date. The accounting guidance establishes a three-tiered hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value as follows:
Level 1: Inputs which include quoted prices in active markets for identical assets and liabilities.
Level 2: Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3: Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
The carrying values of certain assets and liabilities of the Company, such as cash and cash equivalents and accounts payable approximate fair value due to their relatively short maturities. The carrying value of the Company’s short-term financial obligations approximates their fair value as the terms of the borrowing are consistent with current market rates and the duration to maturity is short. The carrying value of the Company's long-term financial obligations approximates fair value because interest rates approximate market rates that the Company could obtain for debt with similar terms and maturities.
Net Loss Per Common Share
Basic net loss per common share is calculated by dividing the net loss by the weighted-average number of common shares outstanding during the period, without consideration for potentially dilutive securities. Diluted net loss per common 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, common stock warrants and stock options are considered to be potential dilutive securities but 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.

8


The following outstanding common stock equivalents were excluded from the computations of diluted net loss per common share for the periods presented as the effect of including such securities would be antidilutive:
 
June 30, 2019
 
June 30, 2018
 
(unaudited)
Warrants to purchase common stock
274,524

 
199,524

Options to purchase common stock
1,765,742

 
1,186,318

Total
2,040,266

 
1,385,842

Recent Accounting Pronouncements
In August 2018, the Financial Accounting Standards Board ("FASB") issued ASU2018-15, Intangible - Goodwill and Other - Internal-Use Software (Subtopic 350-40), which aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. ASU2018-15 is effective for the Company in the first quarter of 2020. Early adoption is permitted. ASU2018-15 permits either a prospective or retrospective transition approach. The Company is currently evaluating ASU2018-15 to determine the impact to its financial statements and disclosures.
In August 2018, the FASB issued ASU2018-13, Fair Value Measurement (Topic 820). The new guidance modifies the disclosure requirements on fair value measurements. ASU2018-13 is effective for the Company beginning in the first quarter of 2020 and must be adopted on a modified retrospective basis, with certain exceptions. Early adoption is permitted. The Company does not expect ASU2018-13 to have a significant impact to its financial statements and disclosures.
The FASB issued ASU2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments in June 2016, ASU2018-19, Codification Improvements to Topic 326, Financial Instruments - Credit Losses in November 2018, and ASU2019-05, Financial Instruments - Credit Losses, Targeted Transition Relief in May 2019. This new guidance is intended to present credit losses on available-for-sale debt securities as an allowance rather than as a write-down. Entities are required to apply the standards' provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is adopted. ASU2016-13, ASU2018-19 and ASU2019-05 are effective for the Company in the first quarter of 2020. The Company is currently evaluating these standards to determine the impact to its financial statements and disclosures.
3.
Cash Equivalents and Investments in Marketable Securities
The following tables present summaries of the Company's cash equivalents and investments in marketable securities measured at fair value on a recurring basis:
 
 
 
Fair Value Measurements
 
Total
 
Quoted prices
in active
market
Level 1
 
Significant
other
observable
inputs
Level 2
 
Significant
unobservable
inputs
Level 3
 
(unaudited; in thousands)
As of June 30, 2019:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Money market funds
$
9,111

 
$
9,111

 
$

 
$

Commercial paper
3,803

 

 
3,803

 

U.S. treasuries
3,991

 
3,991

 

 

Total
$
16,905

 
$
13,102

 
$
3,803

 
$

 
 
 
 
 
 
 
 
Classified as:
 
 
 
 
 
 
 
Cash equivalents
$
13,417

 
 
 
 
 
 
Marketable securities at fair value
3,488

 
 
 
 
 
 
Total
$
16,905

 
 
 
 
 
 

9


 
 
 
Fair Value Measurements
 
Total
 
Quoted prices
in active
market
Level 1
 
Significant
other
observable
inputs
Level 2
 
Significant
unobservable
inputs
Level 3
 
(in thousands)
As of December 31, 2018:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Money market funds
$
4,830

 
$
4,830

 
$

 
$

Commercial paper
1,497

 

 
1,497

 

Corporate notes and bonds
6,989

 

 
6,989

 

U.S. treasuries
8,375

 
8,375

 

 

Total
$
21,691

 
$
13,205

 
$
8,486

 
$

 
 
 
 
 
 
 
 
Classified as:
 
 
 
 
 
 
 
Cash equivalents
$
7,829

 
 
 
 
 
 
Marketable securities at fair value
13,862

 
 
 
 
 
 
Total
$
21,691

 
 
 
 
 
 
The Company did not transfer any marketable securities measured at fair value on a recurring basis to or from Level 1 and Level 2 during the six months ended June 30, 2019.
The following tables summarize the unrealized positions for available-for-sale securities disaggregated by class of instrument:
 
Amortized Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
 
(unaudited; in thousands)
As of June 30, 2019:
 
 
 
 
 
 
 
Money market funds
$
9,111

 
$

 
$

 
$
9,111

Commercial paper
3,804

 

 
(1
)
 
3,803

U.S. treasuries
3,990

 
1

 

 
3,991

Total
$
16,905

 
$
1

 
$
(1
)
 
$
16,905

 
Amortized Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
 
(in thousands)
As of December 31, 2018:
 
 
 
 
 
 
 
Money market funds
$
4,830

 
$

 
$

 
$
4,830

Commercial paper
1,497

 

 

 
1,497

Corporate notes and bonds
6,994

 

 
(5
)
 
6,989

U.S. treasuries
8,375

 

 

 
8,375

Total
$
21,696

 
$

 
$
(5
)
 
$
21,691


10


4.
Balance Sheet Components
The following table summarizes the Company's prepaid expenses and other current assets for each of the periods presented:
 
June 30, 2019
 
December 31, 2018
 
(unaudited; in thousands)
 
(in thousands)
Prepaid services
295

 
88

Prepaid insurance
231

 
45

Prepaid rent
190

 
23

Prepaid software and subscriptions
170

 
42

Other
105

 
160

Total
$
991

 
$
358

The following table summarizes the Company’s property and equipment for each of the periods presented:
 
June 30, 2019
 
December 31, 2018
 
(unaudited; in thousands)
 
(in thousands)
Leasehold improvements
$
16,951

 
$
16,690

Manufacturing equipment
12,140

 
10,387

Laboratory and office equipment
1,817

 
1,434

Computer equipment and software
235

 
206

Construction-in-progress
16,565

 
9,558

 
47,708

 
38,275

Less: accumulated depreciation
(27,140
)
 
(26,359
)
Total
$
20,568

 
$
11,916

Depreciation expense was approximately $0.2 million and $0.2 million for the three months ended June 30, 2019 and 2018, respectively. Depreciation expense was approximately $0.4 million and $0.4 million for the six months ended June 30, 2019 and 2018, respectively.
The gross property and equipment and accumulated depreciation presented in the above table includes right-of-use assets acquired under finance leases and the related accumulated amortization, respectively. Right-of-use assets under finance leases were comprised of office and computer equipment of approximately $54,000 and $24,000 at June 30, 2019 and December 31, 2018, respectively. Accumulated amortization related to right-of-use assets under finance leases was approximately $19,000 at June 30, 2019.
As of June 30, 2019, construction-in-progress included $10.9 million of an asset relating to the build-to-suit arrangement for construction of the Company's commercial coating and primary packaging system, of which capitalized construction period interest was $1.0 million (See Note 6. Debt Financing).
The following table summarizes the Company’s other accrued liabilities for each of the periods presented:
 
June 30, 2019
 
December 31, 2018
 
(unaudited; in thousands)
 
(in thousands)
Construction-in-progress obligations
$
2,055

 
$
395

Pre-clinical and clinical study
891

 
483

Professional service fees
306

 
112

Contract manufacturing
158

 
834

Accrued taxes
20

 
187

Other
248

 
408

Total
$
3,678

 
$
2,419



11


5.
Leases
Operating Leases
The Company has a non-cancelable operating lease for office, research and development, and manufacturing facilities in Fremont, California through August 31, 2024, with an option to further extend the lease for an additional 60 months subject to certain terms and conditions. The operating lease right-of-use asset and associated lease liability do not consider the option to extend the term after August 31, 2024, as the Company is not reasonably certain of exercising the extension option.
The lease agreement calls for monthly base rent of approximately $136,000 for the period commencing September 1, 2017, with annual increases on September 1 of each subsequent year until the lease year beginning September 1, 2023. The agreement also provided for rent abatements, subject to certain conditions, totaling $0.3 million and certain tenant improvements to be completed at the landlord’s expense of approximately $1.0 million.
The Company entered into a three year, non-cancelable lease for telephone equipment in January 2018.
Per the terms of the agreements, the Company does not have any residual value guarantees, restrictions or covenants. In calculating the present value of the lease payments, the Company utilized its incremental borrowing rate, as the rates implicit in the leases were not readily determinable. The Company accounts for lease and non-lease components separately. The building lease includes non-lease components (i.e. common area maintenance) which are charged and paid separately from rent based on actual costs incurred and therefore are not included in the right-of-use asset and lease liability but reflected in operating expense in the period incurred.
Finance Leases
The Company leases certain equipment under non-cancelable agreements which expire between 2021 and 2022 that were accounted for as capital leases under ASC840. The leases were not reassessed at adoption of ASC842 as the Company elected the practical expedient to not reassess existing leases.
The finance lease obligations were as follows:
 
June 30, 2019
 
December 31, 2018
 
(unaudited; in thousands)
 
(in thousands)
Finance lease obligations, current portion
$
15

 
$
5

Finance lease obligations, long-term portion
$
25

 
$
18

The components of lease cost were as follows:
 
 
 
 
Description of lease costs
Three months ended
June 30, 2019
 
Six months ended
June 30, 2019
 
(unaudited; in thousands)
Finance Lease Cost
 
 
 
Amortization of finance lease right-of-use assets
$
4

 
$
19

Interest on finance lease obligations
3

 
12

Operating lease costs
410

 
820

Total
$
417

 
$
851


12


Cash payments for leases were as follows:
Description of cash payment
Six months ended June 30, 2019
 
(unaudited; in thousands)
Operating cash flows from operating leases
$
872

Operating cash flows from finance leases
$
6

Financing cash flows from finance leases
$
6

Lease term and discount rate were as follows:
 
June 30, 2019
Description of other lease information
Operating leases
 
Finance leases
 
(unaudited)
Weighted-average remaining lease term (in years)
5.25

 
2.28

Weighted average discount rate
11
%
 
27
%
As of June 30, 2019, annual scheduled lease payments were as follows:
Year
Operating leases
 
Finance leases
 
(unaudited; in thousands)
Remainder of 2019
$
889

 
$
12

2020
1,815

 
24

2021
1,863

 
14

2022
1,914

 
3

2023
1,970

 

2024
1,340

 

Total undiscounted cash flows
9,791

 
53

Less: amount representing interest
(2,396
)
 
(13
)
Present value of lease liabilities
$
7,395

 
$
40

6.
Debt Financing
Build-to-Suit Obligation with Trinity
In September 2018, the Company entered into a build-to-suit arrangement with Trinity Capital Fund III, L.P. ("Trinity") in order to obtain financing for the third party construction of the Company's commercial coating and primary packaging system (the "Equipment"), expected to be completed in the second quarter of 2020. Under the agreement, Trinity will make available to the Company $14.0 million for equipment costs and associated soft costs ("Total Cost"), with an initial drawdown of $5.0 million and additional drawdowns in increments of not less than $0.5 million, until March 30, 2020. At March 30, 2020, any unused portion of the $14.0 million will be subject to a non-utilization fee equal to 3% of the unused amount. In consideration of the financing arrangement, as collateral, the Company granted Trinity a first-priority lien and security interest in substantially all of the Company's assets.
The Company determined that it controls the Equipment during the construction period due to its involvement in and its obligations related to the construction of the Equipment. Accordingly, construction costs incurred were recorded as construction-in-progress, a component of property and equipment on the balance sheet, and the Trinity financing obligation was recorded as a build-to-suit obligation on the balance sheet.
Under the financing arrangement, each individual drawdown represents a separate financing arrangement with its own 36-month-term and stated interest rate. Each drawdown is non-cancelable, with no prepayment options. Each drawdown has embedded optional purchase options to (i) extend the term for an additional three months, with the option to purchase the equipment at 4% of the Total Cost, which is equal to the drawdown amount, following the end of such extended term, or (ii) purchase the equipment at 12% of the Total Cost, which is equal to the drawdown amount, at the end of the 36-month-term. The Company intends to exercise

13


the optional purchase option of 12% at the end of each 36-month-term ("Purchase Option Fee"). The transfer of title from Trinity to the Company will occur at the end of the final 36-month-term, provided that the purchase option was executed, and the Purchase Option Fee was paid in full at the end of each 36-month-term. Failure to pay any of the Purchase Option Fees will result in Trinity retaining title to the Equipment and the Company paying a 6% restocking fee.
As of June 30, 2019, the Company had drawn down a total of $10.1 million and had a remaining available balance under the line of credit of $3.9 million, which it will use to fund the construction of the Equipment. As of June 30, 2019, the Company had an aggregate commercial coating and primary packaging system construction-in-progress ("CIP") balance of $10.9 million that included $1.0 million of interest related to its build-to-suit obligation, and a net build-to-suit obligation of $8.2 million.
In connection with the build-to-suit arrangement, the Company issued common stock warrants (“Trinity Warrants”) for a total of 75,000 shares of common stock at an exercise price of $3.59 per share. The Trinity Warrants will expire on September 25, 2025. Proceeds allocated to the Trinity Warrants based on their relative fair value approximated $243,000 and were recorded as a discount to the initial $5.0 million drawdown under the Trinity financing arrangement and are being amortized as interest over the term of the September 2018 drawdown.
The Trinity build-to-suit arrangement requires compliance with various affirmative and restrictive covenants in regard to making certain investments and other restricted payments, engaging in mergers or consolidations, and the sale or transfer of certain assets. Failure to comply with any of these covenants, or pay principal, interest or other amounts when due, would constitute an event of default under the applicable agreement. The Company was in compliance with its covenants with respect to the Trinity build-to-suit arrangement as of June 30, 2019.
The following table summarizes the debt obligations as of June 30, 2019:
Drawdown Date
 
Drawdown Amount
 
Principal Balance as of 6/30/19
 
Purchase Option Fee
 
Discount on Purchase Option Fee
 
Unamortized Discounts and Issuance Costs
 
Monthly Payment
 
Stated Interest Rate
 
Effective Interest Rate
 
Maturity Date
 
 
 
 
(unaudited; in thousands)
 
 
 
 
 
 
09/25/2018
 
$
5,000

 
$
3,720

 
$
600

 
$
(85
)
 
$
(520
)
 
$
160

 
9.43
%
 
26.28
%
 
10/01/2021
12/11/2018
 
2,800

 
2,299

 
336

 
(60
)
 
(201
)
 
90

 
9.68
%
 
19.58
%
 
01/01/2022
06/06/2019
 
2,300

 
2,171

 
276

 
(71
)
 
(227
)
 
74

 
9.93
%
 
19.77
%
 
07/01/2022
Total
 
$
10,100

 
$
8,190

 
$
1,212

 
$
(216
)
 
$
(948
)
 
$
324

 

 

 

The following table is a summary of the Company's build-to-suit obligation as of June 30, 2019 (unaudited; in thousands):
Build-to-suit obligation principal amount
 
$
8,190

Build-to-suit obligation Purchase Option Fees at present value
 
996

Less: unamortized Purchase Option Fees
 
(647
)
unamortized fair value of free-standing warrants
 
(141
)
unamortized debt discount
 
(145
)
unamortized debt issuance costs
 
(15
)
Build-to-suit obligation, net of debt issuance costs and discount
 
$
8,238

 
 
 
Build-to-suit obligation, current portion
 
$
3,147

Build-to-suit obligation, long-term portion, net of debt issuance costs and discount
 
5,091

Build-to-suit obligation, net of debt issuance costs and discount
 
$
8,238


14


Future minimum payments on the Company’s build-to-suit obligation, including payment of principal and interest and Purchase Option Fees for each year ending December 31 were as follows:
Year
Principal
 
Interest
 
Purchase Option Fees
 
(unaudited; in thousands)
Remainder of 2019
$
1,508

 
$
363

 
$

2020
3,359

 
530

 

2021
2,964

 
194

 
600

2022
359

 
12

 
612

Total
$
8,190

 
$
1,099

 
$
1,212

Senior Secured Term Loan with Hercules
In June 2014 and June 2015, the Company entered into a loan and security agreement and the first amendment to the loan and security agreement, respectively, with Hercules Capital Inc. (“Hercules”). Hercules provided the Company a $15.0 million loan (“Hercules Term Loan”) of which equal installment payments of principal and interest were due monthly, with a scheduled maturity date of December 1, 2018. The Hercules Term Loan bore interest at a variable rate equal to the greater of (i) 7.95%, or (ii) 7.95% plus the prime rate as quoted in the Wall Street Journal minus 5.25%. On September 25, 2018, the Company paid all its outstanding obligations under the Hercules Term Loan, including an end of term charge of $0.4 million.
For the three and six months ended June 30, 2018, the Company recorded total interest expense of $0.1 million and $0.3 million, respectively, related to the Hercules Term Loan.
7.
Warrants
The following table summarizes the warrants issued and outstanding as of June 30, 2019:
 
Warrants
Outstanding as of
December 31, 2018
 
Warrants Issued
 
Warrants Exercised
 
Warrants Expired
 
Warrants
Outstanding
as of June 30, 2019
 
Exercise Price
 
Expiration Date
 
 
 
(unaudited)
 
 
 
 
PIPE Financing - Series B
195,906

 

 

 

 
195,906

 
$
31.00

 
8/19/2021
Hercules - June 2014
1,583

 

 

 

 
1,583

 
$
176.80

 
1/27/2020
Hercules - June 2015
2,035

 

 

 

 
2,035

 
$
147.40

 
6/23/2020
Trinity - September 2018
75,000

 

 

 

 
75,000

 
$
3.59

 
9/25/2025
Total
274,524

 

 

 

 
274,524

 
 
 
 
8.
Commitments and Contingencies
Employment Arrangements
The Company has entered into employment agreements with its executive officers. Generally, the terms of these agreements provide for base salary, health care coverage, annual bonus and stock options. In addition, if the Company terminates the officer other than for cause, death, or disability, or if the officer terminates his or her employment with the Company for good cause, the officer shall be entitled to receive certain severance compensation and benefits as described in each such agreement as well as automatic acceleration of vesting, at a certain percentage (25% or 100%), of their unvested stock options and other equity awards on the date of such termination.
Equipment Purchase Commitments
The Company has a remaining commitment of $6.3 million with an equipment manufacturer for the construction and purchase of a commercial coating and primary packaging system for the production of its product candidate, Qtrypta™ (M207). The terms of the purchase commitment are contingent upon performance of certain milestones. The Company anticipates that the obligation will be paid within the next 12 months.

15


The Company also has commitments with equipment manufacturers to produce its patch assembly machine and its applicator and retainer machinery. The aggregate purchase price of this equipment is $3.9 million of which $2.0 million was paid as of June 30, 2019.
Contract Manufacturing Organizations
In September 2018, the Company entered into a technology transfer agreement and a manufacturing and supply agreement with a contract manufacturing organization ("CMO") to provide services related to the manufacture and commercialization of Qtrypta™ (M207). During the term of the agreement, the CMO will provide services related to processing, packaging, labeling and storing Qtrypta™ (M207), in addition to other services such as stability testing, quality control and assurance, and waste disposal.
The agreements call for annual fees of $1.0 million in 2019 escalating to $14.0 million in 2024, to be paid in equal monthly installments. Beginning in 2020, the annual fee includes the production of a defined number of units with an option to purchase additional units at a defined price. The agreement contains negotiated representations and warranties, indemnification, limitations of liability, and other provisions. The initial term of the agreement continues until the seventh anniversary of the date on which the Company receives New Drug Application approval of Qtrypta™ (M207) in the United States.
The Company may terminate the agreements upon denial of regulatory approvals or if regulatory approvals are withdrawn under certain circumstances. If the Company elects to terminate the contracts for convenience, the Company would incur cancellation fees in the amount of 50% of the annual fee due in the year that the contract is terminated, and costs to remove the Company's equipment and restore the CMO's facility to its original condition. The Company or the CMO may terminate the agreement for the other’s uncured material breach, uncured force majeure or bankruptcy or insolvency-related events.
As of June 30, 2019, the Company had entered into agreements with two CMOs for the construction of manufacturing space and technology transfer fees for $11.7 million of which $2.8 million had been paid.
Indemnification and Guarantees
In the normal course of business, the Company enters into contracts and agreements that contain a variety of representations and warranties and provide for general indemnifications. The Company’s exposure under these agreements is unknown because it involves claims that may be made against the Company in the future but have not yet been made. To date, the Company has not paid any claims or been required to defend any action related to its indemnification obligations. However, the Company may record charges in the future as a result of these indemnification obligations. The Company also has indemnification obligations to its officers and directors for specified events or occurrences, subject to some limits, while they are serving at the Company’s request in such capacities. There have been no claims to date and the Company has director and officer insurance that may enable the Company to recover a portion of any amounts paid for future potential claims. The Company believes the fair value of these indemnification agreements is minimal. Accordingly, the Company has not recorded any liabilities for these agreements as of June 30, 2019.
Legal Proceedings
The Company is not party to any material pending legal proceedings. However, it may from time to time become involved in litigation relating to claims arising in the ordinary course of business. Such matters are subject to many uncertainties and outcomes and are not predictable with assurance. The Company accrues for contingencies when it believes that a loss is probable and that it can reasonably estimate the amount of any such loss. To the extent that there is a reasonable possibility that a loss exceeding amounts already recognized may be incurred and the amount of such additional loss would be material, the Company will either disclose the estimated additional loss or state that such an estimate cannot be made.
9.
Stock-Based Compensation
The Amended and Restated 2014 Equity and Incentive Plan
The Amended and Restated 2014 Equity and Incentive Plan (“2014 Plan”) provides for the issuance of (i) cash awards and (ii) equity-based awards, denominated in shares of the Company’s common stock, including incentive stock options, non-statutory stock options, stock appreciation rights, restricted stock awards, restricted stock units, unrestricted stock awards, performance share awards and dividend equivalent rights. Incentive stock options may be granted only to Company employees. Nonqualified stock options may be granted to Company employees, outside directors and consultants. As of June 30, 2019, the Company had reserved 1,771,012 shares of its common stock for issuance under the 2014 Plan and a previously terminated plan, subject to automatic annual increases as set forth in the 2014 Plan. Options and awards under the 2014 Plan may be granted for periods of up to ten years. Employee options granted by the Company generally vest over four years. Restricted stock awards granted to employees, directors and consultants can be subject to the same vesting conditions and the right of repurchase by the Company of unvested shares as determined by its board of directors. As of June 30, 2019, the Company had 17,357 shares available for grant under the 2014 Plan.

16


During the six months ended June 30, 2019, the Company granted stock options to purchase 32,500 shares of common stock to non-employee directors.
The following table summarizes option and award activity, excluding inducement grants, for the six months ended June 30, 2019 (unaudited):
 
Shares
Available for
Grant
 
Number of Shares Subject to Outstanding Options
 
Weighted-
Average
Exercise
Price per
Share
 
Weighted-
Average
Remaining
Contractual
Term
(In Years)
 
Aggregate
Intrinsic
Value
Balance at January 1, 2019
55,799

 
1,296,157

 
$
5.75

 
9.23
 
$

Additional shares reserved
419,056

 

 
$

 
 
 
 
Options granted
(496,950
)
 
496,950

 
$
3.27

 
 
 
 
Options canceled/forfeited/expired
39,452

 
(39,452
)
 
$
5.23

 
 
 
 
Balance at June 30, 2019
17,357

 
1,753,655

 
$
5.06

 
9.05
 
$
197

Exercisable at June 30, 2019
 
 
366,022

 
$
8.55

 
8.49
 
$
1

Vested or expected to vest at June 30, 2019
 
 
1,627,577

 
$
5.15

 
9.03
 
$
176

The aggregate intrinsic value is calculated as the difference between the exercise price of the option and the estimated fair value of the Company’s common stock for in-the-money options at June 30, 2019.
Inducement Grants
The Company has also awarded inducement grants to purchase common stock to new employees outside the existing equity compensation plans in accordance with Nasdaq listing rule 5635(c)(4). Such options vest at a rate of 25% of the shares on the first anniversary of the commencement of such employee’s employment with the Company, and then one forty-eighth (1/48) of the shares monthly thereafter subject to such employee’s continued service. 
The following table summarizes the Company’s inducement grant stock option activity (unaudited):
 
Number of Shares Subject to Outstanding Options
 
Weighted-
Average
Exercise
Price per Share
 
Weighted-Average Remaining
Contractual
Term
(In Years)
 
Aggregate
Intrinsic
Value
Balance at January 1, 2019
13,837

 
$
20.60

 
4.52
 
$

Options granted

 
$

 
 
 
 
Options canceled/forfeited/expired
(1,750
)
 
$
22.80

 
 
 
 
Balance at June 30, 2019
12,087

 
$
20.28

 
3.51
 
$

Exercisable at June 30, 2019
9,795

 
$
18.66

 
2.47
 
$

Vested or expected to vest at June 30, 2019
11,952

 
$
20.20

 
3.46
 
$

Stock-Based Compensation Expense
Total stock-based compensation expense recognized was as follows:
 
Three months ended June 30,
 
Six months ended June 30,
 
2019
 
2018
 
2019
 
2018
 
(unaudited; in thousands)
 
(unaudited; in thousands)
Research and development
$
178

 
$
142

 
$
343

 
$
209

General and administrative
208

 
188

 
404

 
260

Total
$
386

 
$
330

 
$
747

 
$
469

As of June 30, 2019, the Company had $4.4 million of total unrecognized stock-based compensation related to outstanding stock options that will be recognized over a weighted-average period of 3.06 years.

17


The Company’s stock-based compensation expense for stock options is estimated at the grant date based on the award’s fair value as calculated by the Black-Scholes option pricing model and is recognized as expense over the requisite service period. The Black-Scholes option pricing model requires various highly judgmental assumptions including expected volatility and expected term. As the Company does not have sufficient historical stock price information to meet the expected life of the stock-based awards, the Company uses a blended volatility that includes the Company's common stock trading history and supplements the remaining historical information with the trading history from the common stock of a set of comparable publicly traded biopharmaceutical companies. The Company will continue to apply this process until a sufficient amount of historical information regarding the volatility of the Company's stock price becomes available. To estimate the expected term, the Company has opted to use the simplified method which is the use of the midpoint of the vesting term and the contractual term. If any of the assumptions used in the Black-Scholes option pricing model changes significantly, stock-based compensation expense may differ materially in the future from that recorded. Through March 31, 2019, the Company estimated the forfeiture rate based on historical experience and its expectations regarding future pre-vesting termination behavior of employees. In the second quarter of 2019, the Company made an accounting policy election to recognize the impact of forfeitures on compensation cost in the period the award is forfeited.
The following table presents the weighted-average assumptions for the Black-Scholes option-pricing model used in determining the fair value of options granted (unaudited):
 
Three months ended June 30,
 
Six months ended June 30,
 
2019
 
2018
 
2019
 
2018
Dividend yield
—%
 
—%
 
—%
 
—%
Risk-free interest rate
1.97% - 2.45%
 
2.74% - 3.11%
 
1.97% - 2.66%
 
2.74% - 3.11%
Expected volatility
108%
 
89%
 
106% - 108%
 
89%
Expected term (years)
5.96 - 6.08
 
6.08
 
5.96 - 6.08
 
6.08
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction with our financial statements and accompanying notes included in this Quarterly Report on Form 10-Q and the financial statements and accompanying notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2018, filed with the Securities and Exchange Commission, or SEC, on March 25, 2019. This discussion contains “forward-looking statements” within the meaning of the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Such forward looking statements involve risks and uncertainties. We use words such as “may,” “continue,” “goal,” “would,” “could,” “might,” “project,” “anticipate,” “intend,” “forecast,” “designated,” “approximate,” “will,” “expect,” “anticipate,” “estimate,” “intend,” “plan,” “predict,” “potential,” “believe,” “should” or negatives of these words and similar expressions and references to future periods to identify forward-looking statements. Although we believe the expectations reflected in these forward-looking statements are reasonable, such statements are inherently subject to risk and we can give no assurances that our expectations will prove to be correct. These statements appearing throughout this Quarterly Report on Form 10-Q are statements regarding our intent, belief, or current expectations, primarily regarding our operations. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this Quarterly Report on Form 10-Q. As a result of many factors, such as those set forth under “Risk Factors” under Item 1A of Part II below, and elsewhere in this Quarterly Report on Form 10-Q, our actual results may differ materially from those anticipated in these forward-looking statements. We undertake no obligation to update these forward-looking statements to reflect events or circumstances after the date of this report or to reflect actual outcomes.
Overview
Zosano Pharma Corporation is a clinical stage biopharmaceutical company focused on providing rapid systemic administration of therapeutics to patients using our proprietary Adhesive Dermally-Applied Microarray, or ADAM, technology. In February 2017, we announced positive results from our ZOTRIP pivotal efficacy trial, or ZOTRIP trial, that evaluated Qtrypta™ (M207), which is our proprietary formulation of zolmitriptan delivered via our ADAM technology, as an acute treatment for migraine. In February 2019, we announced the completion of the final milestone in our long-term safety study for Qtrypta™ (M207). We are focused on developing products where rapid administration of established molecules with known safety and efficacy profiles provides an increased benefit to patients, in markets where patients remain underserved by existing therapies. We anticipate that many of our current and future development programs may enable us to utilize a regulatory pathway that would streamline clinical development and accelerate the path towards commercialization.

18


ADAM is our proprietary, investigational technology platform designed to offer rapid drug absorption into the bloodstream, which can result in an improved pharmacokinetic profile compared to original dosage forms. ADAM consists of an array of drug-coated titanium microprojections mounted on an adhesive backing that is pressed on to the skin using a reusable handheld applicator. The microprojections penetrate the stratum corneum and allow the drug to be absorbed into the microcapillary system of the skin. We focus on developing products based on our ADAM technology for indications in which rapid onset, ease of use and stability offer significant therapeutic and practical advantages, in markets where there is a need for more effective therapies.
Our development efforts are focused on our product candidate, Qtrypta™ (M207). Qtrypta™ (M207) is our proprietary formulation of zolmitriptan delivered utilizing our ADAM technology. Zolmitriptan is one of a class of serotonin receptor agonists known as triptans and is used as an acute treatment for migraine. Migraine is a debilitating neurological disease, symptoms of which include moderate to severe headache pain, nausea and vomiting, and abnormal sensitivity to light and sound. The objective of Qtrypta™ (M207) is to provide faster onset of efficacy and sustained freedom from migraine symptoms by delivering rapid absorption while avoiding the gastrointestinal tract. Feedback from the Food and Drug Administration ("FDA") on Qtrypta™ (M207)’s regulatory path has also been encouraging. The agency has indicated that one positive pivotal efficacy study, in addition to the required safety study, would be sufficient for approval of Qtrypta™ (M207) for the treatment of migraine.
We will use contract manufacturers for the production of Qtrypta™ (M207). These contract manufacturers include companies that will produce our applicator, the various components that comprise our patch, as well as the final packaging of the finished product. Where required, these contract manufacturers will operate within the specifications and in accordance with good manufacturing practices as defined by the FDA. These companies are located in the United States and have expertise and experience in contract manufacturing.
We have no product sales to date, and we will not have product sales unless and until we receive approval from the FDA, or equivalent foreign regulatory bodies, to market and sell our product candidate. Accordingly, our success depends not only on the development, but also on our ability to finance the development of the product. We will require substantial additional funding to complete development and seek regulatory approval for these products. Additionally, we currently have no sales, marketing or distribution capabilities and thus our ability to market our products in the future will depend in part on our ability to develop such capabilities either alone or with collaboration partners.
M207 Long-Term Safety Study
In November 2017, we announced the initiation of enrollment in our long-term safety study for Qtrypta™ (M207) as an acute treatment of migraine (“M207-ADAM”). M207-ADAM was an open label study evaluating the safety of the 3.8mg dose of Qtrypta™ (M207) in migraine patients who had historically experienced at least two migraines per month. Patients were expected to treat a minimum of two migraines per month on average, with no maximum treatment limits. The study was conducted at 31 sites in the United States with a defined data set per protocol in which 150 subjects received repeated doses for six months and 50 subjects received repeated doses for one year. The study was open-label, with investigator visits at months one, two, three, six, nine and twelve to record adverse events, if any. The primary objective of M207-ADAM was to assess safety of Qtrypta™ (M207) during repeated use over six and twelve months. Other endpoints were electrocardiography and laboratory parameters, as well as percentage of headaches with pain-free response.
In October 2018, we announced the completion of the first phase of our long-term safety study with more than 150 evaluable subjects completing six months of treatment with Qtrypta™ (M207). In February 2019, we announced the completion of the second phase of our long-term safety study with more than 50 evaluable subjects completing one year of treatment with Qtrypta™ (M207). As of February 2019, more than 5,800 migraines had been treated with Qtrypta™ (M207). Investigators reported 831 adverse events, of which 297 were reported as application site reactions and 161 were reported as treatment related adverse events. As of February 2019, following treatment with Qtrypta™ (M207), 44% of patients reported pain freedom at two hours, 68% of patients reported relief from most bothersome symptom, while pain relief at two hours was reported for 81% of migraine attacks treated. Final results from the long-term safety study are expected to be presented at upcoming scientific meetings.
C213 for the Treatment of Cluster Headache
In August 2019, we announced that we submitted an Investigational New Drug application to the FDA to initiate a phase 2/3 clinical study for C213 in patients with cluster headache. Like QtryptaTM (M207) for the potential treatment of migraine, C213 for the potential treatment of cluster headache consists of our investigational proprietary formulation of zolmitriptan delivered utilizing our proprietary ADAM technology. In the Phase 2/3 study, if authorized to proceed by the FDA, approximately 120 adults who suffer from chronic or episodic cluster headache will be randomized to receive 1.9 mg of QtryptaTM (M207), 3.8 mg of QtryptaTM (M207), or placebo in a 1:1:1 fashion. The co-primary endpoints of the study will be the proportion of patients who achieve pain relief at 15 minutes and the proportion of patients whose pain relief is sustained from 15 minutes to 60 minutes.

19


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, which have been prepared in accordance with United States generally accepted accounting principles ("U.S. GAAP"). The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported results of operations during the reporting periods. Our estimates are based on our historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from these estimates under different assumptions or conditions.
We are an “emerging growth company” as defined in the Jumpstart Our Business Startups Act of 2012. Emerging growth companies can delay adopting new or revised accounting standards until such time as those standards apply to private companies. We have irrevocably elected not to avail ourselves of this exemption from new or revised accounting standards, and, therefore, will be subject to the same new or revised accounting standards as other public companies that are not emerging growth companies.
Our significant accounting policies are included in “Part II - Item 8 - Financial Statements and Supplementary Data - Note 2 - Summary of Significant Accounting Policies” in our Annual Report on Form 10-K for the year ended December 31, 2018. As discussed in our Annual Report, we adopted the new leases standard in the first quarter of 2019. In the second quarter of 2019, we made an accounting policy election to recognize the impact of stock option forfeitures on stock compensation expense in the period the award is forfeited as permitted under ASC2016-09, Compensation-Stock Compensation (Topic 718). Previously, we estimated the effects of stock option forfeitures at the initial grant date and reduced stock compensation expense for the estimated effect of forfeitures over the requisite service period. There have been no other changes to the Company's significant accounting policies.
Leases
At the inception of an arrangement, we determine whether the arrangement is or contains a lease based on the unique facts and circumstances present. Operating lease liabilities and their corresponding right-of-use assets are recorded based on the present value of lease payments over the expected lease term. If the interest rate implicit in our lease contracts is not readily determinable, we utilize our incremental borrowing rate, which is the rate incurred to borrow on a collateralized basis over a similar term, an amount equal to the lease payments in a similar economic environment. Certain adjustments to the right-of-use asset may be required for items such as initial direct costs paid or incentives received.
Financial Operations Overview
General
As of June 30, 2019, we had an accumulated deficit of $280.0 million. We have incurred significant losses and expect to incur significant and increasing losses in the foreseeable future as we advance our Qtrypta™ (M207) product candidate into later stages of development and, if approved, commercialization. We cannot assure you that we will receive additional capital or collaboration revenue in the future, as a result of any partnership that we might pursue.
We expect our research and development expenses and manufacturing expenses related to the development of our Qtrypta™ (M207) product candidate to increase as we continue to advance this program towards regulatory filing and approval. Because of the numerous risks and uncertainties associated with our technology and drug development, we cannot forecast with any degree of certainty the timing or amount of expenses incurred or when, or if, we will be able to achieve profitability.
We will require additional capital to undertake our planned research and development activities and to meet our operating requirements beyond the fourth quarter of 2019. We intend to raise such capital through the issuance of additional equity through public or private offerings, debt financing, strategic alliances with pharmaceutical partners, or any combination of the above. However, if such financing is not available at adequate levels or on acceptable terms, we could be required to further reduce our operating expenses and suspend, delay or reduce the scope of our Qtrypta™ (M207) development program, out-license intellectual property rights to our intracutaneous delivery technology, or a combination of the above, which may have a material adverse effect on our business, results of operations, financial condition and/or our ability to fund our scheduled obligations on a timely basis or at all.

20


Research and Development Expenses
Research and development expenses represent costs incurred to conduct research, such as the discovery and development of our proprietary product candidates. We recognize all research and development expenses as they are incurred.
Research and development expenses consist of:
production costs which include, but are not limited to, employee-related expenses, including salaries, benefits and stock-based compensation expense, drug formulation and clinical trials;
expenses related to the purchase of active pharmaceutical ingredients and raw materials for the production of our intracutaneous delivery system, including fees paid to contract manufacturing organizations;
fees paid to contract research organizations ("CROs"), clinical consultants, clinical trial sites and vendors, including institutional review boards ("IRBs"), in conjunction with implementing and monitoring our clinical trials and acquiring and evaluating clinical trial data, including all related fees, such as for investigator grants, patient screening fees, laboratory work and statistical compilation and analysis;
fees paid to conduct clinical studies, drug formulation and cost of consumables used in nonclinical and clinical trials;
other consulting fees paid to third parties; and
allocation of certain shared costs, such as facilities-related costs.
Our research and development expenses may increase in the future. The process of conducting the necessary clinical trials to obtain regulatory approval is costly and time consuming. We consider the active management and development of our clinical pipeline to be crucial to our long-term success. The actual probability of success for each product candidate and clinical program may be affected by a variety of factors, including, but not limited to: the quality of the product candidate, early clinical data, investment in the program, competition, manufacturing capability and commercial viability. In situations in which third parties have control over the clinical development of a product candidate, the estimated completion dates are largely under the control of such third parties and not under our control. Additionally, a future collaborative partner may only be interested in applying our technology in the development and advancement of their own product candidates.
Our research and development efforts and resources have focused primarily on advancing the development of Qtrypta™ (M207). While we currently intend to continue clinical development of Qtrypta™ (M207) through commercialization in the United States ourselves, we remain open to opportunities with potential strategic partners to ensure Qtrypta™ (M207) will receive the best chance of commercial success. We are actively seeking opportunities to evaluate collaborations with strategic partners to further the clinical and commercial development of our other product candidates. We cannot forecast with any degree of certainty if Qtrypta™ (M207) or our future product candidates, if any, will be subject to future collaborations or how such arrangements would affect our development plans or capital requirements. As a result of these uncertainties, we are unable to determine the duration and completion costs of our research and development projects or when and to what extent we will generate revenue from the commercialization and sale of any of our product candidates.
General and Administrative Expenses
General and administrative expenses consist principally of personnel-related costs, professional fees for legal, consulting, audit and tax services, rent and other general operating expenses not otherwise included in research and development. As a public company, we expect to invest significant resources to comply with evolving laws, regulations and standards, including the implementation of effective internal controls over financial reporting and compliance with the Sarbanes-Oxley Act.
Other Income and Expenses
Interest income. Interest income consists primarily of interest and amortization of premiums and accretion of discounts related to our investments in marketable securities.
Interest expense. Interest expense consists of interest costs and associated amortization of debt discount and issuance costs, if any, related to debt financing and an equity line of credit.
Other income, net. Other income, net consists of miscellaneous income or expenses that are not included in other categories of the statement of operations.

21


Results of Operations
Comparison of the three months ended June 30, 2019 and 2018
Research and development expenses
 
Three months ended June 30,
 
Change
 
2019
 
2018
 
Amount
 
%
 
(unaudited; in thousands)
 
 
 
 
Research and development
$
6,640

 
$
6,533

 
$
107

 
2
%
Research and development expenses increased approximately $0.1 million, or 2%, for the three months ended June 30, 2019, as compared to the same period in 2018. The $0.1 million increase was primarily attributable to $0.5 million of costs associated with the scale up and technology transfer to our contract manufacturers and an increase of $0.3 million in compensation costs due to an increase in headcount. These increases were offset by a $0.7 million decrease in clinical trial costs primarily due to lower Qtrypta™ (M207) long-term safety study costs as compared to the same period in 2018.
General and administrative expenses
 
Three months ended June 30,
 
Change
 
2019
 
2018
 
Amount
 
%
 
(unaudited; in thousands)
 
 
 
 
General and administrative
$
2,767

 
$
2,272

 
$
495

 
22
%
General and administrative expenses increased approximately $0.5 million, or 22%, for the three months ended June 30, 2019 as compared to the same period in 2018. The increase was primarily attributable to $0.3 million in strategic development and pre-commercialization activities and $0.2 million in professional service fees.
Other income and expense
 
Three months ended June 30,
 
Change
 
2019
 
2018
 
Amount
 
%
 
(unaudited; in thousands)
 
 
 
 
Interest income
$
82

 
$
79

 
$
3

 
4
 %
Interest expense
$
(35
)
 
$
(112
)
 
$
77

 
(69
)%
Other income, net
$

 
$
2

 
$
(2
)
 
*

_______________________________
* Not meaningful
Interest income for the three months ended June 30, 2019 and 2018 resulted from interest recognized related to our marketable securities.
Interest expense decreased approximately $0.1 million, or 69%, for the three months ended June 30, 2019, as compared to the same period in 2018. For the three months ended June 30, 2018, interest expense was primarily attributable to the Hercules Term Loan, for which the outstanding obligation was paid in full in September 2018. For the three months ended June 30, 2019, interest expense was primarily attributed to amortization of deferred offering costs related to an equity line of credit.

22


Results of Operations
Comparison of the six months ended June 30, 2019 and 2018
Research and development expenses
 
Six months ended June 30,
 
Change
 
2019
 
2018
 
Amount
 
%
 
(unaudited; in thousands)
 
 
 
 
Research and development
$
13,256

 
$
12,339

 
$
917

 
7
%
Research and development expenses increased approximately $0.9 million, or 7%, for the six months ended June 30, 2019, as compared to the same period in 2018. The increase was primarily attributable to $1.6 million in costs associated with the scale up and technology transfer to our contract manufacturers. An additional increase of $0.8 million in research and development was the result of an increase in compensation costs primarily due to an increase in headcount. These increases were offset by a decrease of $1.0 million in clinical trial costs, primarily related to Qtrypta™ (M207) long-term safety study costs, a decrease of $0.4 million as a result of a reduction in temporary manufacturing staff due to the completion of regulatory batches and a decrease of $0.2 million in preclinical costs.
General and administrative expenses
 
Six months ended June 30,
 
Change
 
2019
 
2018
 
Amount
 
%
 
(unaudited; in thousands)
 
 
 
 
General and administrative
$
5,638

 
$
4,532

 
$
1,106

 
24
%
General and administrative expenses increased approximately $1.1 million, or 24%, for the six months ended June 30, 2019 as compared to the same period in 2018. The increase was primarily attributable to $0.5 million in strategic development and pre-commercialization activities, $0.4 million in professional services and $0.2 million of compensation costs, including stock-based compensation.
Other income and expense
 
Six months ended June 30,
 
Change
 
2019
 
2018
 
Amount
 
%
 
(unaudited; in thousands)
 
 
 
 
Interest income
$
162

 
$
94

 
$
68

 
72
 %
Interest expense
$
(76
)
 
$
(268
)
 
$
192

 
(72
)%
Other income, net
$
22

 
$
3

 
$
19

 
*

_______________________________
* Not meaningful
Interest income resulted primarily from interest recognized related to our marketable securities. The increase for the six months ended June 30, 2019 as compared to the same period in 2018 resulted from higher balances in investment holdings.
Interest expense decreased approximately $0.2 million, or 72%, for the six months ended June 30, 2019, as compared to the same period in 2018. For the six months ended June 30, 2018, interest expense was primarily attributable to the Hercules Term Loan, for which the outstanding obligation was paid in full in September 2018. For the six months ended June 30, 2019, interest expense was primarily attributed to amortization of deferred offering costs for our equity line of credit.

23


Liquidity and Capital Resources
As of June 30, 2019, we had an accumulated deficit of $280.0 million and $18.6 million of negative cash flows from operating activities for the six months ended June 30, 2019. As of June 30, 2019, we had approximately $17.7 million in cash, cash equivalents, and marketable securities. Presently, we do not have sufficient cash, cash equivalents and marketable securities to enable us to fund our anticipated level of operations and meet our obligations as they become due during the twelve months following the date of issuance of this Quarterly Report on Form 10-Q. Further, to continue operations for the remainder of 2019, we will need to obtain additional capital resources by the end of the fourth quarter of 2019 through an equity offering, a debt financing, a license or collaboration agreement, or through a combination of such sources of capital. The aforementioned factors raise substantial doubt about our ability to continue as a going concern.
On April 11, 2019, we closed a public offering of 5,000,000 shares of common stock at a price to the underwriter of $3.29 per share. On May 8, 2019, the underwriter purchased an additional 750,000 shares at a price to the underwriter of $3.29 per share pursuant to the exercise of the underwriter's option to purchase additional shares. The aggregate net proceeds were approximately $18.3 million, after deducting underwriting costs and estimated offering expenses.
Our ability to complete the sale of equity securities and access the market as a source of liquidity is dependent on investor demand, market conditions and other factors. Therefore, we can provide no assurance that any such offering will be on terms favorable to us or our stockholders, or that such offering will be successful at all. Our inability to obtain required funding in the near future or our inability to obtain funding on favorable terms will have a material adverse effect on our operations and strategic development plan for future growth. If we cannot successfully raise additional capital and implement our strategic development plan, our liquidity, financial condition and business prospects will be materially and adversely affected, and we may have to cease operations.
Since our inception in October 2006, we have funded our operations primarily through a combination of equity offerings, secured and unsecured borrowings from private investors, bank credit facilities, and licensing and service revenue from license and collaboration agreements. We also have an equity line of credit pursuant to a purchase agreement with Lincoln Park Capital, LLC, which provides for the purchase of up to $35.0 million worth of our common stock over the term of the purchase agreement, subject to certain conditions and limitations. Additionally, we have access to $3.9 million from our arrangement with Trinity to fund the manufacture of our commercial coating and primary packaging system.
We expect to incur additional losses in the future and will require additional financing to develop our Qtrypta™ (M207) product candidate, conduct pre-commercialization manufacturing activities and fund our operations. Failure to raise capital as and when needed could have a negative impact on our financial condition and our ability to pursue our business strategies. We anticipate that we will need to raise substantial additional capital, the requirements of which will depend on many factors, including:
the scope, progress, expansion and costs of manufacturing our product candidates;
the scope, progress, expansion, costs and results of our clinical trials;
the timing of and costs involved in obtaining regulatory approvals;
the type, number, costs and results of the product candidate development programs which we are pursuing or may choose to pursue in the future;
our ability to establish and maintain development partnering arrangements;
the timing, receipt and amount of contingent, royalty and other payments from any of our future development partners;
the emergence of competing technologies and other adverse market developments;
the costs of maintaining, expanding and protecting our intellectual property portfolio, including potential litigation costs and liabilities;
the resources we devote to marketing and, if approved, commercializing our product candidates;
our ability to draw funds from our build-to-suit arrangement; and
the costs associated with being a public company.
If we are unable to raise additional funds when needed, we may be required to suspend, delay, reduce or terminate our development programs and clinical trials. We may also be required to sell or license our technologies, clinical product candidates, or programs, if any, which we would prefer to develop and commercialize ourselves.

24


Cash Flows
The following table shows a summary of our cash flows:
 
Six Months Ended June 30,
 
2019
 
2018
 
(unaudited; in thousands)
Net cash (used in) provided by:
 
 
 
Operating activities
$
(18,614
)
 
$
(14,393
)
Investing activities
4,211

 
(23,581
)
Financing activities
19,515

 
42,520

Net increase in cash and cash equivalents
$
5,112

 
$
4,546

Operating Cash Flow: Net cash used in operating activities was approximately $18.6 million and $14.4 million for the six months ended June 30, 2019 and 2018, respectively. Net cash used during the first six months of 2019 was primarily used for technology transfer costs in conjunction with services performed by our contract manufacturers and clinical trial costs, in addition to other research and development and administrative expenses incurred in the course of our continuing operations. Net cash used during the first six months of 2018 was primarily due to clinical trial costs for the Qtrypta™ (M207) long-term safety study production and support, in addition to other research and development and administrative expenses incurred in the course of our continuing operations.
Investing Cash Flow: Net cash provided by investing activities was approximately $4.2 million for the six months ended June 30, 2019 and net cash used in investing activities was approximately $23.6 million for the six months ended June 30, 2018. Net cash provided by investing activities during the first six months of 2019 was primarily the result of $10.4 million of net proceeds from maturities of marketable securities, offset by $6.2 million of property and equipment purchases to support our pre-commercialization activities. Net cash used in investing activities during the first six months of 2018 was primarily due to $21.5 million of net purchases of marketable securities and $2.1 million of property and equipment purchases.
Financing Cash Flow: Net cash provided by financing activities was approximately $19.5 million and $42.5 million for the six months ended June 30, 2019 and 2018, respectively. Net cash provided by financing activities for the first six months of 2019 was primarily due to $18.5 million of net proceeds from a registered public offering, $2.3 million of net proceeds from Trinity, offset by $1.2 million in principal payments on our build-to-suit obligation with Trinity. Net cash provided by financing activities for the first six months of 2018 was primarily due to proceeds from a registered public offering of $45.6 million, net of underwriter's commissions and offering costs, offset by $3.1 million of principal payments on the Hercules Term Loan.
Contractual Obligations and Commitments
Our contractual obligations primarily consist of our obligations under non-cancelable operating and finance leases, our build-to-suit obligation with Trinity, and other purchase obligations, such as those for equipment purchases and for contract manufacturing.
There were no material changes in our commitments under contractual obligations, as disclosed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in our Annual Report on Form 10-K for the year ended December 31, 2018, filed with the SEC on March 25, 2019, other than a non-cancelable commitment of $7.0 million to our primary contract manufacturer for the build-out of our commercial suite, which we expect to pay over the next twelve months.
Recent Accounting Pronouncements
See Note 2. Summary of Significant Accounting Policies, to the accompanying condensed financial statements for Recent Accounting Pronouncements.
Off-Balance Sheet Arrangements
We currently have no off-balance sheet arrangements, such as structured finance, special purpose entities or variable interest entities.

25


Item 3.
Quantitative and Qualitative Disclosures About Market Risk
We are exposed to market risks in the ordinary course of our business. Some of the securities that we invest in have market risk where a change in prevailing interest rates may cause the principal amount of the marketable securities to fluctuate. Financial instruments which potentially subject us to concentrations of credit risk consist principally of cash and cash equivalents, as well as investments in marketable securities. We had cash and cash equivalents of $14.3 million as of June 30, 2019, which consisted of bank deposits and money market funds. We had investments in marketable securities at fair value of $3.5 million as of June 30, 2019, which consisted primarily of U.S. treasuries and commercial paper. The primary objectives of our investment activities are to ensure liquidity and to preserve principal while at the same time maximizing the income we receive from our marketable securities without significantly increasing risk. Additionally, we established guidelines regarding approved investments and maturities of investments, which are designed to maintain safety and liquidity.
Our cash and cash equivalents are held for working capital purposes. Cash balances are insured by the Federal Deposit Insurance Corporation (“FDIC”) up to regulatory limits, and we are exposed to credit risk when our cash balances exceed FDIC insurance limits. Our total cash and cash equivalent balances exceed the maximum amounts insured by the FDIC.
Our primary exposure to market risk is interest rate sensitivity, which is affected by changes in the general level of United States interest rates. We hold interest-earning instruments, which carry a degree of interest rate risk. In addition, the monthly rent factor on future drawdowns from our build-to-suit arrangement is determined and indexed to the Prime Lending Rate as reported in the Wall Street Journal. To date, fluctuations in interest income and expense have not been significant. However, fluctuations in market interest rates in the future could have a material impact on our financial condition and results of operations.
Item 4.
Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of June 30, 2019. The term “disclosure controls and procedures,” as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by the company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Securities Act of 1933, as amended, is accumulated and communicated to the company's management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosures.
Based on the evaluation of our disclosure controls and procedures as of June 30, 2019, our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures are designed to, and are effective to, provide assurance at a reasonable level that the information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures.
Our management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
Changes in Internal Control over Financial Reporting
 There were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities and Exchange Act of 1934, as amended) during the quarter ended June 30, 2019, that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

26


PART II. OTHER INFORMATION
Item 1.
Legal Proceedings
We are not party to any material pending legal proceedings. However, we may from time to time become involved in litigation relating to claims arising in the ordinary course of our business.
Item 1A.
Risk Factors
Investing in our common stock involves a high degree of risk. You should carefully consider the following risks and uncertainties, as well as general economic and business risks, and all of the other information contained in our Annual Report on Form 10-K for the year ended December 31, 2018 and other documents that we file with the U.S. Securities and Exchange Commission, or the SEC. Any of the following risks could have a material adverse effect on our business, operating results, financial condition and prospects and cause the trading price of our common stock to decline, which would cause you to lose all or part of your investment. You should also refer to the other information contained in this Quarterly Report on Form 10-Q, including our condensed financial statements and the related notes thereto.
RISKS RELATED TO OUR FINANCIAL POSITION AND NEED FOR ADDITIONAL CAPITAL
We will need substantial additional funding to fund our operations, and we may not be able to continue as a going concern if we are unable to do so. We could also be forced to delay, reduce or terminate our product development, other operations or commercialization effort.
Developing and commercializing biopharmaceutical products, including launching new products into the marketplace and conducting preclinical studies and clinical trials, is an expensive and highly uncertain process that takes years to complete. As of June 30, 2019, we had an accumulated deficit of $280.0 million as well as negative cash flows from operating activities. As of June 30, 2019, we had approximately $17.7 million in cash, cash equivalents and marketable securities, and we do not have sufficient cash, cash equivalents and marketable securities to fund our anticipated level of operations and meet our obligations as they become due during the twelve months following the date of issuance of this Quarterly Report on Form 10-Q. The aforementioned factors raise substantial doubt about our ability to continue as a going concern.
There is no assurance that such additional funds will be obtained for our ongoing operations or that we will succeed in our future operations. Our audited financial statements included in our Annual Report for the year ended December 31, 2018 include an explanatory paragraph regarding our ability to continue as a going concern which may discourage some third parties from contracting with us and some investors from purchasing our stock or providing alternative capital financing, which could adversely affect our business, financial condition, results of operations and prospects.
We have a history of operating losses. We expect to continue to incur losses over the next several years and may never become profitable.
Since inception, we have incurred significant operating losses. For the six months ended June 30, 2019, we incurred a net loss of $18.8 million. As of June 30, 2019, we had an accumulated deficit of $280.0 million. We expect to continue to incur additional significant operating losses and capital expenditures and anticipate that our expenses will increase substantially in the foreseeable future as we continue the development of our product candidate, Qtrypta™ (M207), or any other products we develop. These expenditures will be incurred for development, clinical trials, regulatory compliance, infrastructure, and manufacturing. Even if we succeed in developing, obtaining regulatory approval for and commercializing Qtrypta™ (M207) or any other products we develop, because of the numerous risks and uncertainties associated with our commercialization efforts, we are unable to predict that we will ever be able to manufacture, distribute and sell any of our products profitably, and we may never generate revenue that is significant enough to achieve or maintain profitability. Even if we do achieve profitability, we may not be able to sustain or increase profitability on an ongoing basis.
We have generated only limited revenues and will need additional capital to develop and commercialize our product candidate, which may cause dilution to our existing stockholders, restrict our operations or require us to relinquish rights to our technologies or lead product candidate.
Since inception, we have generated no revenues from product sales. We are not approved to make and have not made any commercial sales of products. We expect that our product development activities will require additional significant operating and capital expenditures resulting in negative cash flow for the foreseeable future.

27


We expect to finance our cash needs through a combination of equity offerings, debt financing and license and collaboration agreements. In addition, we may seek additional capital due to favorable market conditions or strategic considerations, even if we believe we have sufficient funds for our current or future operating plans.
However, adequate and additional funding may not be available to us on acceptable terms or at all. To the extent that we raise additional capital through the sale of equity or convertible debt securities, your ownership interest will be diluted, and the terms of these securities may include liquidation or other preferences that adversely affect your rights as a common stockholder. Debt financing and preferred equity financing, if available, may involve agreements that include covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making capital expenditures or declaring dividends on our common stock.
If we raise additional funds through collaborations, strategic alliances or marketing, distribution or licensing arrangements with third parties, we may be required to relinquish valuable rights to our research programs or product candidate or grant licenses on terms that may not be favorable to us.
If we are unable to raise additional funds through equity or debt financings or other arrangements with third parties when needed, we may be required to delay, limit, reduce or terminate our development or future commercialization efforts or partner with third parties to develop and market product candidate that we would otherwise prefer to develop and market ourselves. The amount and timing of our future financing requirements will depend on many factors, including:
the scope, progress, expansion, and costs of manufacturing our product candidate;
the scope, progress, expansion, costs, and results of our clinical trials;
the timing of, and costs involved in, obtaining regulatory approvals;
the type, number, costs, and results of the product candidate development programs which we are pursuing or may choose to pursue in the future;
our ability to establish and maintain development partnering arrangements;
the timing, receipt and amount of contingent, royalty, and other payments from any of our future development partners;
the emergence of competing technologies and other adverse market developments;
the costs of maintaining, expanding, and protecting our intellectual property portfolio, including potential litigation costs and liabilities;
the resources we devote to marketing, and if approved, commercializing our product candidate;
our ability to draw funds from our build-to-suit arrangement; and
the costs associated with being a public company.
Our build-to-suit arrangement with Trinity Capital Fund III, L.P. (“Trinity”) imposes restrictions on our business, and if we default on our obligations, Trinity would have a right to request payment in full of the build-to-suit obligation.
We also agreed to covenants in connection with the Trinity build-to-suit arrangement that may limit our ability to take some actions without the consent of Trinity, as applicable. In particular, without Trinity’s consent under the terms of the build-to-suit arrangement, we are restricted in our ability to:
create liens on our property;
sell, transfer, or otherwise dispose of all or substantially all of our assets;
transfer, dispose or relocate financed equipment;
acquire or merge with another entity; and
engage in a transaction that would constitute 50% or more in change in control.
Our indebtedness to Trinity may prevent us from engaging in activities that could be beneficial to our business and our stockholders unless we repay the outstanding obligation, which may not be desirable or possible.
We have pledged substantially all of our assets, including our intellectual property, to secure our obligations to Trinity. If we default on our obligations prior to repaying this indebtedness and are unable to obtain a waiver for such default, Trinity would have a right to accelerate our payments under the build-to-suit arrangement, as applicable, and possibly foreclose on the collateral,

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which would potentially include our intellectual property. Any such action on the part of Trinity would significantly harm our business and our ability to operate.
We have limited operating history and capabilities.
Although our business was formed in 2006, we have had limited operations since that time. We do not currently have the ability to perform the sales, marketing and manufacturing functions necessary for the production and sale of Qtrypta™ (M207) on a commercial scale. The successful commercialization of Qtrypta™ (M207) will require us to perform a variety of functions, including:
continuing to conduct clinical development of our product candidate;
obtaining required regulatory approvals;
formulating and manufacturing product; and
conducting sales and marketing activities.
Our operations continue to be focused on acquiring, developing and securing our proprietary technology and undertaking preclinical and clinical trials of our product candidate.
We expect our financial condition and operating results to continue to fluctuate from quarter to quarter and year to year due to a variety of factors, many of which are beyond our control. We will need to transition at some point from a company with a research and development focus to a company capable of undertaking commercial activities. We may encounter unforeseen expenses, difficulties, complications and delays and may not be successful in such a transition.

RISKS RELATED TO THE DEVELOPMENT AND COMMERCIALIZATION OF OUR PRODUCT CANDIDATE
The development and commercialization of our product candidate is subject to many risks. If we do not successfully develop, receive approval for, and commercialize our product candidate, our business will be adversely affected.
We have focused our clinical development efforts on our product candidate, Qtrypta™ (M207). The development and commercialization of Qtrypta™ (M207) and any product candidate we may develop and commercialize in the future is subject to many risks including:
we may be unable to obtain additional funding to develop our product candidate;
we may experience delays in regulatory review and approval of our product candidate in clinical development;
the results of our clinical trials may not meet the level of statistical or clinical significance required by the FDA for marketing approval;
the FDA may disagree with the number, design, size, conduct or implementation of our clinical trials;
the FDA may not find the data from preclinical studies and clinical trials sufficient to demonstrate that clinical and other benefits outweigh its safety risks;
the FDA may disagree with our interpretation of data from our preclinical studies and clinical trials or may require that we conduct additional studies or trials;
the FDA may not accept data generated at our clinical trial sites;
we may be unable to obtain and maintain regulatory approval of our product candidate in the United States and foreign jurisdictions;
potential side effects of our product candidate could delay or prevent commercialization, limit the indications for any approved product candidate, require the establishment of a risk evaluation and mitigation strategy ("REMS"), or cause an approved product candidate to be taken off the market;
the FDA may identify deficiencies in our manufacturing processes or facilities or those of our contract manufacturing organizations ("CMOs");
the FDA may change its approval policies or adopt new regulations;
we may need to depend on third party manufacturers to supply or manufacture our products;
we depend on contract research organizations to conduct our clinical trials;

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we may experience delays in the commencement of, enrollment of patients in and timing of our clinical trials;
we may not be able to demonstrate that our product candidate is safe and effective as a treatment for its intended indications to the satisfaction of the FDA or other similar regulatory bodies;
we may be unable to establish or maintain collaborations, licensing or other arrangements;
the market may not accept our product candidate;
we may be unable to establish and maintain an effective sales and marketing infrastructure, either through the creation of a commercial infrastructure or through strategic collaborations;
we may experience competition from existing products or new products that may emerge; and
we and our licensors may be unable to successfully obtain, maintain, defend and enforce intellectual property rights important to protect our product candidate.
Moreover, principal investigators for our clinical trials may serve as scientific advisors or consultants to us from time to time and receive compensation in connection with such services. Under certain circumstances, we may be required to report some of these relationships to regulatory authorities, which may conclude that a financial relationship between us and a principal investigator has created a conflict of interest or otherwise affected interpretation of a study. This could result in a delay in approval, or rejection, of our marketing applications. If any of these risks materializes, we could experience significant delays or an inability to successfully commercialize our product candidate, which would have a material adverse effect on our business, financial condition and results of operations.
The long-term safety study for Qtrypta™ (M207) is an important step in the development of Qtrypta™ (M207). If we cannot produce results that satisfy FDA requirements, the regulatory approval process could be delayed or failed, and our business could be adversely affected.
In February 2019, we announced the completion of the final phase of our long-term safety study where more than 50 evaluable subjects were treated for a year. This long-term safety study will need to produce results that satisfy FDA requirements. If the results do not satisfy the FDA’s requirements, we could be required to conduct additional clinical or preclinical studies or we may be required to delay, limit, reduce or terminate our development of Qtrypta™ (M207). Also, even though we have discussed our development strategy with the FDA on our Qtrypta™ (M207) program and received feedback from the FDA about the size and the length of the safety study, the FDA may require us to provide more data than we currently anticipate, which would further delay the regulatory approval process and require additional clinical or preclinical work.
If the FDA does not conclude that our product candidate satisfies the requirements for the 505(b)(2) regulatory approval pathway, or if the requirements for approval of our product candidate under Section 505(b)(2) are not as we expect, the approval pathway for our product candidate will likely take significantly longer, cost significantly more and encounter significantly greater complications and risks than anticipated, and in any case may not be successful.
We intend to seek FDA approval through the 505(b)(2) regulatory pathway for our product candidate described in this Annual Report on Form 10-K. The Drug Price Competition and Patent Term Restoration Act of 1984, also known as the Hatch-Waxman Act, added Section 505(b)(2) to the Federal Food, Drug and Cosmetics Act ("FDCA"). Section 505(b)(2) permits the filing of a New Drug Application ("NDA") where at least some of the information required for approval comes from studies that were not conducted by or for the applicant.
If the FDA does not allow us or any partner with which we collaborate to pursue the 505(b)(2) regulatory pathway for our product candidate, we or they may need to conduct additional clinical trials, provide additional data and information and meet additional standards for regulatory approval. If this were to occur, we or they will need to successfully complete additional Phase 2 and/or Phase 3 clinical trials and submit to the FDA for approval one or more NDAs in order to obtain FDA approval to market our product candidate. The time and financial resources required to obtain FDA approval for our product candidate would likely substantially increase. The conduct of later-stage clinical trials and the submission of a successful NDA is a complicated process. To date, we have conducted only one Phase 2/3 clinical trial and have initiated a long-term safety study of Qtrypta™ (M207), we have limited experience in preparing and submitting regulatory filings, and we have not previously submitted an NDA for any product candidate. Consequently, we may be unable to successfully and efficiently execute and complete necessary clinical trials in a way that leads to an NDA submission for Qtrypta™ (M207) or for any other product candidate we may develop in the future.
Moreover, the inability to pursue the 505(b)(2) regulatory pathway could result in new competitive products reaching the market faster than our product candidate, which could materially adversely impact our competitive position and prospects. Even if we are allowed to pursue the 505(b)(2) regulatory pathway for a product candidate, we cannot assure you that we will receive the requisite approvals for commercialization of such product candidate.

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In addition, our competitors may file petitions with the FDA in an attempt to persuade the FDA that our product candidate, or the clinical studies that support their approval, contain deficiencies. Such actions by our competitors could delay or even prevent the FDA from approving any NDA that we submit under Section 505(b)(2).
Clinical trials are very expensive, time-consuming and difficult to design and implement.
Human clinical trials are very expensive, time-consuming and difficult to design and implement, in part because they are subject to rigorous regulatory requirements, and their outcome is inherently uncertain. Furthermore, failure of a product candidate can occur at any stage of the trials, and we could encounter problems that cause us to abandon or repeat clinical trials.
Further, we may experience delays in our ongoing clinical trials and we do not know whether planned clinical trials will begin on time, need to be redesigned, enroll patients on time or be completed on schedule, if at all. The commencement and completion of clinical trials may be delayed by several factors, including:
changes in government regulation, administrative action or changes in FDA policy with respect to clinical trials that change the requirements for approval;
delays in obtaining authorization from regulators and required IRB approval at each site to commence a trial;
imposition of a clinical hold for safety reasons or following an inspection of our clinical trial operations or trial sites by the FDA or other regulatory authority;
delays in reaching agreement on acceptable terms with prospective CROs and clinical trial sites, or failure by such CROs or trial sites to carry out the clinical trial at each site in accordance with the terms of our agreements with them;
difficulties or delays in having patients complete participation in a trial or return for post-treatment follow-up;
clinical sites electing to end their participation in one of our clinical trials, which would likely have detrimental effect on subject enrollment;
time required to add new clinical sites;
delays by our contract manufacturers to produce and deliver sufficient supply of clinical trial materials;
unforeseen safety issues;
determination of dosing issues;
lack of effectiveness during clinical trials;
slower than expected rates of patient recruitment and enrollment;
inability to raise or delays in raising funding necessary to initiate or continue a trial;
inability to monitor patients adequately during or after treatment; and
inability or unwillingness of medical investigators to follow our clinical protocols.
In addition, we, the FDA, or other regulatory authorities and ethics committees with jurisdiction over our studies may terminate or suspend our clinical trials at any time if it appears that we are exposing participants to unacceptable health risks or if the FDA or other authorities find deficiencies in our regulatory submissions or the conduct of these trials. Therefore, we cannot predict with any certainty the schedule for existing or future clinical trials. Any such unexpected expenses or delays in our clinical trials could increase our need for additional capital, which may not be available on favorable terms or at all.
If we are required to conduct additional clinical trials or other testing of our product candidate beyond those that we currently contemplate, if we are unable to successfully complete clinical trials of our product candidate or other testing, if the results of these clinical trials or tests are not positive or are only modestly positive and/or if there are safety concerns, we may:
be delayed in obtaining marketing approval for our product candidate;
not obtain marketing approval at all;
obtain approval for indications or patient populations that are not as broad as intended or desired;
obtain approval with labeling that includes significant use or distribution restrictions or safety warnings;
be subject to additional post-marketing testing requirements; or
have our product candidate(s) removed from the market after obtaining marketing approval.

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Our development costs will also increase if we experience delays in testing or in obtaining marketing approvals. We do not know whether any of our preclinical studies or clinical trials will begin as planned, will need to be restructured or will be completed on schedule, or at all. Significant preclinical study or clinical trial delays also could shorten any periods during which we may have the exclusive right to commercialize our product candidate or allow our competitors to bring a product candidate to market before we do, and thereby impair our ability to successfully commercialize our product candidate.
The results of our clinical trials may not support the intended use of Qtrypta™ (M207) or any other product candidates we may develop.
Even if our clinical trials are completed as planned, we cannot be certain that the results will support the intended use of our products. Success in preclinical testing and early clinical trials does not ensure that later clinical trials will be successful, and we cannot be sure that the results of later clinical trials will replicate the results of prior clinical trials and preclinical testing. The clinical trial process may fail to demonstrate that our product candidate is safe and effective in humans for its intended uses. This failure would cause us to abandon a product candidate and may delay development of other product candidates. Any delay in, or termination of, our clinical trials will delay the submission of our NDA with the FDA and, ultimately, our ability to commercialize our product candidate and generate revenues. In addition, our clinical trials to date have involved small patient populations. Because of the small sample sizes, the results of these clinical trials may not be indicative of future results.
Clinical failure can occur at any stage of clinical development. Because the results of earlier clinical trials are not necessarily predictive of future results, any product candidate we advance through clinical trials may not have favorable results in later clinical trials or receive regulatory approval.
Clinical failure can occur at any stage of clinical development. Clinical trials may produce negative or inconclusive results, and we may decide, or regulators may require us, to conduct additional clinical or preclinical trials. In addition, data obtained from trials are susceptible to varying interpretations, and regulators may not interpret our data as favorably as we do, which may delay, limit or prevent regulatory approval. Success in preclinical testing, early clinical trials and even later stage clinical trials, such as our phase 2/3 ZOTRIP trial, does not ensure that later clinical trials will generate the same results or otherwise provide adequate data to demonstrate the efficacy and safety of a product candidate. Frequently, product candidates that have shown promising results in early clinical trials have subsequently suffered significant setbacks in later clinical trials. In addition, the design of a clinical trial can determine whether its results will support approval of a product and flaws in the design of a clinical trial may not become apparent until the clinical trial is well advanced or completed. While members of our management team have experience in designing clinical trials, we have limited experience in designing clinical trials and we may be unable to design and execute a clinical trial to support regulatory approval. Further, clinical trials of potential products often reveal that it is not practical or feasible to continue development efforts. If our product candidate is found to be unsafe or lack efficacy, we will not be able to obtain regulatory approval for them and our business would be harmed.
We may in the future conduct clinical trials for product candidates in sites around the world, and government regulators, including the FDA in the United States, may choose to not accept data from trials conducted in such locations.
We have conducted, and may in the future choose to conduct, one or more of our clinical trials outside the United States.
There is no guarantee that data from these clinical trials will be accepted by regulators approving our product candidate for commercial sale. In the case of the United States, although the FDA may accept data from clinical trials conducted outside the United States, acceptance of this data is subject to certain conditions imposed by the FDA. For example, the clinical trial must be conducted in accordance with good clinical practices ("GCP") requirements and conducted such that the FDA is able to validate the data from the study through an onsite inspection if deemed necessary. In addition, while these clinical trials are subject to the applicable local laws, FDA acceptance of the data will be dependent upon its determination that the trials also complied with all applicable U.S. laws and regulations. There can be no assurance the FDA will accept data from trials conducted outside of the United States. If the FDA does not accept the data from our clinical trials, it would likely result in the need for additional clinical trials, which would be both costly and time-consuming and likely to delay or permanently halt our development of a product candidate. Similar regulations and risks apply to other jurisdictions as well.
In addition, the conduct of clinical trials outside the United States could have a significant negative impact on us. Risks inherent in conducting international clinical trials include:
foreign regulatory requirements that could restrict or limit our ability to conduct our clinical trials;
administrative burdens of conducting clinical trials under multiple foreign regulatory schema;
foreign exchange fluctuations; and
diminished protection of intellectual property in some countries.

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We will not be able to sell our products if we do not obtain required United States regulatory approvals.
We cannot assure you that we will receive the approvals necessary to commercialize Qtrypta™ (M207) or any product candidate we acquire or develop in the future. We will need FDA approval to commercialize our product candidate in the United States. In order to obtain FDA approval of any product candidate, we expect that we will have to submit to the FDA an NDA demonstrating that the product candidate is safe for humans and effective for its intended indication and indicated use. This demonstration requires significant research and animal tests, which are referred to as preclinical studies, as well as human tests, which are referred to as clinical trials. Satisfaction of the FDA’s regulatory requirements typically takes many years, depends upon the type, complexity and novelty of the product candidate and requires substantial resources for research, development and testing. We cannot predict whether our product candidate will ultimately be considered safe for humans and effective for indicated uses by the FDA. The FDA has substantial discretion in the drug approval process and may require us to conduct additional preclinical and clinical testing or to perform post-marketing studies. The approval process may also be delayed by changes in government regulation, future legislation or administrative action or changes in FDA policy that occur prior to or during its regulatory review. Delays in obtaining regulatory approvals may:
delay commercialization of, and our ability to derive product revenues from, our products;
impose costly procedures on us; and
diminish any competitive advantages that we may otherwise enjoy.
We may never obtain regulatory approval for any of our product candidates. Failure to obtain approval of any of our product candidates will severely undermine our business by leaving us without a saleable product, and therefore without any source of revenues, unless other products can be developed. There is no guarantee that we will ever be able to develop or acquire another product.
Even if Qtrypta™ (M207) or any other product candidates we develop in the future receive regulatory approval, our business is subject to extensive regulatory requirements which include ongoing and continued regulatory review, which may result in significant expense and limit our ability to commercialize our products.
The manufacturing processes, post-approval clinical data, labeling, advertising and promotional activities for our product candidates will be subject to continual requirements of and review by the FDA and other regulatory authorities. These requirements include submissions of safety and other post-marketing information and reports, registration and listing requirements, current good manufacturing practice ("cGMP") requirements relating to quality control, quality assurance and corresponding maintenance of records and documents, requirements regarding the distribution of samples to physicians and recordkeeping. The regulatory approvals for our product candidate may be subject to limitations on the indicated uses for which the products may be marketed or to the conditions of approval or contain requirements for costly post-marketing testing and surveillance to monitor the safety or efficacy of the product candidate.
The FDA has the authority to require a REMS as part of an NDA or after approval, which may impose further requirements or restrictions on the distribution or use of an approved drug, such as limiting prescribing authorization to certain physicians or medical centers that have undergone specialized training, limiting treatment to patients who meet certain safe-use criteria or requiring patient testing, monitoring and/or enrollment in a registry.
We may also be subject, directly or indirectly through our customers and partners, to various fraud and abuse laws, including, without limitation, the U.S. Anti-Kickback Statute, U.S. False Claims Act, and similar state laws, which impact, among other things, our proposed sales, marketing, and scientific/educational grant programs. If we participate in the U.S. Medicaid Drug Rebate Program, the Federal Supply Schedule of the U.S. Department of Veterans Affairs, or other government drug programs, we will be subject to complex laws and regulations regarding reporting and payment obligations. All of these activities are also potentially subject to U.S. federal and state consumer protection and unfair competition laws and similar requirements in other countries.
With respect to sales and marketing activities by us or any future partner, advertising and promotional materials must comply with FDA rules in addition to other applicable federal, state and local laws in the United States and similar legal requirements in other countries. In addition, our product labeling, advertising and promotion would be subject to regulatory requirements and continuing regulatory review. The FDA strictly regulates the promotional claims that may be made about prescription products. In particular, a product may not be promoted for uses that are not approved by the FDA as reflected in the product’s approved labeling. If we receive marketing approval for our products, physicians may nevertheless legally prescribe our products to their patients in a manner that is inconsistent with the approved label. If we are found to have promoted such off-label uses, we may become subject to significant liability and government fines. The FDA and other agencies actively enforce the laws and regulations prohibiting the promotion of off-label uses, and a company that is found to have improperly promoted off-label uses may be subject to significant sanctions, including revocation of its marketing approval. The federal government has levied large civil and criminal

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fines against companies for alleged improper promotion and has enjoined several companies from engaging in off-label promotion. The FDA has also requested that companies enter into consent decrees of permanent injunctions under which specified promotional conduct is changed or curtailed.
In addition, later discovery of previously unknown problems with our product candidate, manufacturing processes, or failure to comply with regulatory requirements, may yield various results, including:
restrictions on such product candidate, or manufacturing processes;
restrictions on the labeling or marketing of a product;
restrictions on product distribution or use;
requirements to conduct post-marketing clinical trials;
warning or untitled letters;
withdrawal of the products from the market;
refusal to approve pending applications or supplements to approved applications that we submit;
recall of products;
fines, restitution or disgorgement of profits or revenue;
suspension or withdrawal of marketing approvals;
refusal to permit the import or export of our products;
product seizure; or
injunctions or the imposition of civil or criminal penalties.
The occurrence of any event or penalty described above may inhibit our ability to commercialize our products and generate revenue. Adverse regulatory action, whether pre- or post-approval, can also potentially lead to product liability claims and increase our product liability exposure.
Changes in funding for the FDA and other government agencies could hinder their ability to hire and retain key leadership and other personnel, or otherwise prevent new products and services from being developed or commercialized in a timely manner, which could negatively impact our business.
The ability of the FDA to review and approve new products can be affected by a variety of factors, including government budget and funding levels, ability to hire and retain key personnel and accept the payment of user fees, and statutory, regulatory, and policy changes. Average review times at the agency have fluctuated in recent years as a result. In addition, government funding of other government agencies that fund research and development activities is subject to the political process, which is inherently fluid and unpredictable.
Disruptions at the FDA and other agencies may also slow the time necessary for new drugs to be reviewed and/or approved by necessary government agencies, which would adversely affect our business. For example, over the last several years, including for 35 days beginning on December 22, 2018, the U.S. government has shut down several times and certain regulatory agencies, such as the FDA, have had to furlough critical FDA employees and stop critical activities. If a prolonged government shutdown occurs, it could significantly impact the ability of the FDA to timely review and process our regulatory submissions, which could have a material adverse effect on our business.
We or any of our future partners may choose not to continue developing a product or product candidate at any time during development or commercialize it after approval, which would reduce or eliminate our potential return on investment for that product or product candidate.
We currently do not have any products approved for sale and currently are focusing our clinical development efforts solely on Qtrypta™ (M207). Currently, we do not have any collaborations with any partners for any of our products.
At any time, we or any partners with whom we collaborate in the future may decide to discontinue the development of a marketed product or product candidate or not to continue commercializing a marketed product or a product candidate for a variety of reasons, including the appearance of new technologies that make our product obsolete, the position of our partner in the market, competition from another product, or changes in or failure to comply with applicable regulatory requirements. If we or our partners terminate a program in which we have invested significant resources, we will not receive any return on our investment and we will have lost the opportunity to allocate those resources to potentially more productive uses. If one of our future partners terminates

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a development program or ceases to market an approved or commercial product, we will not receive any future milestone payments or royalties relating to that program or product under a partnership agreement with that party.
Our long-term growth will be limited unless we successfully develop a pipeline of additional product candidates.
Our long-term growth will be limited unless we successfully develop a pipeline of additional product candidates. We do not have internal new drug discovery capabilities, and our primary focus is on developing improved intracutaneous drug delivery systems by reformulating drugs previously approved by the FDA using our proprietary technologies.
If we are unable to expand our product candidate pipeline and obtain regulatory approval for our product candidate on the timelines we anticipate, we will not be able to execute our business strategy effectively and our ability to substantially grow our revenues will be limited, which would harm our long-term business, results of operations, financial condition and prospects.
Our product candidate may cause adverse effects or have other properties that could delay or prevent their regulatory approval or limit the scope of any approved label or market acceptance, or result in significant negative consequences following market approval, if any.

Qtrypta™ (M207) and any other product candidates we develop in the future may have undesirable side effects or have characteristics that are unexpected. These could be attributed to the active ingredient or class of drug or to our unique formulation of our product candidate, or other potentially harmful characteristics. Such characteristics could cause us, our IRBs, clinical trial sites, the FDA or other regulatory authorities to interrupt, delay or halt clinical trials, including the imposition of clinical holds, and could result in a more restrictive label or delay, denial or withdrawal of regulatory approval, which may harm our business, financial condition and prospects significantly.
In addition, if our product candidate receives marketing approval, and we or others later identify serious adverse events or undesirable side effects caused by such product, a number of potentially significant negative consequences could result, including:
regulatory authorities may require the addition of labeling statements, specific warnings, a contraindication or field alerts to physicians and pharmacies;
we may be required to change the way the product candidate is administered, conduct additional clinical trials or change the labeling of the product;
we may be required to implement REMS, which could result in substantial cost increases and have a negative impact on our ability to commercialize the product candidate;
we may be required to limit the patients who can receive the product candidate;
we may be subject to limitations on how we promote the product candidate;
sales of the product candidate may decrease significantly;
regulatory authorities may require us to take our approved product candidate off the market;
we may be subject to litigation or product liability claims; and
our reputation may suffer.
Any of these events could prevent us from achieving or maintaining market acceptance of the affected product candidate or could substantially increase commercialization costs and expenses, which in turn could delay or prevent us from generating significant revenues from the sale of our product candidate.

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We may encounter manufacturing risks or failures that could impede or delay supply for our clinical trials of our product candidate.
While we currently manufacture Qtrypta™ (M207) internally, we have entered into agreements with third party CMOs related to the development, manufacture, and supply of Qtrypta™ (M207). Any failure or delay in our internal manufacturing operations or those of our CMOs, or the technology transfer process in connection with our plan to transition to rely on such CMOs for manufacture and supply, could hinder our ability to meet Qtrypta™ (M207) production demand for our clinical trials and delay the development or regulatory approval of Qtrypta™ (M207). We and our CMOs may encounter difficulties involving, among other things, material supplies, production yields, regulatory compliance, quality control and quality assurance, and shortages of qualified personnel. The manufacturing facilities in which Qtrypta™ (M207), or our future product candidates, are made could be adversely affected by equipment failures, labor shortages, natural disasters, power failures and numerous other factors. We may incur other charges and expenses for products that fail to meet specifications, undertake costly remediation efforts or seek more costly manufacturing alternatives. Regulatory approval of Qtrypta™ (M207) or our future product candidates could be impeded, delayed, limited or denied if the FDA does not maintain the approval of the manufacturing processes and facilities in which such product candidates are made.
Difficulties in relevant manufacturing processes and facilities implicated could result in supply shortfalls of Qtrypta™ (M207) or our future product candidates, and could delay our preclinical studies, clinical trials and regulatory submissions with respect thereto. In addition, Qtrypta™ (M207) (or our future product candidates) that has been produced and is stored for later use, may degrade, become contaminated or suffer other quality defects (including in connection with any shipment thereof), which may cause the affected product candidate to no longer be suitable for its intended use in clinical trials or other development activities. If the defective product candidate cannot be replaced in a timely fashion, we may incur significant delays in our development programs that could adversely affect the value of such product candidate.
We have only manufactured our proposed product candidate for our clinical trials and we have no experience manufacturing on a commercial scale.
We have limited experience manufacturing our product candidate, Qtrypta™ (M207), and to date have only manufactured our product candidate for our clinical trials. If our product candidate is approved, we will need to scale up our own capabilities or those of our CMOs to support the production of commercial level quantities of our product candidate, which may require expensive process improvements.
While we intend to rely on CMOs, including Patheon to support commercial scale manufacture of Qtrypta™ (M207) and have entered into agreements regarding the same, we may nevertheless not be able to successfully produce, develop and market Qtrypta™ (M207) or our future product candidates, or we may be delayed in doing so. Significant scale up of manufacturing may also require process improvements as well as additional technologies and validation studies, which are costly, may not be successful and which the FDA must review and approve. If we or our CMOs are unable to establish a new manufacturing facility or expand existing manufacturing facilities, purchase equipment, hire adequate personnel to support our manufacturing efforts, or comply with cGMPs, or implement necessary process improvements, we may be unable to produce commercial materials or meet demand, if any should develop, for Qtrypta™ (M207) or our future product candidates. Any such failure would have a material adverse effect on our business, financial condition and results of operations.
Reliance on CMOs also entails risks to which we would not be subject if we manufactured the product candidate ourselves, including reliance on the third party for regulatory compliance and quality control and assurance, volume production, the possibility of breach of the manufacturing agreement by the third party because of factors beyond our control (including a failure to synthesize and manufacture our product candidate in accordance with our product specifications) and the possibility of termination or nonrenewal of the agreement by the third party at a time that is costly or damaging to us. In addition, the FDA and other regulatory authorities require that our product candidate be manufactured according to cGMP and similar foreign standards. Any failure by our CMOs to comply with cGMP or failure to scale up manufacturing processes, including any failure to deliver sufficient quantities of our product candidate in a timely manner, could lead to a delay in, or failure to obtain, regulatory approval of our product candidate, or a recall or withdrawal of approval in the future. CMOs may not be able to manufacture our product candidate at a cost or in quantities or in a timely manner necessary to develop and commercialize it. If our CMOs are unable to successfully scale up the manufacture of our product candidate in sufficient quality and quantity and at commercially reasonable prices, and we are unable to find one or more replacement manufacturers capable of production at a substantially equivalent cost in substantially equivalent volumes and quality, and we are unable to successfully transfer the processes on a timely basis, the development of that product candidate and regulatory approval or commercial launch for any resulting products may be delayed, or there may be a shortage in supply, either of which could significantly harm our business, financial condition, operating results and prospects. Our reliance on CMOs will further expose us to the possibility that they, or third parties with access to their facilities, will have access to and may misappropriate our trade secrets or other proprietary information.

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Even if we receive regulatory approval for any product candidate, we still may not be able to successfully commercialize it and the revenue that we generate from its sales, if any, may be limited.
If approved for marketing, the commercial success of Qtrypta™ (M207) or any product candidates we develop in the future will depend upon their acceptance by the medical community, including physicians, patients and health care payers. The degree of market acceptance of any product candidate will depend on a number of factors, including:
demonstration of clinical safety and efficacy of our products generally;
relative convenience and ease of administration;
prevalence and severity of any adverse effects;
willingness of physicians to prescribe our product and of the target patient population to try new therapies and routes of administration;
efficacy and safety of our products compared to competing products;
introduction of any new products, including generics, that may in the future become available to treat indications for which our products may be approved;
new procedures or methods of treatment that may reduce the incidences of any of the indications in which our products may show utility;
pricing and cost-effectiveness;
effectiveness of our or any future collaborators’ sales and marketing strategies;
limitations or warnings contained in FDA-approved labeling; and
our ability to obtain and maintain sufficient third party coverage or adequate reimbursement from government health care programs, including Medicare and Medicaid, private health insurers and other third party payers.
If our product candidate is approved but does not achieve an adequate level of acceptance by physicians, health care payers and patients, we may not generate sufficient revenue and we may not be able to achieve or sustain profitability. Our efforts to educate the medical community and third party payers on the benefits of our product candidate may require significant resources and may never be successful.
Even if we obtain regulatory approvals, the timing or scope of any approvals may prohibit or reduce our ability to commercialize our product candidate successfully. For example, if the approval process takes too long, we may miss market opportunities and give other companies the ability to develop competing products or establish market dominance. Any regulatory approval we ultimately obtain may be limited or subject to restrictions or post-approval commitments that render our product candidate not commercially viable. For example, regulatory authorities may approve our product candidate for fewer or more limited indications than we request, may not approve the price we intend to charge for our product candidate, may grant approval contingent on the performance of costly post-marketing clinical trials, or may approve our product candidate with a label that does not include the labeling claims necessary or desirable for the successful commercialization of that indication. Further, the FDA may place conditions on approvals including potential requirements or risk management plans and the requirement for a REMS to assure the safe use of the drug or a black-box warning (which is a warning required by the FDA that appears on the package insert for or in literature describing certain prescription drugs, signifying that medical studies indicate that the drug carries a significant risk of serious adverse effects). If the FDA concludes a REMS is needed, the sponsor of the NDA must submit a proposed REMS; the FDA will not approve the NDA without an approved REMS, if required. A REMS could include medication guides, physician communication plans, or elements to assure safe use, such as restricted distribution methods, patient registries and other risk minimization tools. A black-box warning will limit how we are able to market and advertise our product. Any of these limitations on approval or marketing could restrict the commercial promotion, distribution, prescription or dispensing of our product candidate. Moreover, approvals may be withdrawn for non-compliance with regulatory standards or if problems occur following the initial marketing of product candidate. Any of the foregoing scenarios could materially harm the commercial success of our product candidate.
We may expend our limited resources to pursue a particular product candidate and fail to capitalize on a product candidate that may be more profitable or for which there is a greater likelihood of success.
Because we have limited financial and managerial resources, we have decided to focus on developing our product candidate Qtrypta™ (M207) for treatment of migraine. As a result, we may forego or delay pursuit of opportunities with other product candidates or for other indications that later prove to have greater commercial potential. Our resource allocation decisions may cause us to fail to capitalize on viable commercial product candidates or profitable market opportunities. Our spending on current

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and future research and development programs and product candidate for specific indications may not yield any commercially viable products. If we do not accurately evaluate the commercial potential or target market for a particular product candidate, we may relinquish valuable rights to that product candidate through collaboration, licensing or other royalty arrangements in cases in which it would have been more advantageous for us to retain sole development and commercialization rights to such product candidate.

RISKS RELATED TO OUR DEPENDENCE ON THIRD PARTIES
We use customized equipment to coat and package our microneedle patch system; any production or equipment performance failures could negatively impact our clinical trials of Qtrypta™ (M207) or any other product candidates we may develop or sales of our product candidate(s), if approved.
We presently use customized equipment to coat and package our microneedle patch system. We also rely on third parties to manufacture our equipment. If we experience equipment malfunctions and we do not have adequate inventory of spare parts or qualified personnel to repair the equipment, we may encounter delays in the manufacture of our microneedle patch system and may not have sufficient inventory to meet the demands of our clinical development programs of any future product candidates and if approved, our customers’ demands for Qtrypta™ (M207) or our future approved product candidate(s), if any each of which could adversely affect our business, financial condition and results of operations.
We rely on CMOs for various components of our microneedle patch system, and our business could be harmed if those third parties fail to provide us with sufficient quantities of those components at acceptable quality levels and prices or fail to maintain or achieve satisfactory regulatory compliance.
We rely on CMOs for various components of our microneedle patch system, including active pharmaceutical ingredients ("API") raw materials used in manufacturing, and capital equipment. Reliance on third party manufacturers entails additional risks, including reliance on the third party for regulatory compliance and quality assurance. In addition, CMOs may not be able to comply with cGMP, or similar regulatory requirements outside the United States. Our reliance on these third parties reduces our control over these activities but does not relieve us of our responsibility to ensure compliance with all required legal, regulatory and scientific standards. The failure of our third party manufacturers, to comply with applicable regulations could result in sanctions being imposed on us, including fines, injunctions, civil penalties, delays, suspension or withdrawal of approvals, license revocation, seizures or recalls of products, operating restrictions and criminal prosecutions, any of which could significantly and adversely affect supplies of our product candidate or any other product candidates that we may develop.
There can be no assurance that our supply of these various components will not be limited, interrupted, or of satisfactory quality or continue to be available at acceptable prices. Additionally, we do not have any control over the process or timing of the acquisition or manufacture of materials by our manufacturers and cannot ensure that they will deliver to us the components we order on time, or at all. Any failure or refusal to supply the components for Qtrypta™ (M207) or any other product candidates that we may develop could delay, prevent or impair our clinical development or commercialization efforts. If our CMOs were to fail to fill our purchase orders, the development or commercialization of the affected product candidate could be delayed, which could have an adverse effect on our business. Any change in our manufacturers could be costly because the commercial terms of any new arrangement could be less favorable, the lead time needed to establish a new relationship can be lengthy, and because the expenses relating to the transfer of necessary technology and processes could be significant. It may take several years to establish an alternative source of supply for our product candidate and to have any such new source approved by the FDA, the European Medicines Agency, or EMA, or any other relevant regulatory authorities.
We rely on third parties to conduct our clinical trials and those third parties may not perform satisfactorily, including failing to comply with applicable regulatory requirements or to meet deadlines for the completion of such trials.
We rely on a third party contract research organization, or CRO, to manage our clinical trials. In addition, we rely on other third parties, such as clinical data management organizations, medical institutions and clinical investigators, to conduct those clinical trials. While we have agreements governing their activities, we will have limited influence over their actual performance and we will control only certain aspects of their activities. In addition, the use of third party service providers requires us to disclose our proprietary information to these parties, which could increase the risk that this information will be misappropriated. Further, agreements with such third parties might terminate for a variety of reasons, including a failure to perform by the third parties. If there is any dispute or disruption in our relationship with our CROs or if we need to enter into alternative arrangements, that would delay our product development activities.
There are limited number of third party service providers that specialize or have the expertise required to achieve our business objectives. In particular, there would be a significant increase in clinical trial expenses, including adopting a new electronic data capture platform or other technology platforms, the need to enter into new contracts and costs associated with the transfer of data,

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as well as an increased risk of the loss of data. Identifying, qualifying and managing performance of third party service providers can be difficult, time-consuming and may cause delays in our development programs. These investigators and CROs will not be our employees and we will not be able to control, other than by contract, the amount of resources, including time, which they devote to our product candidate and clinical trials. Our reliance on these third parties for research and development activities will reduce our control over these activities but will not relieve us of our responsibilities. For example, we will remain responsible for ensuring that each of our clinical trials is conducted in accordance with the general investigational plan and protocols for the trial. If any of our CROs’ processes, methodologies or results were determined to be invalid or inadequate, our own clinical data and results and related regulatory approvals could be adversely affected. Moreover, the FDA requires us to comply with standards, commonly referred to as GCPs for conducting, recording and reporting the results of clinical trials to assure that data and reported results are credible and accurate and that the rights, integrity and confidentiality of trial participants are protected. The FDA enforces GCPs through periodic inspections of trial sponsors, principal investigators and clinical trial sites. If we or our CRO or trial sites fail to comply with applicable GCPs, the clinical data generated in our clinical trials may be deemed unreliable and the FDA may require us to perform additional clinical trials before approving any marketing applications. Upon inspection, the FDA may determine that our clinical trials did not comply with GCPs. In addition, our clinical trials will require a sufficiently large number of test subjects to evaluate the safety and effectiveness of a product candidate. Accordingly, if our CROs fail to comply with these regulations or fail to recruit a sufficient number of patients, our clinical trials may be delayed, or we may be required to repeat such clinical trials, which would delay the regulatory approval process.
Furthermore, these third parties may also have relationships with other entities, some of which may be our competitors. If these third parties do not successfully carry out their contractual duties, meet expected deadlines, or if the quality of the clinical data they obtain is compromised due to the failure to conduct our clinical trials in accordance with regulatory requirements or our stated protocols, we will not be able to obtain, or may be delayed in obtaining, marketing approvals for our product candidate and will not be able to, or may be delayed in our efforts to, successfully commercialize our product candidate.
We currently depend primarily on one supplier for manufacture of our product. If this manufacturer fails to provide us or our collaborators with adequate supplies of materials for clinical trials or commercial product or fails to comply with the requirements of regulatory authorities, we may be unable to develop or commercialize Qtrypta™ (M207) or any other product candidates we may develop.
We have contracted with CMOs (including Patheon) to produce, in collaboration with us, Qtrypta™ (M207), for commercial use in the United States. We have not entered into any agreements with any alternate suppliers for Qtrypta™ (M207) product or API. Even if we were able to enter into other long-term agreements for manufacture of commercial supply on reasonable terms, we may face delays or increased costs in our supply chain that could jeopardize the commercialization of Qtrypta™ (M207). Additionally, if Qtrypta™ (M207) or any other future product candidates is approved by the FDA or other regulatory agencies for commercial sale or if Qtrypta™ (M207) is approved for commercial sale in jurisdictions outside the United States, we will need to contract with a third party to manufacture such products for commercial sale in the United States and/or in such other jurisdictions.
Our dependence on single source suppliers with respect to our supply chain for Qtrypta™ (M207) exposes us to certain risks, including the following:
our supplier may cease or reduce production or deliveries, raise prices or renegotiate terms;
we may be unable to locate a suitable replacement on acceptable terms or on a timely basis, if at all;
delays caused by supply issues may harm our reputation; and
our ability to progress our business could be materially and adversely impacted if our single-source supplier upon which we rely were to experience a significant business challenge, disruption or failure due to issues such as financial difficulties or bankruptcy, issues relating to regulatory or quality compliance, or other legal or reputational issues.
Even though we have an agreement with a CMO, Patheon, to supply Qtrypta™ (M207), and even if we enter into other long-term agreements with other CMOs, the FDA may not approve the facilities of such CMOs, the CMOs may not perform as agreed or the CMOs may terminate their agreements with us. If any of the foregoing circumstances occur, we may need to find alternative manufacturing facilities, which would significantly impact our ability to develop, maintain or obtain, as applicable, regulatory approval for or market Qtrypta™ (M207) or any other future product candidate. In the event that we seek such alternative sources, we may not be able to enter into replacement arrangements without delays or additional expenditures. We cannot estimate these delays or costs with certainty but, if they were to occur, they could cause a delay in our development and commercialization efforts.
The manufacturer(s) of Qtrypta™ (M207) are obliged to operate in accordance with FDA-mandated or cGMPs, and we have limited control over the ability of CMOs to maintain adequate quality control, quality assurance and qualified personnel to ensure compliance to cGMPs. In addition, the facilities used by our CMOs to manufacture Qtrypta™ (M207) must be approved

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by the FDA pursuant to inspections that will be conducted prior to any grant or regulatory approval by the FDA. If any of our CMOs are unable to successfully manufacture material that conform to our specifications and the FDA’s strict regulatory requirements, and pass regulatory inspections, they will not be able to secure or maintain approval for the manufacturing facilities. Additionally, a failure by any of our CMOs to establish and follow cGMPs or to document their adherence to such practices may negatively impact our commercialization or lead to significant delays in the launch and commercialization of any other products that we may have in the future. Failure by our CMOs or us to comply with application regulations could result in sanctions being imposed on us, including fines, injunctions, civil penalties, failure of the government to grant pre-market approval of drugs, delays, suspensions or withdrawal of approvals, seizures or recalls of product, operating restrictions, and criminal prosecutions.
The manufacturer of pharmaceutical products requires significant expertise and capital investment, including the development of advanced manufacturing techniques an