Aclaris Therapeutics, Inc. - Annual Report: 2018 (Form 10-K)

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

 

 

ACLARIS THERAPEUTICS, INC.

 

 

640 Lee Road, Suite 200

Wayne, PA 19087

(484) 324-7933

 

Securities registered pursuant to Section 12(b) of the Exchange Act:

 

 

Securities registered pursuant to Section 12(g) of the Exchange Act:

 

None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ◻     No ☒ 

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act. Yes ◻      No ☒

 

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

 

Indicate by check mark whether the registrant has submitted electronically 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 ☒     No ◻ 

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulations S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☒

 

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

 

 

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

 

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

 

As of June 30, 2018, the last business day of the registrant’s last completed second quarter, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was approximately $528.2 million based on the closing price of the registrant’s common stock, as reported by the Nasdaq Global Select Market, on such date. 

 

As of March 15, 2019, 41,269,643 shares of common stock, $0.00001 par value, were outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the Company's definitive proxy statement, to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934, for its 2019 Annual Meeting of Stockholders are incorporated by reference in Part III of this Form 10-K.

 

 

 

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

This Annual Report on Form 10-K, or this Annual Report, contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act, that involve substantial risks and uncertainties. The forward-looking statements are contained principally in Part I, Item 1. “Business,” Part I, Item 1A. “Risk Factors,” and Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” but are also contained elsewhere in this Annual Report. In some cases, you can identify forward-looking statements by the words “may,” “might,” “will,” “could,” “would,” “should,” “expect,” “intend,” “plan,” “objective,” “anticipate,” “believe,” “estimate,” “predict,” “project,” “potential,” “continue” and “ongoing,” or the negative of these terms, or other comparable terminology intended to identify statements about the future. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from the information expressed or implied by these forward-looking statements. Although we believe that we have a reasonable basis for each forward-looking statement contained in this Annual Report, we caution you that these statements are based on a combination of facts and factors currently known by us and our expectations of the future, about which we cannot be certain. Forward-looking statements include statements about:

 

 

You should refer to “Item 1A. Risk Factors” in this Annual Report for a discussion of important factors that may cause our actual results to differ materially from those expressed or implied by our forward‑looking statements. As a result of these factors, we cannot assure you that the forward‑looking statements in this Annual Report will prove to be accurate. Furthermore, if our forward‑looking statements prove to be inaccurate, the inaccuracy may be material. In light of the significant uncertainties in these forward‑looking statements, you should not regard these statements as a representation or warranty by us or any other person that we will achieve our objectives and plans in any specified time frame, or at all. The forward-looking statements in this Annual Report represent our views as of the date of this Annual Report. We anticipate that subsequent events and developments may cause our views to change. However, while we may elect to update these forward-looking statements at some point in the future, we undertake no obligation to publicly update any forward‑looking statements, whether as a result of new information, future events or otherwise, except as required by law. You should, therefore, not rely on these forward-looking statements as representing our views as of any date subsequent to the date of this Annual Report.

 

All brand names or trademarks appearing in this Annual Report, including ESKATA, ESKERIELE, RHOFADE, Physician’s Wart Assessment and THWART, are the property of their respective owners. Unless the context requires otherwise, references in this report to “Aclaris,” the “Company,” “we,” “us,” and “our” refer to Aclaris Therapeutics, Inc. and its subsidiaries.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

TABLE OF CONTENTS

 

 

 

PART I

Item 1. Business

 

Overview

 

We are a physician-led biopharmaceutical company focused on dermatological and immuno-inflammatory diseases.  We have two commercial products and a diverse pipeline of drug candidates.

 

Our first commercial product, ESKATA (hydrogen peroxide) topical solution, 40% (w/w), or ESKATA, is a proprietary formulation of high-concentration hydrogen peroxide topical solution which was approved by the U.S. Food and Drug Administration, or FDA, in December 2017 as an office-based prescription treatment for raised seborrheic keratosis, or SK, a common non-malignant skin tumor.  We launched ESKATA in the United States in May 2018.  We also submitted a Marketing Authorization Application, or MAA, for ESKATA in select countries in the European Union, Norway and Iceland in July 2017 using a decentralized procedure.  In February 2019, we received approval from the Swedish Medical Products Agency to market ESKATA (hydrogen peroxide) cutaneous solution, 685 mg for the treatment in adults of SKs that are not pedunculated and have up to a maximum diameter of 15 millimeters each.  We have also received approval to market ESKATA in the United Kingdom, Iceland and Belgium.

 

In November 2018, we acquired RHOFADE (oxymetazoline hydrochloride) cream, 1%, or RHOFADE, which includes an exclusive license to certain intellectual property for RHOFADE, as well as additional intellectual property, from Allergan Sales, LLC, or Allergan.  RHOFADE was approved by the FDA in January 2017 for the topical treatment of persistent facial erythema (redness) associated with rosacea in adults. Persistent facial redness is the most common sign of rosacea in most skin types.

 

We continue to develop our sales, marketing and product distribution capabilities for ESKATA and RHOFADE in order to support our commercialization efforts in the United States.  We plan to continue to deploy sales representatives in approximately 50 territories in the United States which we believe will allow us to reach the health care providers in the United States with the highest potential for prescribing ESKATA and RHOFADE to their patients.

 

We are also developing another high-concentration formulation of hydrogen peroxide, A-101 45% Topical Solution, as a prescription treatment for common warts, also known as verruca vulgaris.  On an annual basis, approximately 2.0 million people in the United States are diagnosed with common warts.

 

Additionally, in 2015, we in-licensed exclusive, worldwide rights from Rigel Pharmaceuticals, Inc., or Rigel, to certain inhibitors of the Janus kinase, or JAK, family of enzymes, for specified dermatological conditions, including alopecia areata, or AA.  AA is an autoimmune dermatologic condition typically characterized by patchy non-scarring hair loss on the scalp and body.  More severe forms of AA include total scalp hair loss, known as alopecia totalis, or AT, and total hair loss on the scalp and body, known as alopecia universalis, or AU. We are also developing these JAK inhibitors for the treatment of vitiligo, androgenetic alopecia, or AGA, also known as male or female pattern baldness, and atopic dermatitis.    

 

In 2016, in connection with the acquisition of Vixen Pharmaceuticals, Inc., or Vixen, we acquired additional intellectual property rights for the development and commercialization of certain JAK inhibitors for specified dermatological conditions.  We intend to continue to in-license or acquire additional drug candidates and technologies to build a fully integrated biopharmaceutical company.

 

In 2017, we acquired Confluence Life Sciences, Inc. (now known as Aclaris Life Sciences, Inc.), or Confluence.  The acquisition of Confluence added small molecule drug discovery and preclinical development capabilities that allowed us to bring early-stage research and development activities in-house that we previously outsourced to third parties.  We intend to leverage the proprietary KINect drug discovery platform to identify potential drug candidates that we may develop independently or with partners. We also acquired several preclinical drug candidates, including additional topical JAK inhibitors known as soft-JAK inhibitors, inhibitors of the MK-2 signaling pathway and inhibitors of interleukin-2-inducible T cell kinase, or ITK. Soft-JAK inhibitors may be topically applied and active in the skin, but will be rapidly metabolized and inactivated when they enter the bloodstream, which may result in significantly reduced systemic exposure. We also earn revenue from Confluence’s provision of contract research services to third parties.

 

Our intellectual property portfolio contains issued patents directed to methods of use for high-concentration hydrogen peroxide compositions of at least 23% or more hydrogen peroxide, including ESKATA and A-101 45% Topical Solution, issued patents directed to methods of treating erythema associated with rosacea by administering oxymetazoline and pharmaceutical cream compositions of oxymetazoline, including RHOFADE and its approved use, and issued patents directed to our JAK inhibitor drug candidates, ATI-501 and ATI-502.

 

Our Drug Candidates

 

We have utilized our experience to establish a pipeline of drug candidates in dermatological and immuno-inflammatory diseases.  Our pipeline of drug candidates is summarized in the table below:

 

 

A-101 45% Topical Solution for the Treatment of Common Warts

 

We are developing A-101 45% Topical Solution for the treatment of common warts.  Although common warts are generally not harmful and in most cases eventually clear without medical treatment, they may be painful and aesthetically unattractive and are contagious.  On an annual basis, approximately 2.0 million people in the United States are diagnosed with common warts. As with SK lesions, cryosurgery is the most frequently used in-office treatment for common warts.  Common warts can also be removed with slow-acting, over-the-counter products containing salicylic acid.  We are not aware of any prescription drugs that have been approved by the FDA for the treatment of common warts. 

 

We completed a Phase 2 clinical trial, WART-201, in August 2016 evaluating 40% and 45% concentrations of A-101 for the treatment of common warts, in which we observed statistically significant improvements in the mean change in the Physician’s Wart Assessment, or PWA, score and in complete clearance of common warts in subjects treated with the 45% concentration of A-101 compared to placebo.  The PWA score is a four-point scale of the investigators assessment of the severity of a target wart at a particular time point. 

 

In June 2017, we commenced two additional Phase 2 clinical trials, WART-202 and WART-203, of A-101 45% Topical Solution to assess the dose frequency in adult and pediatric subjects with common warts.  Both trials evaluated the safety and efficacy of A-101 45% Topical Solution as compared to placebo, or vehicle.  The two randomized, double-blind, vehicle-controlled trials were designed to understand the effects of dose frequency and to explore additional clinical endpoints that are now being further evaluated in our Phase 3 development program.  We enrolled a total of 316 subjects at 34 investigational centers in the United States across both trials.

The WART-202 trial evaluated 157 subjects who self-administered either A-101 45% Topical Solution or placebo once weekly through Day 56, for a total of 8 treatments.  Each subject had between one and four warts at baseline. The trial achieved its primary endpoint, which was mean change from baseline in the PWA score of the target wart at Day 56 (one week after the last treatment).  The mean reduction in PWA score at Day 56 on the target warts was 0.77 points in subjects who received A-101 45% Topical Solution, compared to a reduction of 0.23 points for the target warts that received placebo, a result that was also statistically significant (p<0.001). 

 

The WART-203 trial evaluated 159 subjects who self-administered either A-101 45% Topical Solution or placebo twice weekly through Day 56, for a total of 16 treatments.  Each subject had between one and six warts at baseline.  The WART-203 trial achieved its primary endpoint, which was mean change from baseline in the PWA scale score at Day 56 (Visit 10 or one week after the last treatment).  The mean reduction in PWA score at Day 56 on the target warts was 0.87 points in subjects who received A-101 45% Topical Solution, compared to a reduction of 0.17 points for the target warts that received placebo, a result that was statistically significant (p<0.001).

 

In March 2018, we reported final results, which included a 3-month drug-free follow-up phase, from the WART-203 clinical trial.  In addition, in April 2018, we concluded the WART-202 clinical trial, in which we evaluated a different dosing regimen from the one used in the WART-203 clinical trial.  In both of these clinical trials, subjects treated with A-101 45% Topical Solution achieved clinically and statistically significant outcomes for the primary and secondary endpoints of each of the trials.  There were no treatment-related serious adverse events among subjects treated with A-101 45% Topical Solution.

 

Based on the results from these clinical trials, we held an end of Phase 2 meeting with the FDA.  A twice-weekly dosing regimen is being evaluated in our two Phase 3 pivotal clinical trials, which we refer to as THWART-1 and THWART-2, of A-101 45% Topical Solution for the treatment of common warts, which we initiated in September 2018.  We expect approximately 1,000 patients will be enrolled in these two trials by the end of March 2019. We expect to report data from both of these trials in the second half of 2019.  In addition, in February 2019, we commenced an open-label safety extension trial investigating A-101 45% Topical Solution for the treatment of common warts.  If the results of these three ongoing trials are positive, we expect to submit a New Drug Application, or NDA, to the FDA for A-101 45% Topical Solution for the treatment of common warts in the first half of 2020. 

 

ATI-501 and ATI-502 for the Treatment of AA and Other Dermatological Indications

 

We are developing our JAK inhibitors, ATI-501 and ATI-502, which we in-licensed from Rigel, as potential treatments for AA and other dermatological indications. AA is an autoimmune dermatologic condition typically characterized by patchy non-scarring hair loss on the scalp and body.  More severe forms of AA include AT, which is total scalp hair loss, and AU, which is total hair loss on the scalp and body.  AA is estimated to affect up to 1.8% of people in the United States and 2.0% of people globally at some point during their lifetime, with two-thirds of affected individuals being 30 years old or younger at the time of disease onset. Treatment options for the less severe, patchy forms of AA include corticosteroids, either topically applied or injected directly into the scalp where the bare patches are located, or the induction of an allergic reaction at the site of hair loss using a topical contact sensitizing agent, an approach known as topical immunotherapy.  The same treatment options are utilized for the more severe forms of AA, although utilization of these treatment options for the more severe forms of AA is limited due to limited efficacy, certain side effects, and their impracticality for extensive surface areas.

 

We are developing ATI-501 as an oral treatment for AA.  We submitted an investigational new drug application, or IND, to the FDA for ATI-501 for the treatment of AA in October 2016. Since the filing of the IND, we have conducted several Phase 1 clinical trials to evaluate the pharmacokinetic and pharmacodynamic, or PK/PD, properties of various formulations of ATI-501.  Based on the results from these clinical trials, we selected an oral suspension and initiated a Phase 2 dose-response clinical trial of ATI-501 for the treatment of AA.

 

We are developing ATI-502 as a topical treatment for AA, vitiligo, AGA and atopic dermatitis.  We submitted an IND to the FDA for ATI-502 for the treatment of AA in July 2017.  The following table summarizes the status of our ongoing Phase 2 clinical trials of ATI-501 and ATI-502, including their indications, trial objectives, number of subjects enrolled and expected timing for receipt of preliminary results:

 

(1)AA-202 interim data reported in June 2018.

(2)Approximate number of subjects per protocol.

(3)AUATB-201 interim data reported in December 2018.

(4)VITI-201 6-month interim data expected in the second quarter of 2019 and 12-month data expected in the second half of 2019.

(5)AGA-201 6-month data expected in the second quarter of 2019 and 12-month data expected in the second half of 2019.

 

 

JAK Inhibitors, ITK Inhibitors and MK-2 Inhibitors

 

In August 2017, we acquired Confluence.  This acquisition added small molecule drug discovery and preclinical development capabilities that allowed us to bring early-stage research and development activities in-house that we previously outsourced to third parties.  We also acquired several preclinical drug candidates as part of the acquisition, including soft-JAK inhibitors, inhibitors of the MK-2 signaling pathway and ITK inhibitors.  We expect to submit an IND to the FDA for ATI-450, an MK-2 inhibitor, for rheumatoid arthritis in mid-2019. If the IND is allowed by the FDA, we expect to initiate a Phase 1 and Phase 2 trial in the second half of 2019. We are considering developing ATI-450 for the treatment of rheumatoid arthritis, psoriasis, hidradenitis suppurativa, cryopyrin-associated periodic syndrome (CAPS), and pyoderma gangrenosum.  We expect to submit an IND to the FDA for ATI-1777, a soft-JAK inhibitor, by the end of the first half of 2020. We are considering developing ATI-1777 for the treatment of several dermatological conditions, including atopic dermatitis, vitiligo and AA.  We are considering developing our ITK inhibitors as a potential treatment for psoriasis, inflammatory dermatoses, and inflammatory bowel disease.

 

Our Commercial Products

 

ESKATA for the Treatment of Raised Seborrheic Keratosis

 

ESKATA is the first FDA-approved drug for the treatment of raised SKs.  SK lesions are among the most common non-malignant skin tumors and one of the most frequent diagnoses made by dermatologists. SK lesions typically have a waxy, scaly, slightly elevated appearance, and multiple lesions are often present.  The lesions can vary in color from light tan to dark brown or black and typically appear on the face, trunk and extremities.  Though the lesions are non-malignant, patients often elect to have their condition treated by a health care provider, either because the lesions have become inflamed or because the patient feels they are cosmetically unattractive.  SK lesions are usually treated by cryosurgery, electrodesiccation, curettage or excision. Each of these methods may be painful or can result in pigmentary changes or scarring at the treatment site. 

 

Our NDA for ESKATA for the treatment of raised SKs was approved by the FDA in December 2017.  We launched ESKATA in the United States in May 2018.   We submitted an MAA in select countries in the European Union, Norway and Iceland in July 2017 using a decentralized procedure.  In February 2019, we received approval from the Swedish Medical Products Agency to market ESKATA (hydrogen peroxide) cutaneous solution, 685 mg for the treatment in adults of SKs that are not pedunculated and have up to a maximum diameter of 15 millimeters each. We have also received approval to market ESKATA in the United Kingdom, Iceland and Belgium.  We are seeking a commercial partner or partners to market the medicine as an aesthetic skin treatment in various European countries with the brand name ESKATA in Finland, Iceland, Netherlands, Norway, Portugal, Spain, Sweden, Czech Republic and Belgium, and the brand name ESKERIELE in Austria, France, Germany, Ireland, Italy, and the United Kingdom.

 

In April 2018, we entered into an exclusive license agreement with Cipher Pharmaceuticals Inc., or Cipher, for the rights to obtain regulatory approval of and commercialize A-101 40% Topical Solution, which we market under the brand name ESKATA in the United States, in Canada for the treatment of SK, or the Cipher License Agreement.  Under the Cipher License Agreement, Cipher is responsible for obtaining marketing approval in Canada for A-101 40% Topical Solution.  Cipher submitted a New Drug Submission for A-101 40% Topical Solution for the treatment of raised SKs, which was accepted for review by Health Canada in December 2018. We will supply Cipher with finished product, and, if regulatory approval is obtained, Cipher will be responsible for distribution and commercialization of A-101 40% Topical Solution in Canada.  Additionally, Cipher is responsible for all expenses related to regulatory and commercial activities for A-101 40% Topical Solution in Canada.

 

RHOFADE for the Treatment of Persistent Facial Erythema (Redness) Associated with Rosacea in Adults

 

In November 2018, we acquired from Allergan the worldwide rights to RHOFADE, which includes an exclusive license to certain intellectual property for RHOFADE.  RHOFADE is indicated for the topical treatment of persistent facial erythema (redness) associated with rosacea in adults. Rosacea is a chronic disease characterized by enduring facial redness and/or skin thickening. Other signs of rosacea include facial flushing, visible blood vessels (telangiectasia), blemishes resembling acne (papules and pustules), and eye irritation. Burning or stinging, swelling (edema), and dry appearance may accompany these signs. Persistent facial redness is the most common sign of rosacea in most skin types and, according to a survey of 1,289 patients with rosacea conducted by the National Rosacea Society, affects 71% of patients with rosacea.

 

RHOFADE was approved by the FDA in January 2017, and it became commercially available in the United States in May 2017.

 

Manufacturing and Supply

 

We do not have any manufacturing facilities.  We rely on third parties for the manufacture of preclinical and clinical supplies for all of our drug candidates.  We also rely on third parties for the commercial manufacture of ESKATA and RHOFADE. 

 

We have entered into an exclusive, ten-year, automatically renewable supply agreement with PeroxyChem LLC, or PeroxyChem, to provide hydrogen peroxide, the active pharmaceutical ingredient, or API, that can be used in ESKATA for the treatment of raised SKs and a number of other specified dermatological indications.  The ten-year term commenced on the date of first commercial sale of ESKATA in the United States. We or PeroxyChem may terminate the supply agreement with prior written notice immediately for specified financial reasons, after a 10-business day and 60-day cure period for material monetary and material non-monetary breaches, respectively, and in the event of a force majeure event, that continues for 90 consecutive days. In addition, we may terminate the PeroxyChem supply agreement, with prior written notice, for PeroxyChem’s failure to supply API to us for more than 90 cumulative days in a year.

 

We have entered into an exclusive commercial supply agreement with James Alexander Corporation, or James Alexander, for the manufacture of the finished dosage form of ESKATA.  We must meet a minimum purchase requirement each year through 2022.  In the event that we do not meet the minimum purchase requirements, James Alexander may, at its discretion, convert the agreement into a non-exclusive agreement.  Additionally, during the term of the agreement, James Alexander will not manufacture any competitive product, as defined in the agreement. The term of the agreement with James Alexander is five years from the date of the first commercial sale of ESKATA in the United States and thereafter will be renewed automatically for one-year periods. Either party may terminate the agreement for any reason upon 180 days prior written notice. In addition, either party has the right to immediately terminate the supply agreement under certain circumstances, including (i) the other party files for bankruptcy, (ii) the other party materially breaches the

supply agreement and such breach is not cured within a specified period and (iii) any required license, permit or certificate required of the other party to perform its obligations under the supply agreement is not approved or issued or is revoked by an applicable governmental regulatory authority. 

 

We are also party to a manufacturing and supply agreement with a third party for the finished dosage form of RHOFADE.

 

Commercialization

 

We are commercializing ESKATA and RHOFADE ourselves in the United States, and intend to establish partnerships with third parties to commercialize them outside the United States in countries where we have received, or in the future may receive, approval.  We are continuing to develop our sales, marketing and product distribution capabilities for ESKATA and RHOFADE in order to support our commercialization efforts in the United States.  We plan to continue to deploy sales representatives in approximately 50 territories in the United States which we believe will allow us to reach the health care providers in the United States with the highest potential for prescribing ESKATA and RHOFADE to their patients.  Our sales force is supported by sales and marketing management, internal sales and marketing, an advertising campaign, and commercial product distribution.

 

We sell ESKATA to one wholesaler, McKesson Specialty Care Distribution, or McKesson, which in turn resells ESKATA to health care providers.  We have also entered into agreements with two group purchasing organizations, or GPOs, and may enter into additional agreements with other GPOs and corporate accounts that provide for administrative fees and discounted pricing in the form of volume-based rebates and chargebacks.  We have no sales of ESKATA in countries outside of the United States.  We have a no returns policy for ESKATA. 

 

We believe dermatologists will be inclined to adopt ESKATA to treat their patients with SK lesions not only because of its clinical profile, but also because it may provide an expanded source of revenue for their practices. Dermatologists expect declining reimbursements from third-party payors for providing medical services. In addition, a greater portion of the cost of medical care has been shifted to patients, in the form of higher deductibles and co‑insurance. Collecting from patients can be difficult and costly for physician practices. We believe many dermatologists are interested in expanding the cash-pay aesthetic portion of their practices, meaning the portion of procedures that are not medically necessary and not reimbursed by third-party payors, by treating new aesthetic patients and by offering new services to current aesthetic patients. Though SK patients typically come into the dermatology practice seeking a medical diagnosis, we believe they often are willing to pay for removal of SK lesions to improve appearance even after they learn that the lesions are non-malignant, and that removal may not be reimbursed. In addition, since ESKATA can be administered by non-physician staff, we believe it could provide incremental practice revenue with minimal time commitment by the dermatologist after the diagnosis is made.

 

We began commercializing RHOFADE in the United States in December 2018.  We currently rely on Allergan to distribute RHOFADE on our behalf pursuant to the terms of a transition services agreement while we develop our sales, marketing and distribution capabilities to support the commercialization of RHOFADE in the United States.  We sell RHOFADE to wholesalers in the United States, which, in turn, distribute it to pharmacies that will ultimately fill patient prescriptions.  We may also enter into arrangements with health care providers, pharmacy benefit managers, third-party payors, and GPOs which provide for government mandated and/or privately negotiated rebates, chargebacks, and discounts, with respect to the purchase of RHOFADE.  We have no sales of RHOFADE in countries outside of the United States.

 

It is estimated that 16.0 million people in the United States suffer from rosacea.  Persistent facial redness is the most common sign of rosacea in most skin types. Although there are many branded and generic oral and topical medications prescribed to treat the papules and pustules of rosacea, they are not indicated for the treatment of persistent facial redness.

 

We believe dermatologists tend to be particularly focused on the safety of pharmaceutical products because, while skin diseases can have profound effects on patients’ quality of life, few are life-threatening. As a result, we believe that dermatologists, as well as their patients, often prefer to use topical treatments when possible to limit the risk of systemic side effects. Dermatologists also tend to place a high level of emphasis on products that are easy to use because they often manage high volumes of patients. We believe this also contributes to a general preference for topical treatments. Finally, in our experience, dermatologists tend to engage with sales and medical affairs personnel from the pharmaceutical industry

regarding the scientific evidence supporting dermatology products and the challenges experienced by physicians and patients in the use of these products. Dermatologists often rely on trusted relationships with scientifically oriented, customer-focused sales representatives who can provide them with the necessary information to support their use of appropriate treatments.

 

Competition

 

The pharmaceutical industry is characterized by rapidly advancing technologies, intense competition and a strong emphasis on proprietary drugs. While we believe that our knowledge, experience and scientific resources provide us with competitive advantages, we face potential competition from many different sources, including major pharmaceutical, biotechnology and specialty pharmaceutical companies, academic institutions and governmental agencies and public and private research institutions. Our products compete with, and any drug candidates that are approved and we successfully develop and commercialize will compete with, existing treatments and new treatments that may become available in the future.

 

The key competitive factors affecting the success of ESKATA for the treatment of raised SKs, are likely to be its efficacy, safety, non-invasiveness, pain profile and ability to be administered by non-physician staff.  With respect to ESKATA for the treatment of raised SKs, we are aware of the following companies that have treatments or are developing treatments for SK: BioLineRx Ltd. is developing an over-the-counter drug candidate targeting multiple skin conditions, including SK; Skincential Sciences, Inc. currently markets a line of cosmetic products targeting skin conditions, including SK; Epipharm, AG is developing a topical drug candidate targeting multiple skin conditions, including SK; and Pulse Biosciences, Inc. is developing a device targeting multiple skin conditions, including SK.  We are also aware of early research being conducted with Akt inhibitors as a potential treatment for SK. None of these products have been approved by the FDA for the treatment of SK in the United States.

 

With respect to RHOFADE for the treatment of persistent facial erythema (redness) due to rosacea, we are aware of one other drug that is approved for this indication: MIRVASO (brimonidine) topical gel, 0.33%, which was approved by the FDA in 2013, and which is currently marketed by Galderma Laboratories, L.P.

 

With respect to A-101 45% Topical Solution for the treatment of common warts, we are aware of the following companies that have treatments or are developing treatments for common warts: Perrigo Company plc received a CE Mark approval for BL-5010, which it licenses from BioLineRx Ltd., as a novel over-the-counter treatment for the non-surgical removal of warts in the European Economic Area; and each of Nielsen BioSciences, Inc., Cutanea Lifesciences, Inc., Phio Pharmaceuticals Corp. and Verrica Pharmaceuticals Inc. is developing a drug candidate for the treatment of common warts. In addition, other drugs have been used off-label as treatments for common warts. 

 

With respect to ATI-501 and ATI-502 for the treatment of AA, we anticipate competing with sensitizing agents such as diphencyprone, and topical, intralesional and systemic corticosteroids, which have been found to occasionally reduce symptoms of AA. Other treatments utilized for patchy AA include anthralin and minoxidil solution. We may also compete with companies developing chemical agents to be used in topical immunotherapies, as well as companies developing biologics, immunosuppressive agents, laser therapy, phototherapy, other JAK inhibitors and prostaglandin analogues to treat AA.

 

With respect to ATI-502 for the treatment of vitiligo, we are aware of one other company, Incyte Corporation, developing a topical JAK inhibitor for the treatment of vitiligo.

 

Our commercial opportunity could be reduced or eliminated if our competitors develop and commercialize drugs that are safer, more effective, have fewer or less severe side effects, are more convenient or are less expensive than ESKATA, RHOFADE or any other drug that we may develop. Our competitors also may obtain FDA or other regulatory approval for their drug candidates more rapidly than we may obtain approval for our drug candidates, which could result in our competitors establishing a strong market position before we are able to enter the market. Many of the companies against which we are competing, or against which we may compete in the future, have significantly greater financial resources and expertise in research and development, manufacturing, preclinical testing, conducting clinical trials, obtaining regulatory approvals and marketing approved drugs than we do. Mergers and acquisitions in the pharmaceutical and biotechnology industries may result in even more resources being concentrated among a smaller number of our competitors. Smaller or early-stage companies may also prove to be significant competitors, particularly through collaborative arrangements with large and established companies. These competitors also compete with us in recruiting

and retaining qualified scientific and management personnel and establishing clinical trial sites and subject registration for clinical trials, as well as in acquiring technologies complementary to, or that may be necessary for, our programs.

 

Intellectual Property

 

Our success depends in large part upon our ability to obtain and maintain proprietary protection for our products and drug candidates and to operate without infringing the proprietary rights of others. We seek to avoid the latter by monitoring patents and publications that may affect our business, and to the extent we identify such developments, evaluate and take appropriate courses of action. Our policy is to protect our proprietary position by, among other methods, filing patent applications on inventions that are important to the development and conduct of our business with the U.S. Patent and Trademark Office, or USPTO, and its foreign counterparts.

 

With respect to ESKATA and A-101 45% Topical Solution, we do not currently rely on licenses to any third party’s intellectual property. We own two U.S. patents that include claims that cover the use of high-concentration hydrogen peroxide of at least 23%, including ESKATA and A-101 45% Topical Solution, for the alleviation of SK and acrochordons. The patents in Australia, New Zealand and India include claims that cover the use of high-concentration hydrogen peroxide of at least 23%, including ESKATA and A-101 45% Topical Solution, for the alleviation of various skin conditions including SK, acrochordons, corns, tags, acne, warts and rosacea. The patents in Germany, the United Kingdom, Mexico and Singapore include claims that cover the use of high-concentration hydrogen peroxide of at least 23%, including ESKATA and A-101 45% Topical Solution for the alleviation of acrochordons. The issued patents relating to the use of ESKATA and A-101 45% Topical Solution begin to expire in 2022, subject to any applicable patent term extension that may be available in a particular country.

 

We also own three issued U.S. patents and pending U.S., European and other foreign patent applications directed to various formulations comprising high-concentration hydrogen peroxide, including ESKATA and A-101 45% Topical Solution dosing regimens for such formulations, applicators for use with such formulations, and methods of treating various skin conditions, including SK and common warts, by the topical administration of such formulations.  Our U.S. formulation, method of use and applicator patents expire in 2035 and any claims that issue from the pending formulation applications will expire in 2035, subject to any applicable patent term adjustment or extension that may be available in a particular country.  In addition, we own a U.S. and PCT patent application directed to the use of high-concentration hydrogen peroxide, including ESKATA and A-101 45% Topical Solution, for the treatment of warts.  We are in the process of filing national applications from this PCT patent application in Europe and other foreign countries.  Any claims that issue from these applications will expire in 2037, subject to any applicable patent term adjustment or extension that may be available in a particular country.

 

With respect to our patent portfolio relating to RHOFADE, we exclusively license from Allergan a family of U.S. patents and pending applications, including three issued U.S. patents directed to methods of treating erythema associated with rosacea by administering alpha-1 adrenergic receptor agonists, including oxymetazoline, which cover the approved use of RHOFADE, that expire between 2024 and 2028.  We also own issued U.S. and European patents and pending U.S. and European applications, and other foreign country patents and applications directed to pharmaceutical cream compositions of oxymetazoline, including RHOFADE, that expire, or will expire, in 2031.  We also own an issued U.S. patent and pending U.S. and European applications, and other foreign country applications directed to methods of treating facial erythema by topically administering once or twice daily 1% or 1.5% oxymetazoline hydrochloride, which cover the approved use of RHOFADE, that expire, or will expire, in 2035.  We also own a family of patents in the United States, Europe and other foreign countries directed to methods of treating purpura by administering alpha-1 adrenergic receptor agonists, including oxymetazoline, which expire in 2028 and 2029 and a family of patents and applications in the United States, Europe and other foreign countries directed to methods of treating erythema associated with rosacea by administering oxymetazoline, which expire, or will expire, in 2032.  We also exclusively sublicense from Allergan certain patents and applications in the United States and foreign countries owned by a third party for oxymetazoline for the treatment of rosacea or purpura by topical application, which expire in 2024.

 

With respect to ATI-501 and ATI-502, we exclusively license from Rigel multiple families of patents and applications relating to these compounds and the uses thereof in the field of dermatology.  In particular, we exclusively license patents and applications with claims that specifically cover the composition of matter for these compounds in the United States, the European Union, and other major foreign markets. The issued patents specifically directed to these compounds begin to expire in 2030, subject to any applicable patent term extension that may be available in a particular country. We also exclusively license an issued U.S. patent and pending applications in the United States, Australia, Canada,

the European Union and Japan with claims that cover the use of these compounds for the treatment of alopecia areata.  The U.S. patent, and any claims that issue from these applications, expire, or will expire, in 2034, subject to any applicable patent term adjustment or extension that may be available in a particular country. We also licensed a family of patents and applications that relate to ATI-501 and ATI-502 that expire in 2023, subject to any applicable patent term extension that may be available in a particular country.

 

We also exclusively license patents and applications from Columbia University relating to the use of JAK inhibitors to induce hair growth and treat hair loss disorders, including AA and AGA.  In particular, we exclusively license multiple U.S. patents with claims directed to the use of certain third-party JAK inhibitors for the treatment of hair loss disorders, including AA and AGA, and inducing hair growth, which expires in 2031.  We also exclusively license patents and applications with claims directed to the use of certain JAK1, JAK2 or JAK3 inhibitors for the treatment of hair loss disorders, including AA and AGA, and inducing hair growth in the U.S., the European Union, Japan and South Korea.  Any claims that issue from the pending applications begin to expire in 2031, subject to any applicable patent term adjustment or extension that may be available in a particular country.  In addition, we exclusively license patent applications in the United States and other foreign countries directed to methods of inducing hair growth with JAK1, JAK2 or JAK3 inhibitors as well as biomarkers for AA, which if claims issue, would expire in 2036, subject to any applicable patent term adjustment or extension that may be available in a particular country.

 

With respect to our inhibitors of the MK-2 signaling pathway, we own one U.S. patent and pending applications in the European Union and other foreign countries that cover ATI-450, our lead candidate.  The U.S. patent expires in 2034 and any claims that issue from the pending applications expire in 2034, subject to any applicable patent term adjustment or extension that may be available in a particular country.  We also own seven U.S. patents and pending foreign patent applications directed to other inhibitors of the MK-2 signaling pathway, which expire or will expire between 2031 and 2034, subject to any applicable patent term adjustment or extension that may be available in a particular country. 

 

With respect to our soft-JAK inhibitors, we have filed two U.S. and PCT applications directed to various novel inhibitors of JAK1 and/or JAK3 and methods of using the same.  Any claims that may issue would expire in 2038, subject to any applicable patent term adjustment or extension that may be available in a particular country.

 

With respect to our ITK inhibitors, we own multiple U.S. patents and pending applications in the United States and foreign countries directed to novel inhibitors of ITK and methods of using the same.  The patents and pending applications, if issued, expire between 2035 and 2038, subject to any applicable patent term adjustment or extension that may be available in a particular country.

 

We also use other forms of protection, such as trademark, copyright, and trade secret protection, to protect our intellectual property, particularly where we do not believe patent protection is appropriate or obtainable. We aim to take advantage of all of the intellectual property rights that are available to us and believe that this comprehensive approach will provide us with proprietary positions for our products and drug candidates, where available.

 

Patents extend for varying periods according to the date of patent filing or grant and the legal term of patents in various countries where patent protection is obtained. The actual protection afforded by a patent, which can vary from country to country, depends on the type of patent, the scope of its coverage and the availability of legal remedies in the country. In most countries in which we file, the patent term is 20 years from the earliest date of filing a non-provisional patent application. In the United States, a patent term may be shortened if a patent is terminally disclaimed over another patent or as a result of delays in patent prosecution by the patentee, and a patent’s term may be lengthened by patent term adjustment, which compensates a patentee for administrative delays by the USPTO in granting a patent or by patent term extension, which compensates a patentee for delays at the FDA. The patent term of a European patent is 20 years from its filing date; however, unlike in the United States, the European patent does not grant patent term adjustments. The European Union does have a compensation program similar to patent term extension called supplementary patent certificate that would effectively extend patent protection for up to five years.

 

We also protect our proprietary information by requiring our employees, consultants, contractors and other advisors to execute nondisclosure and assignment of invention agreements upon commencement of their respective employment or engagement. Agreements with our employees also prevent them from bringing the proprietary rights of third parties to us. In addition, we also require confidentiality or service agreements from third parties that receive our confidential information or materials.

 

Acquisition and License Agreements

 

Assignment Agreement with the Estate of Mickey Miller and Finder’s Services Agreement with KPT Consulting, LLC

 

In August 2012, we entered into an assignment agreement, or, as amended, the Assignment Agreement, with the Estate of Mickey Miller, or the Miller Estate, under which we acquired some of the intellectual property rights covering ESKATA and A-101 45% Topical Solution.  The assignment of intellectual property rights covers specified know-how, along with modifications of, improvements to and variations on A-101 that meet defined chemical properties. Under this agreement, we have the sole and exclusive right, but not the duty, to develop, obtain marketing approval for and commercialize ESKATA and A-101 45% Topical Solution in various countries throughout the world. We are required to use commercially reasonable efforts to develop and commercialize at least one product for at least one indication in the United States. In connection with obtaining the assignment of the intellectual property from the Miller Estate, in August 2012 we also entered into a separate finder’s services agreement, or the Finder’s Services Agreement, with KPT Consulting, LLC. 

 

Under the terms of the Assignment Agreement and the Finder’s Services Agreement, we made aggregate upfront payments of $0.6 million in 2012 and one-time milestone payments of $0.4 million in 2013 upon the dosing of the first human subject with ESKATA in our Phase 2 clinical trial. There are no remaining potential milestone payments under the Assignment Agreement. Under the Finder’s Services Agreement, we made a one-time milestone payment of $0.3 million in February 2016 upon the dosing of the first human subject with ESKATA in our Phase 3 clinical trial, a one-time milestone payment of $1.0 million in April 2017 upon the achievement of a specified regulatory milestone, and a one-time milestone payment of $1.5 million in May 2018 upon the achievement of a specified commercial milestone.  Under the terms of the Finder’s Services Agreement, we are obligated to make an additional milestone payment of $3.0 million upon the achievement of a specified commercial milestone.  Under each of the Assignment Agreement and the Finder’s Services Agreement, we are also obligated to pay royalties on sales of ESKATA or related products, at low single-digit percentages of net sales, subject to reduction in specified circumstances. Both agreements will terminate upon the expiration of the last pending, viable patent claim of the patents acquired under the Assignment Agreement, but no sooner than 15 years from the effective date of the agreements.

 

License Agreement with Rigel

 

In August 2015, we entered into an exclusive, worldwide license and collaboration agreement with Rigel for the development and commercialization of products containing two specified JAK inhibitors, ATI-501 and ATI-502, or the Rigel License Agreement. Under this agreement, we intend to develop these JAK inhibitors for the treatment of AA and other dermatological conditions. We are required to use commercially reasonable efforts to develop and commercialize at least one product. We paid Rigel an upfront nonrefundable payment of $8.0 million and have agreed to make aggregate payments of up to $80.0 million upon the achievement of specified pre-commercialization milestones, such as clinical trials and regulatory approvals. Further, we have agreed to pay up to an additional $10.0 million to Rigel upon the achievement of a second set of development milestones. With respect to any products we commercialize under the Rigel License Agreement, we will pay Rigel quarterly tiered royalties on our annual net sales of each product at a high single-digit percentage of annual net sales, subject to specified reductions, until the date that all of the patent rights for that product have expired, as determined on a country-by-country and product-by-product basis or, in specified countries under specified circumstances, ten years from the first commercial sale of such product.

 

The Rigel License Agreement terminates on the date of expiration of all royalty obligations unless earlier terminated by either party for a material breach. We may also terminate the Rigel License Agreement without cause at any time upon advance written notice to Rigel. Rigel, after consultation with us, will be responsible for maintaining and prosecuting the patent rights, and we will have final decision-making authority regarding such patent rights for a product in the United States and the European Union. To the extent that we jointly develop intellectual property, we will confer and decide which party will be responsible for filing, prosecuting and maintaining those patent rights. The Rigel License Agreement also establishes a joint steering committee composed of an equal number of representatives for each party, which will monitor progress of the development of products.

 

Stock Purchase Agreement with Vixen Pharmaceuticals, Inc.

 

In March 2016, we entered into a stock purchase agreement, or the Vixen Agreement, with Vixen and JAK1, LLC, JAK2, LLC and JAK3, LLC, or together, the Selling Stockholders, and Shareholder Representative Services LLC, as the representative of the Selling Stockholders.  Pursuant to the Vixen Agreement, we acquired all shares of Vixen’s capital stock from the Selling Stockholders, or the Vixen Acquisition.  Following the Vixen Acquisition, Vixen became our wholly-owned subsidiary.  We paid $0.6 million upfront and issued an aggregate of 159,420 shares of our common stock to the Selling Stockholders. We are obligated to make annual payments of $0.1 million through March 2022, with such amounts being creditable against specified future payments that may be paid under the Vixen Agreement.

 

Under the Vixen Agreement, we agreed to use commercially reasonable efforts to develop and commercialize at least one product for the treatment of AA in humans and at least one product for the treatment of AGA in humans, in each case for commercial sale and distribution throughout the United States and such other areas of the world as we determine to be commercially prudent.  In the event we do not comply with these obligations, we are obligated to license, on a non-exclusive basis, certain intellectual property rights related to the products to the Selling Stockholders or their designee, on terms to be mutually agreed to by the parties, among other rights exercisable by the Selling Stockholders.

 

Under the Vixen Agreement, we are obligated to make aggregate payments of up to $18.0 million to the Selling Stockholders upon the achievement of specified pre-commercialization milestones for three products in the United States, the European Union and Japan, and aggregate payments of up to $22.5 million upon the achievement of specified commercial milestones. With respect to any commercialized products covered by the Vixen Agreement, we are obligated to pay low single-digit royalties on net sales, subject to specified reductions, limitations and other adjustments, until the date that all of the patent rights for that product have expired, as determined on a country-by-country and product-by-product basis or, in specified circumstances, ten years from the first commercial sale of such product. If we sublicense any of Vixen’s patent rights and know-how acquired pursuant to the Vixen Agreement, we will be obligated to pay a portion of any consideration we receive from such sublicenses in specified circumstances. 

 

License Agreement with Columbia University 

 

As a result of the Vixen Acquisition, we became party to the Exclusive License Agreement, by and between Vixen and the Trustees of Columbia University in the City of New York, or Columbia, dated as of December 31, 2015, or as amended, the Columbia License Agreement.  Pursuant to the Columbia License Agreement, we have an exclusive, worldwide license under specified Columbia patent rights and a non-exclusive, worldwide license under specified Columbia know-how in all fields to develop and commercialize a product that otherwise infringes a Columbia patent right or uses Columbia know-how.  Our rights to this Columbia intellectual property cover the use of specified JAK inhibitor compounds for the potential treatment of AA, AGA and other dermatological conditions. 

 

We are obligated to pay Columbia an annual license fee of $10,000, subject to specified adjustments for patent expenses incurred by Columbia and creditable against any royalties that may be paid under the Columbia License Agreement. We are also obligated to pay up to an aggregate of $11.6 million upon the achievement of specified commercial milestones, including specified levels of net sales of products covered by Columbia patent rights and/or know-how, and royalties at a sub-single-digit percentage of annual net sales of products covered by Columbia patent rights and/or know-how, subject to specified adjustments. If we sublicense any of Columbia’s patent rights and know-how acquired pursuant to the Columbia License Agreement, we will be obligated to pay Columbia a portion of any consideration received from such sublicenses in specified circumstances.  The royalties, as determined on a country-by-country and product-by-product basis, are payable until the date that all of the patent rights for that product have expired, the expiration of any market exclusivity period granted by a regulatory body or, in specified circumstances, ten years from the first commercial sale of such product.

 

We have agreed to use commercially reasonable efforts to develop and commercialize at least one product. In the event we do not comply with this obligation, Columbia has the option to terminate the license or convert the exclusive patent license to a non-exclusive patent license. Further, in the event we do not comply with our obligations under the Vixen Agreement to develop and commercialize products, our rights under the Columbia License Agreement may revert to a party to be designated by the Selling Stockholders.  Columbia is responsible for maintaining and prosecuting the patent rights, giving due consideration to our reasonable comments related thereto.

 

The Columbia License Agreement terminates on the date of expiration of all royalty obligations thereunder unless earlier terminated by either party for a material breach, subject to a specified cure period. We may also terminate the Columbia License Agreement without cause at any time upon advance written notice to Columbia.

 

Agreement and Plan of Merger with Confluence

 

In August 2017, we entered into an Agreement and Plan of Merger, or the Confluence Agreement, with Confluence, Aclaris Life Sciences, Inc., our wholly-owned subsidiary, or Merger Sub, and Fortis Advisors LLC, as representative of the equity holders of Confluence.  Pursuant to the terms of the Confluence Agreement, the Merger Sub merged with and into Confluence, with Confluence surviving as our wholly-owned subsidiary, resulting in our acquisition of 100% of the outstanding shares of Confluence.  We paid $10.3 million in cash and issued 349,527 shares of our common stock with a fair value of $9.7 million to the Confluence equity holders. 

 

In November 2018, we achieved a development milestone specified in the Confluence Agreement.  The milestone payment to the former Confluence equity holders was comprised of $2.5 million in cash and 253,208 shares of our common stock with a fair value of $2.2 million.  We also agreed to pay the former Confluence equity holders aggregate additional contingent consideration of up to $75.0 million, based upon the achievement of certain regulatory and commercial milestones set forth in the Confluence Agreement. In addition, we have agreed to pay the former Confluence equity holders specified future royalty payments calculated as a low single-digit percentage of annual net sales, subject to specified reductions, limitations and other adjustments, until the date that all of the patent rights for that product have expired, as determined on a country-by-country and product-by-product basis or, in specified circumstances, ten years from the first commercial sale of such product.  In addition, if we sell, license or transfer any of the intellectual property acquired from Confluence to a third party, we will be obligated to pay the former Confluence equity holders a portion of any incremental consideration (in excess of the development and milestone payments described above) that we receive from such sale, license or transfer in specified circumstances. 

 

Asset Purchase Agreement with Allergan

 

In November 2018, we closed the acquisition of the worldwide rights to RHOFADE, which includes an exclusive license to certain intellectual property for RHOFADE, as well as additional intellectual property, from Allergan, pursuant to the terms of the Asset Purchase Agreement dated as of October 15, 2018, or as amended, the Asset Purchase Agreement.

 

At the closing of the acquisition, we paid total cash consideration of approximately $66.1 million, consisting of approximately $59.6 million paid to Allergan and $6.5 million placed in escrow. We have also agreed to pay Allergan a one-time payment of $5.0 million upon the achievement of a specified development milestone related to the potential development of an additional dermatology product. In addition, we have agreed to pay Allergan specified royalty payments, ranging from a mid-single digit percentage to a mid-teen percentage of net sales, subject to specified reductions, limitations and other adjustments, on a country-by-country basis until the date that the patent rights related to a particular product, such as RHOFADE, have expired or, if later, November 30, 2028. In addition, we have agreed to assume the obligation to pay specified royalties and milestone payments under agreements with Aspect Pharmaceuticals, LLC and Vicept Therapeutics, Inc. Members of our management team, including Neal Walker, Frank Ruffo, Christopher Powala and Stuart Shanler, as well as Stephen Tullman, the chairman of our board of directors, are former stockholders of Vicept Therapeutics, Inc., and Dr. Shanler is also a current member of Aspect Pharmaceuticals, LLC. In their capacities as current or former holders of equity interests in these entities, these individuals may be entitled to receive a portion of the potential future payments payable by us.

 

Government Regulation and Product Approval

 

Governmental authorities in the United States, at the federal, state and local level, and analogous authorities in other countries extensively regulate, among other things, the research, development, testing, manufacture, safety surveillance, efficacy, quality control, labeling, packaging, distribution, record keeping, promotion, storage, advertising, distribution, marketing, sale, export and import, and the reporting of safety and other post-market information of products such as the ones we are commercializing and developing. A drug candidate must be approved by the FDA before it may be legally promoted in the United States and by comparable foreign regulatory authorities before marketing in other jurisdictions.  The process of obtaining regulatory approvals and the subsequent compliance with applicable federal, state, local and foreign statutes and regulations require the expenditure of substantial time and resources. Failure to comply with the applicable U.S. requirements at any time during the product development process, approval process or after approval may subject an applicant and/or sponsor to a variety of administrative or judicial sanctions, including refusal by regulatory authorities to approve applications, withdrawal of an approval, imposition of a clinical hold, import/export delays, issuance of warning letters and untitled letters, product recalls, product seizures, total or partial suspension of production or distribution, injunctions, fines, refusals of government contracts, restitution, disgorgement of profits, or civil or criminal investigations and penalties brought by FDA and the Department of Justice or other governmental entities.

 

United States Government Regulation

 

NDA Approval Processes

 

In the United States, the FDA regulates drug and medical device products under the Federal Food, Drug, and Cosmetic Act, or FDCA, and its implementing regulations.  A-101 45% Topical Solution is comprised of both a drug component (the hydrogen peroxide solution) and a pen-type applicator. The FDA’s Center for Drug Evaluation and Research has primary jurisdiction over the premarket development, review and approval of our drug candidates. Accordingly, we are investigating our drug candidates pursuant to IND applications and expect to seek approval through the NDA pathway. Based on our discussions with the FDA to date, we do not anticipate that the FDA will require us to submit a separate marketing application for the pen-type applicator that will be used with A-101 45% Topical Solution for the treatment of common warts, but this could change during the course of the FDA’s review of the NDA.

 

An applicant seeking approval to market and distribute a new drug product in the United States must typically undertake the following:

 

 

Once a drug candidate is identified for development, it enters the preclinical or nonclinical testing stage. Preclinical studies include laboratory evaluations of product chemistry, pharmacology, toxicity and formulation. An IND sponsor must submit the results of the preclinical studies, together with manufacturing information and analytical data, to the FDA as part of the IND. Some preclinical studies may continue even after the IND is submitted. In addition to including the results of the preclinical studies, the IND will also include a protocol detailing, among other things, the objectives of the clinical trial, the parameters to be used in monitoring safety and the effectiveness criteria to be evaluated if the first

phase lends itself to an efficacy determination. The IND automatically becomes effective 30 days after receipt by the FDA, unless the FDA, within the 30-day time period, places the IND on clinical hold. In such a case, the IND sponsor and the FDA must resolve any outstanding concerns before clinical trials can begin. A clinical hold may occur at any time during the life of an IND, and may affect one or more specific clinical trials or all clinical trials conducted under the IND.

 

All clinical trials must be conducted under the supervision of one or more qualified investigators in accordance with current GCP regulations. They must be conducted under protocols detailing the objectives of the trial, dosing procedures, research subject selection and exclusion criteria and the safety and effectiveness criteria to be evaluated. Each protocol must be submitted to the FDA as part of the IND, and progress reports detailing the status of the clinical trials must be submitted to the FDA annually. Sponsors also must timely report to FDA serious and unexpected adverse reactions, any clinically important increase in the rate of a serious suspected adverse reaction over that listed in the protocol or investigator brochure, or any findings from other studies or animal or in vitro testing that suggest a significant risk in humans exposed to the drug. An IRB at each institution participating in the clinical trial must review and approve the protocol before the clinical trial commences at that institution and must also approve the information regarding the trial and the consent form that must be provided to each research subject or the subject’s legal representative, monitor the study until completed and otherwise comply with IRB regulations.

 

Clinical trials are typically conducted in three sequential phases that may overlap or be combined:

 

 

Phase 4 clinical trials are conducted after approval to gain additional experience from the treatment of patients in the intended therapeutic indication and to document a clinical benefit in the case of drugs approved under accelerated approval regulations, or when otherwise requested by the FDA in the form of post-market requirements or commitments. Failure to promptly conduct any required Phase 4 clinical trials could result in withdrawal of approval.

 

Clinical trials are inherently uncertain, and Phase 1, Phase 2 and Phase 3 testing may not be successfully completed. The FDA or the sponsor may suspend a clinical trial at any time for a variety of reasons, including a finding that the research subjects or patients are being exposed to an unacceptable health risk. Similarly, an IRB can suspend or terminate approval of a clinical trial at its institution if the clinical trial is not being conducted in accordance with the IRB’s requirements or if the drug has been associated with unexpected serious harm to patients. In some cases, clinical trials are overseen by an independent group of qualified experts organized by the trial sponsor, which is called the clinical monitoring board or data safety monitoring board. This group provides authorization for whether or not a trial may move forward at designated check points. These decisions are based on the limited access to data from the ongoing trial.

 

During the development of a new drug, sponsors are given opportunities to meet with the FDA at certain points. These points may be prior to the submission of an IND, at the end-of-Phase 2 and before an NDA is submitted. Meetings at other times may be requested. These meetings can provide an opportunity for the sponsor to share information about the data gathered to date and for the FDA to provide advice on the next phase of development. Sponsors typically use the meeting at the end-of-Phase 2 to discuss their Phase 2 clinical trial results and present their plans for the pivotal Phase 3 clinical trial or trials that they believe will support the approval of the new drug.

 

Concurrent with clinical trials, sponsors usually complete additional animal safety studies and also develop additional information about the chemistry and physical characteristics of the drug and finalize a process for manufacturing commercial quantities of the product in accordance with cGMP requirements. The manufacturing process must be capable of consistently producing quality batches of the drug and the manufacturer must develop methods for testing the quality, purity and potency of the drug. Additionally, appropriate packaging must be selected and tested, and stability studies must be conducted to demonstrate that the drug candidate does not undergo unacceptable deterioration over its proposed shelf-life.

 

The results of product development, preclinical studies and clinical trials, along with descriptions of the manufacturing process, analytical tests and other control mechanisms, proposed labeling and other relevant information are submitted to the FDA as part of an NDA requesting approval to market the product. The submission of an NDA is subject to the payment of user fees, but a waiver of such fees may be obtained under specified circumstances. The FDA reviews all NDAs submitted for a period of 60 days to ensure that they are sufficiently complete for substantive review before it accepts them for filing. It may request additional information rather than accept an NDA for filing. In this event, the NDA must be resubmitted with the additional information. The resubmitted application also is subject to review before the FDA accepts it for filing.

 

During the approval process, the FDA also will determine whether a risk evaluation and mitigation strategy, or REMS, is necessary to assure the safe use of the product. If the FDA concludes a REMS is needed, the sponsor of the application must submit a proposed REMS, and the FDA will not approve the application without an approved REMS, if required. A REMS can substantially increase the costs of obtaining approval. The FDA could also require a special warning, known as a boxed warning, to be included in the product label in order to highlight a particular safety risk.

 

Once the submission is accepted for filing, the FDA begins an in-depth review. The FDA reviews an NDA to determine, among other things, whether a product is safe and effective for its intended use and whether its manufacturing is cGMP-compliant. The FDA may refer the NDA to an advisory committee for review and recommendation as to whether the application should be approved and under what conditions. The FDA is not bound by the recommendation of an advisory committee, but it generally follows such recommendations. NDAs receive either standard or priority review. A drug representing a significant improvement in treatment, prevention or diagnosis of disease may receive priority review. A priority review designation is intended to direct overall attention and resources to the evaluation of such applications, and to shorten the FDA’s goal for taking action on the NDA from ten months to six months from FDA filing of the NDA. After the FDA evaluates the NDA and conducts inspections of manufacturing facilities where the drug product and/or its API will be produced, it may issue an approval letter or a Complete Response Letter. An approval letter authorizes commercial marketing of the drug with specific prescribing information for specific indications. A Complete Response Letter indicates that the review cycle of the application is complete, and the application is not ready for approval. A Complete Response Letter may require additional clinical data and/or an additional pivotal Phase 3 clinical trial(s), and/or other significant, expensive and time-consuming requirements related to clinical trials, preclinical studies or manufacturing. Even if such data and information are submitted, the FDA may ultimately decide that the NDA does not satisfy the criteria for approval.

 

Post-approval Requirements

 

Drugs manufactured or distributed pursuant to FDA approvals are subject to pervasive and continuing regulation by the FDA and other governmental agencies, including, among other things, requirements relating to recordkeeping, periodic reporting, product sampling and distribution, advertising and promotion and reporting of adverse experiences with the product. Once an approval is granted, the FDA may withdraw the approval if compliance with regulatory requirements is not maintained or if problems occur after the product reaches the market. Later discovery of previously unknown problems with a product may result in restrictions on the product or even complete withdrawal of the product from the market. After approval, some types of changes to the approved product, such as adding new indications, manufacturing changes and additional labeling claims, are subject to further FDA review and approval. There also are continuing, annual user fee requirements for products and the establishments at which such products are manufactured, as well as new application fees for certain supplemental applications. In addition, the FDA may require testing and surveillance programs to monitor the effect of approved products that have been commercialized, and the FDA has the power to prevent or limit further marketing of a product based on the results of these post-marketing programs.

 

Drug manufacturers and other entities involved in the manufacture and distribution of approved drugs are required to register their establishments with the FDA and certain state agencies, and are subject to periodic unannounced

inspections by the FDA and some state agencies for compliance with GMP regulations and other laws. The FDA has promulgated specific requirements for drug cGMPs and device cGMPs embodied in the Quality System Regulation. Changes to the manufacturing process are strictly regulated and often require prior FDA approval before being implemented. FDA regulations also require investigation and correction of any deviations from cGMP requirements and impose reporting and documentation requirements upon the sponsor and any third-party manufacturers that the sponsor may decide to use. Accordingly, manufacturers must continue to expend time, money, and effort in the area of production and quality control to maintain cGMP compliance.

 

Failure to comply with the applicable U.S. requirements at any time during the product development process or approval process, or after approval, may subject us to administrative or judicial sanctions, any of which could have a material adverse effect on us. These sanctions could include:

 

 

The FDA strictly regulates the marketing, labeling, advertising and promotion of drug products that are placed on the market. Drugs may be promoted only for the approved indications and in accordance with the provisions of the approved label.  However, companies may share truthful and not misleading information that is otherwise consistent with the product’s FDA approved labeling. The FDA and other agencies actively enforce the laws and regulations prohibiting the promotion of off-label uses, and a company that is found to have improperly promoted off-label uses may be subject to significant liability.

 

From time to time, legislation is drafted, introduced and passed in Congress that could significantly change the statutory provisions governing the approval, manufacturing and marketing of products regulated by the FDA. In addition, FDA regulations and guidance are often issued revised or reinterpreted by the agency in ways that may significantly affect our business and our products. It is impossible to predict whether legislative changes will be enacted, or whether FDA regulations, guidance or interpretations will be issued or changed or what the impact of such changes, if any, may be.

 

Non-patent Exclusivity

 

The FDCA provides a five-year period of non-patent marketing exclusivity within the United States to the first applicant to obtain approval of an NDA for a new chemical entity, or NCE. A drug is an NCE if the FDA has not previously approved any other new drug containing the same active moiety, which is the molecule or ion responsible for the action of the drug substance.  If market exclusivity is granted for an NCE, during the exclusivity period, the FDA may not accept for review or approve an abbreviated new drug application, or ANDA, or a 505(b)(2) NDA submitted by another company for another version of such drug where the applicant does not own or have a legal right of reference to all the data required for approval. However, an application may be submitted after four years if it contains a certification of patent invalidity or non-infringement to one of the patents listed with the FDA by the innovator NDA holder.

 

The FDCA also provides three years of marketing exclusivity for an NDA, or supplement to an existing NDA if new clinical investigations, other than bioavailability studies, that were conducted or sponsored by the applicant are deemed by the FDA to be essential to the approval of the application, for example new indications, dosages, dosage forms or strengths of an existing drug.  This three-year exclusivity covers only the conditions associated with the new clinical investigations and prohibits the FDA from approving an ANDA, or a 505(b)(2) NDA submitted by another company with overlapping conditions associated with the new clinical investigations for the three-year period.  Clinical investigation exclusivity does not prohibit the FDA from approving ANDAs for drugs containing the original active agent. Five-year and three-year exclusivity will not delay the submission or approval of an NDA for the same drug. However, an applicant submitting an NDA would be required to conduct or obtain a right of reference to all of the preclinical studies and adequate and well-controlled clinical trials necessary to demonstrate safety and effectiveness.

 

Regulation Outside of the United States

 

In addition to regulations in the United States, we will be subject to regulations of other countries governing our business activities, including, our clinical trials and the commercial sale and distribution of our product. Even if we obtain FDA approval for a product, we must obtain approval by the comparable regulatory authorities of countries outside of the United States before we can commence clinical trials in such countries and approval of the regulators of such countries or economic areas, such as the European Union before we may market products in those countries or areas. The approval process and requirements governing the conduct of clinical trials, product licensing and promotion, pricing and reimbursement vary greatly by geographic region, and the time may be longer or shorter than that required for FDA approval.

 

In the European Economic Area, or EEA, which is composed of the 28 Member States of the European Union plus Norway, Iceland and Liechtenstein, medicinal products can only be commercialized after obtaining a Marketing Authorization, or MA.

 

There are two types of MAs:

 

 

In the EEA, upon receiving marketing authorization, new chemical entities generally receive eight years of data exclusivity and an additional two years of market exclusivity. If granted, data exclusivity prevents regulatory authorities in the EEA from referencing the innovator’s data to assess a generic application. During the additional two-year period of market exclusivity, a generic marketing authorization can be submitted, and the innovator’s data may be referenced, but no generic product can be marketed until the expiration of the market exclusivity. However, there is no guarantee that a product will be considered by the EEA’s regulatory authorities to be a new chemical entity, and products may not qualify for data exclusivity.

 

Other Health Care Laws

 

Health care providers, physicians and third-party payors in the United States and elsewhere will play a primary role in the recommendation and prescription of ESKATA, RHOFADE and any other drug candidates for which we obtain marketing approval.  Our arrangements with third-party payors, health care professionals and customers may expose us to broadly applicable fraud and abuse and other health care laws and regulations, including, without limitation, the federal Anti-Kickback Statute and the federal civil False Claims Act, that may constrain the business or financial arrangements and relationships through which we sell, market and distribute any drugs for which we obtain marketing approval. In addition, we may be subject to transparency laws and patient privacy regulation by the federal government and by the U.S. states and foreign jurisdictions in which we conduct our business.

 

The federal Anti-Kickback Statute makes it illegal for any person or entity, including a prescription drug manufacturer (or a party acting on its behalf) to knowingly and willfully, directly or indirectly, solicit, receive, offer, or pay any remuneration that is intended to induce the referral of business, including the purchase, order, or lease of any good, facility, item or service for which payment may be made under a federal health care program, such as Medicare or Medicaid. The term "remuneration" has been broadly interpreted to include anything of value. The Anti-Kickback Statute has been interpreted to apply to arrangements between pharmaceutical manufacturers on one hand and prescribers, purchasers, formulary managers, and beneficiaries on the other. Although there are a number of statutory exceptions and regulatory safe harbors protecting some common activities from prosecution, the exceptions and safe harbors are drawn narrowly. Practices that involve remuneration that may be alleged to be intended to induce prescribing, purchases or recommendations may be subject to scrutiny if they do not qualify for an exception or safe harbor. Failure to meet all of the requirements of a particular applicable statutory exception or regulatory safe harbor does not make the conduct per se illegal under the Anti-Kickback Statute. Instead, the legality of the arrangement will be evaluated on a case-by-case basis based on a cumulative review of all its facts and circumstances. Several courts have interpreted the statute’s intent requirement to mean that if any one purpose of an arrangement involving remuneration is to induce referrals of federal health care covered business, the Anti-Kickback Statute has been violated. Violations of this law are punishable by up to five years in prison, and can also result in criminal fines, civil money penalties, administrative penalties and exclusion from participation in federal health care programs.

 

Additionally, the intent standard under the Anti-Kickback Statute was amended by the Patient Protection and Affordable Care Act of 2010, as amended by the Health Care and Education Reconciliation Act of 2010, or collectively the Affordable Care Act, to a stricter standard such that a person or entity no longer needs to have actual knowledge of the statute or specific intent to violate it in order to have committed a violation. In addition, the Affordable Care Act codified case law that a claim including items or services resulting from a violation of the federal Anti-Kickback Statute constitutes a false or fraudulent claim for purposes of the federal civil False Claims Act.

 

Federal false claims and false statement laws, including the federal civil False Claims Act, prohibits, among other things, any person or entity from knowingly presenting, or causing to be presented, for payment to, or approval by, federal programs, including Medicare and Medicaid, claims for items or services, including drugs, that are false or fraudulent or not provided as claimed. Entities can be held liable under these laws if they are deemed to "cause" the submission of false or fraudulent claims by, for example, providing inaccurate billing or coding information to customers, promoting a product off-label, or for providing medically unnecessary services or items. In addition, our activities relating to the sale and marketing of our products are subject to scrutiny under this law. Penalties for the federal civil False Claims Act violations may include up to three times the actual damages sustained by the government, plus mandatory civil penalties for each separate false claim, the potential for exclusion from participation in federal health care programs, and, although the federal civil False Claims Act is a civil statute, False Claims Act violations may also implicate various federal criminal statutes.  For example, the federal Health Insurance Portability and Accountability Act of 1996, or HIPAA, created federal criminal statutes that prohibit among other actions, knowingly and willfully executing, or attempting to execute, a scheme to defraud any health care benefit program, including private third-party payors, knowingly and willfully embezzling or stealing from a health care benefit program, willfully obstructing a criminal investigation of a health care offense, and knowingly and willfully falsifying, concealing or covering up a material fact or making any materially false, fictitious or fraudulent statement in connection with the delivery of or payment for health care benefits, items or services. Like the Anti-Kickback Statute, the Affordable Care Act amended the intent standard for the health care fraud statute under HIPAA such that a person or entity no longer needs to have actual knowledge of the statute or specific intent to violate it in order to have committed a violation.

 

The civil monetary penalties statute imposes penalties against any person or entity that, among other things, is determined to have presented or caused to be presented a claim to a federal health program that the person knows or should know is for an item or service that was not provided as claimed or is false or fraudulent.

 

Also, many states have similar fraud and abuse statutes or regulations that may be broader in scope and may apply regardless of payor, in addition to items and services reimbursed under Medicaid and other state programs. Additionally, to the extent that our product is sold in a foreign country, we may be subject to similar foreign laws.

 

In addition, legislation imposing marketing restrictions and transparency requirements on pharmaceutical manufacturers has been enacted at the state and federal levels.  For example, the Affordable Care Act imposed, among other things, annual reporting requirements for covered manufacturers for certain payments and other transfers of value provided to physicians and teaching hospitals, as well as ownership and investment interests held by physicians and their

immediate family members. Failure to submit timely, accurately and completely the required information for all payments, transfers of value and ownership or investment interests may result in civil monetary penalties for "knowing failures."  Certain states also mandate implementation of compliance programs, impose restrictions on drug manufacturer marketing practices, require registration of certain employees engaged in marketing activities in the location, and/or require the tracking and reporting of gifts, compensation and other remuneration to physicians. 

 

Because we are commercializing and intend to commercialize products that are reimbursed under a federal health care program and other governmental health care programs, we intend to continue to develop a comprehensive compliance program that establishes internal controls to facilitate adherence to the rules and program requirements to which we will or may become subject. Although the development and implementation of compliance programs designed to establish internal controls and facilitate compliance can mitigate the risk of investigation, prosecution, and penalties assessed for violations of these laws, or any other laws that may apply to us, the risks cannot be entirely eliminated. If our operations are found to be in violation of any of such laws or any other governmental regulations, we may be subject to significant penalties, including, without limitation, administrative, civil, and criminal penalties, damages, fines, disgorgement, contractual damages, reputational harm, diminished profits and future earnings, the curtailment or restructuring of our operations, exclusion from participation in federal and state health care programs, additional reporting requirements and oversight if we become subject to a corporate integrity agreement or similar agreement to resolve allegations of non-compliance with these laws and individual imprisonment, any of which could adversely affect our ability to operate our business and our financial results.

 

We may also be subject to data privacy and security regulation by both the federal government and the states in which we conduct our business. HIPAA, as amended by the Health Information Technology for Economic and Clinical Health Act, or HITECH, and their implementing regulations, including the final omnibus rule published on January 25, 2013, mandates, among other things, the adoption of uniform standards for the electronic exchange of information in common health care transactions, as well as standards relating to the privacy and security of individually identifiable health information, which require the adoption of administrative, physical and technical safeguards to protect such information. Among other things, HITECH makes HIPAA’s security standards directly applicable to "business associates", namely independent contractors or agents of HIPAA covered entities that create, receive or obtain protected health information in connection with providing a service for or on behalf of a covered entity. HITECH also increased the civil and criminal penalties that may be imposed against covered entities and business associates, and gave state attorneys general new authority to file civil actions for damages or injunctions in federal courts to enforce the federal HIPAA laws and seek attorneys’ fees and costs associated with pursuing federal civil actions. In addition, certain state laws govern the privacy and security of health information in certain circumstances, some of which are more stringent than HIPAA and many of which differ from each other in significant ways and may not have the same effect, thus complicating compliance efforts. Failure to comply with these laws, where applicable, can result in the imposition of significant civil and/or criminal penalties.

 

Health Care Reform

 

In the United States, there have been and continue to be a number of significant legislative initiatives to contain health care costs. For example, in March 2010, the Affordable Care Act was passed, which has had, and is expected to continue to have, a significant impact on the health care industry. The Affordable Care Act was designed to expand coverage for the uninsured and at the same time containing overall health care costs. With regard to pharmaceutical products, among other things, the Affordable Care Act expanded and increased industry rebates for drugs covered under Medicaid programs; addressed a new methodology by which rebates owed by manufacturers under the Medicaid Drug Rebate Program are calculated for drugs that are inhaled, infused, instilled, implanted or injected; extended the rebate program to individuals enrolled in Medicaid managed care organizations; established annual fees and taxes on manufacturers of certain branded prescription drugs; made changes to the coverage requirements under the Medicare prescription drug benefit; and established a new Medicare Part D coverage gap discount program, in which manufacturers, as a condition for their outpatient drugs to be covered under Medicare Part D,  must agree to offer 70% point-of-sale discounts off negotiated prices of applicable brand drugs to eligible beneficiaries during their coverage gap period.  Moreover, the Affordable Care Act provided incentives to programs that increase the federal government’s comparative effectiveness research and implemented payment system reforms including a national pilot program on payment bundling meant to encourage hospitals, physicians and other providers to improve the coordination, quality and efficiency of certain health care services.

 

Since its enactment there have been judicial and Congressional challenges to, as well efforts by the Trump Administration to repeal or replace certain aspects of the Affordable Care Act.  For example, since January 2017, President Trump has signed two executive orders and other directives designed to delay, circumvent, or loosen certain requirements mandated by the Affordable Care Act. Concurrently, Congress has considered legislation that would repeal or repeal and replace all or part of the Affordable Care Act. While Congress has not passed comprehensive repeal legislation, two bills affecting the implementation of certain taxes under the Affordable Care Act have been signed into law.  The Tax Cuts and Jobs Act of 2017 includes a provision repealing, effective January 1, 2019, the tax-based shared responsibility payment imposed by the Affordable Care Act on certain individuals who fail to maintain qualifying health coverage for all or part of a year that is commonly referred to as the “individual mandate”.  Additionally, on January 22, 2018, President Trump signed a continuing resolution on appropriations for fiscal year 2018 that delayed the implementation of certain Affordable Care Act-mandated fees, including the so-called “Cadillac” tax on certain high cost employer-sponsored insurance plans, the annual fee imposed on certain health insurance providers based on market share, and the medical device excise tax on non-exempt medical devices. Further, the Bipartisan Budget Act of 2018, or the BBA, among other things, amended the Affordable Care Act, effective January 1, 2019, to close the coverage gap in most Medicare drug plans, commonly referred to as the “donut hole”.  In July 2018, the Centers for Medicare & Medicaid Services, or CMS, published a final rule permitting further collections and payments to and from certain Affordable Care Act qualified health plans and health insurance issuers under the Affordable Care Act risk adjustment program in response to the outcome of federal district court litigation regarding the method CMS uses to determine this risk adjustment. On December 14, 2018, a Texas U.S. District Court Judge ruled that the Affordable Care Act is unconstitutional in its entirety because the “individual mandate” was repealed by Congress as part of the Tax Cuts and Jobs Act of 2017. While the Texas U.S. District Court Judge, as well as the Trump Administration and CMS, has stated that the ruling will have no immediate effect pending appeal of the decision, it is unclear how this decision, subsequent appeals, and other efforts to repeal and replace the Affordable Care Act will impact the Affordable Care Act. 

 

In addition, other legislative changes have been proposed and adopted since the Affordable Care Act was enacted. For example, in August 2011, President Obama signed into law the Budget Control Act of 2011, which, among other things, created the Joint Select Committee on Deficit Reduction to recommend to Congress proposals in spending reductions. The Joint Select Committee on Deficit Reduction did not achieve a targeted deficit reduction of at least $1.2 trillion for fiscal years 2012 through 2021, triggering the legislation’s automatic reduction to several government programs. This includes aggregate reductions in Medicare payments to providers of 2% per fiscal year, which went into effect beginning on April 1, 2013 and, due to subsequent legislative amendments to the statute, including the BBA, will stay in effect through 2027, unless additional Congressional action is taken. Additionally, in January 2013, the American Taxpayer Relief Act of 2012 was signed into law, which, among other things, reduced Medicare payments to several providers, including hospitals, cancer treatment centers and imaging centers. Moreover, the Drug Supply Chain Security Act imposes new obligations on manufacturers of pharmaceutical products related to product tracking and tracing. Legislative and regulatory proposals have been made to expand post-approval requirements and restrict sales and promotional activities for pharmaceutical products.

 

More recently, there has been heightened governmental scrutiny over the manner in which manufacturers set prices for their marketed products. Such scrutiny has resulted in several recent Congressional inquiries and proposed and enacted federal and state legislation designed to, among other things, bring more transparency to product pricing, review the relationship between pricing and manufacturer patient programs, and reform government program reimbursement methodologies for products.  At the federal level, the Trump Administration’s budget proposal for fiscal year 2019 contains further drug price control measures that could be enacted during the 2019 budget process or in other future legislation, including, for example, measures to permit Medicare Part D plans to negotiate the price of certain drugs under Medicare Part B, to allow some states to negotiate drug prices under Medicaid, and to eliminate cost sharing for generic drugs for low-income patients. Further, the Trump Administration released a “Blueprint”, or plan, to lower drug prices and reduce out of pocket costs of drugs that contains additional proposals to increase drug manufacturer competition, increase the negotiating power of certain federal health care programs, incentivize manufacturers to lower the list price of their products, and reduce the out-of-pocket costs of drug products paid by consumers. The Department of Health and Human Services, or HHS, has already started the process of soliciting feedback on some of these measures and, at the same time, is immediately implementing others under its existing authority. For example, in September 2018, CMS announced that it will allow Medicare Advantage plans the option to use step therapy for Part B drugs beginning January 1, 2019, and in October 2018, CMS proposed a new rule that would require direct-to-consumer television advertisements of prescription drugs and biological products, for which payment is available through or under Medicare or Medicaid, to include in the advertisement the Wholesale Acquisition Cost, or list price, of that drug or biological product. On January 31, 2019, the HHS Office of Inspector General proposed modifications to the federal Anti-Kickback Statute discount safe harbor for the

purpose of reducing the cost of drug products to consumers which, among other things, if finalized, will affect discounts paid by manufacturers to Medicare Part D plans, Medicaid managed care organizations and pharmacy benefit managers working with these organizations. While some of these and other proposed measures may require authorization through additional legislation to become effective, Congress and the Trump Administration have both stated that they will continue to seek new legislative and/or administrative measures to control drug costs. At the state level, legislatures have become increasingly active in passing legislation and implementing regulations designed to control pharmaceutical and biological product pricing, including price or patient reimbursement constraints, discounts, restrictions on certain product access and marketing cost disclosure and transparency measures, and, in some cases, designed to encourage importation from other countries and bulk purchasing.

 

The Affordable Care Act, as well as other federal and state health care reform measures that have been and may be adopted in the future, could harm our future revenue.  Additional legislative actions may be taken in the future which may change current regulations, guidance and interpretations.  The impact of such actions on our business, if any, cannot presently be determined.

 

The Hatch Waxman Amendments to the FDC Act

 

Orange Book Listing

 

In seeking approval for a drug through an NDA, applicants are required to list with the FDA each patent whose claims cover the applicant’s product or a method of using the product. Upon approval of a drug, each of the patents listed in the application for the drug is then published in the FDA’s Approved Drug Products with Therapeutic Equivalence Evaluations, commonly known as the Orange Book. Drugs listed in the Orange Book can, in turn, be cited by potential competitors in support of approval of an ANDA or an application covered by Section 505(b)(2) of the FDCA. An ANDA provides for marketing of a drug product that has the same active ingredients, generally in the same strengths and dosage form, as the listed drug and has been shown through pharmacokinetic, or PK, testing to be bioequivalent to the listed drug. Drugs approved in this way are commonly referred to as "generic equivalents" to the listed drug, and can often be substituted by pharmacists under prescriptions written for the original listed drug. Other than the requirement for bioequivalence testing, ANDA applicants are generally not required to conduct, or submit results of, preclinical studies or clinical tests to prove the safety or effectiveness of their drug product. Section 505(b)(2) applications provide for marketing of a drug product that may have the same active ingredients as the listed drug and contains full safety and effectiveness data as an NDA, but at least some of this information comes from studies not conducted by or for the applicant. This alternate regulatory pathway enables the applicant to rely, in part, on the FDA’s findings of safety and efficacy for an existing product, or published literature, in support of its application. The FDA may then approve the new drug candidate for all or some of the labeled indications for which the referenced product has been approved, as well as for any new indication sought by the 505(b)(2) applicant.

 

The ANDA or Section 505(b)(2) applicant is required to certify to the FDA concerning any patents listed for the approved product in the FDA’s Orange Book. Specifically, the applicant must certify that: (i) the required patent information has not been filed; (ii) the listed patent has expired; (iii) the listed patent has not expired, but will expire on a particular date and approval is sought after patent expiration; or (iv) the listed patent is invalid or will not be infringed by the new product. The ANDA or Section 505(b)(2) applicant may also elect to submit a statement certifying that its proposed ANDA label does not contain, or carves out, any language regarding a patented method of use rather than certify to such listed method of use patent. If the applicant does not challenge the listed patents by filing a certification that the listed patent is invalid or will not be infringed by the new product, the ANDA or Section 505(b)(2) application will not be approved until all the listed patents claiming the referenced product have expired.

 

A certification that the new product will not infringe the already approved product’s listed patents, or that such patents are invalid, is called a Paragraph IV certification. If the ANDA or Section 505(b)(2) applicant has provided a Paragraph IV certification to the FDA, the applicant must also send notice of the Paragraph IV certification to the NDA and patent holders once the ANDA or Section 505(b)(2) application has been accepted for filing by the FDA. The NDA and patent holders may then initiate a patent infringement lawsuit in response to the notice of the Paragraph IV certification. The filing of a patent infringement lawsuit within 45 days of the receipt of a Paragraph IV certification automatically prevents the FDA from approving the ANDA or Section 505(b)(2) application until the earliest of 30 months, expiration of the patent, settlement of the lawsuit, and a decision in the infringement case that is favorable to the ANDA or Section 505(b)(2) applicant. This prohibition is generally referred to as the 30-month stay. Thus, approval

of an ANDA or 505(b)(2) NDA could be delayed for a significant period of time depending on the patent certification the applicant makes and the reference drug sponsor’s decision to initiate patent litigation.

 

The ANDA or Section 505(b)(2) application also will not be approved until any applicable non-patent exclusivity listed in the Orange Book for the referenced product has expired.

 

Patent Term Extension

 

In the United States, after NDA approval, owners of relevant drug patents may apply for up to a five year patent extension, which provides patent term restoration as compensation for the patent term lost during the FDA regulatory review process for the first permitted commercial marketing of a drug product. The Drug Price Competition and Patent Term Restoration Act of 1984, or the Hatch-Waxman Act, permits a patent term extension of up to five years beyond the expiration of the patent. The allowable patent term extension is calculated as half of the drug’s testing phase, which is the time between the IND submission becoming effective and the NDA submission, and all of the review phase, which is the time between NDA submission and approval, up to a maximum extension of five years. The time can be shortened if the FDA determines that the applicant did not pursue approval with due diligence. Patent extension cannot extend the remaining term of a patent beyond a total of 14 years from the date of product approval and only one patent applicable to an approved drug may be extended. 

 

Similar provisions are available in the European Union and other foreign jurisdictions to extend the term of a patent that covers an approved drug. For example, in Japan, it may be possible to extend the patent term for up to five years and in the European Union, it may be possible to obtain a supplementary patent certificate that would effectively extend patent protection for up to five years.

 

Coverage and Reimbursement

 

We do not expect third-party payors to cover and reimburse health care providers who use ESKATA on patients for the treatment of raised SKs. Third-party payors generally do not reimburse the provider for the product used to remove non-malignant lesions, including SK. In addition, they do not generally reimburse providers for the procedure removing such lesions, since the procedure is considered to be cosmetic in nature, unless there is a medical need to remove the lesion such as confirming a diagnosis with a biopsy or treating SK that are causing the patient physical discomfort. We anticipate that in some cases, ESKATA may be used to remove SK lesions that are inflamed and causing the patient discomfort. Any reduction in reimbursement for the procedure to remove inflamed SK may result in a higher percentage of patients needing to pay out of pocket for treatment with ESKATA. Accordingly, the commercial success of ESKATA depends on the extent to which patients are willing to pay out of pocket for the in-office procedure using our product.  By contrast, in the case of RHOFADE, we believe our success will depend on continued coverage and adequate reimbursement, and in the case of A-101 45% Topical Solution for the treatment of common warts or our other drug candidates, if approved, on obtaining and maintaining coverage and adequate reimbursement, for a prescription treatment or in the absence of coverage and adequate reimbursement, on the extent to which patients will be willing to pay out of pocket for our prescription drug products.

 

Third-party payors determine which prescription drug products they will cover and establish reimbursement levels. Reimbursement by a third-party payor may depend upon a number of factors, including: the third-party payor’s determination that a product is safe, effective, and medically necessary; appropriate for the specific patient; cost-effective; supported by peer-reviewed medical journals or current clinical practice guidelines; and whether there are competitive products, either branded or generic, and the pricing of those products.  Many private third-party payors, such as managed care plans, manage access to drug products’ coverage partly to control costs for their plans, and may use drug formularies and medical policies to limit their exposure.  Obtaining and maintaining favorable reimbursement can be a time-consuming and expensive process, and we may not be able to negotiate or continue to negotiate reimbursement or pricing terms for our products with third-party payors at levels that are profitable to us, or at all.  

 

In addition to uncertainties surrounding coverage policies, there are periodic changes to reimbursement.  Third-party payors regularly update reimbursement amounts and also from time to time revise the methodologies used to determine reimbursement amounts.  Accordingly, these updates could impact the demand for RHOFADE or A-101 45% Topical Solution for the treatment of common warts or our other drug candidates, if approved. Our products may not be considered cost effective, and government and third-party private health insurance coverage and reimbursement may not be available to patients or sufficient to allow us to sell our products on a competitive and profitable basis.  Our results of

operations could be adversely affected by the Affordable Care Act and by other health care reforms that may be enacted or adopted in the future.  In addition, increasing emphasis on managed care in the United States will continue to put pressure on the pricing of pharmaceutical products.  Cost control initiatives could decrease the price that we or any potential partners could receive for any of our products and could adversely affect our profitability.

 

Foreign governments also have their own health care reimbursement systems, which vary significantly by country and region, and we cannot be sure that coverage and adequate reimbursement will be made available with respect to our products under any foreign reimbursement system.  In some foreign countries, including major markets in the European Union and Japan, the pricing of prescription pharmaceuticals is subject to governmental control.  In these countries, pricing negotiations with governmental authorities can take up to 12 months or longer after the receipt of regulatory marketing approval for a product.  To obtain reimbursement or pricing approval in some countries, we may be required to conduct a pharmacoeconomic study that compares the cost-effectiveness of our product to other available therapies.  Such pharmacoeconomic studies can be costly and the results uncertain.  Our business could be harmed if reimbursement of our products is unavailable or limited in scope or amount or if pricing is set at unsatisfactory levels.

 

Employees

 

As of December 31, 2018, we had 169 full-time and part-time employees. All of our employees are located in the United States. None of our employees are represented by a labor union or covered by a collective bargaining agreement. We consider our relationship with our employees to be good.

 

Corporate Information

 

We were incorporated under the laws of the State of Delaware in July 2012. Our principal executive offices are located at 640 Lee Road, Suite 200, Wayne, PA 19087. Our telephone number is (484) 324-7933. We completed our initial public offering in October 2015 and our common stock is listed on the Nasdaq Global Select Market under the symbol “ACRS”.

 

Available Information

 

Our internet website address is www.aclaristx.com.  In addition to the information contained in this Annual Report, information about us can be found on our website. Our website and information included in or linked to our website are not part of this Annual Report. 

 

Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act are available free of charge through our website as soon as reasonably practicable after they are electronically filed with or furnished to the Securities and Exchange Commission, or SEC.

 

 

 

 

 

 

 

 

 

 

 

 

Item 1A. Risk Factors

 

Our business is subject to numerous risks. You should carefully consider the following risks and all other information contained in this Annual Report, as well as general economic and business risks, together with any other documents we file with the SEC. If any of the following events actually occur or risks actually materialize, it could have a material adverse effect on our business, operating results and financial condition and cause the trading price of our common stock to decline.

 

Risks Related to Our Business, Our Financial Position and Capital Needs

 

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

 

We have a limited operating history. Since inception, we have incurred significant net losses. We incurred net losses of $132.7 million and $68.5 million for the years ended December 31, 2018 and 2017, respectively. As of December 31, 2018, we had an accumulated deficit of $292.2 million. We have financed our operations since inception primarily from sales of our convertible preferred stock and, beginning with our initial public offering in October 2015, from public offerings and a private placement of our common stock.  We currently have two products, ESKATA and RHOFADE, that generate revenue from product sales. 

 

We have devoted substantially all of our financial resources and efforts to the development of our drug candidates, including preclinical studies and clinical trials, and beginning in 2017, to the commercialization of our products. Our net losses may fluctuate significantly from quarter to quarter and year to year. We expect to continue to incur significant expenses and operating losses over the next several years as we:

 

 

To become and remain profitable, we must succeed in commercializing our products and developing and eventually commercializing drug candidates that generate significant revenue. This will require us to be successful in a range of challenging activities, including completing preclinical testing and clinical trials of our drug candidates, obtaining marketing approval, and manufacturing, marketing and selling any products and drug candidates for which we have obtained and may obtain marketing approval, as well as discovering and developing additional drug candidates. We are only in the early stages of most of these activities. We may never succeed in these activities and, even if we do, may never generate revenue that is significant enough to achieve profitability.

 

For ESKATA, RHOFADE and for any drug candidates for which we are successful in obtaining marketing approval, our revenue is and will continue to be dependent, in part, upon the size of the markets in the territories for which we gain marketing approval, the accepted price for the product, the ability to obtain coverage and reimbursement, if any, and whether we own the commercial rights for that territory. If the number of our addressable patients is not as significant as we estimate, the indication approved by regulatory authorities is narrower than we expect, or the treatment population is narrowed by competition, physician choice or treatment guidelines, we may not generate significant revenue from sales of such drug products, even if approved. 

 

Because of the numerous risks and uncertainties associated with drug development, we are unable to accurately predict the timing or amount of expenses or when, or if, we will be able to achieve profitability. If we are required by regulatory authorities to perform studies in addition to those expected, or if there are any delays in the initiation and completion of our clinical trials or the development of any of our drug candidates, our expenses could increase.

 

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

 

We will need substantial additional funding to meet our financial obligations and to pursue our business objectives. If we are unable to raise capital when needed, we could be forced to curtail our planned operations and the pursuit of our growth strategy. 

 

Identifying potential drug candidates and conducting preclinical testing and clinical trials is a time-consuming, expensive and uncertain process that takes years to complete, and we may never generate the necessary data or results required to obtain marketing approval and achieve product sales. We expect to continue to incur significant expenses and operating losses over the next several years as we continue to commercialize ESKATA and RHOFADE and conduct clinical trials of and seek marketing approval for our drug candidates.  In addition, ESKATA and RHOFADE, and our drug candidates, if approved, may not achieve commercial success. In addition, if we obtain marketing approval for A-101 45% Topical Solution for the treatment of common warts or any other drug candidates that we develop, we expect to incur additional significant commercialization expenses related to product sales, marketing, distribution and manufacturing. We also expect an increase in our expenses associated with creating additional infrastructure to support our continuing operations as a public company.

 

As of December 31, 2018, we had cash, cash equivalents and marketable securities of $168.0 million. We believe that our existing cash, cash equivalents and marketable securities as of the date of this Annual Report will enable us to fund our operating expenses and capital expenditure requirements for a period greater than 12 months from the date of this report based on our current operating assumptions. These assumptions may prove to be wrong, and we could use our available capital resources sooner than we expect. Changes may occur beyond our control that would cause us to consume our available capital before that time, including changes in and progress of our development activities, acquisitions of additional products or drug candidates, and changes in regulation. Our future capital requirements will depend on many factors, including:

 

 

We expect that we will require additional capital to complete the clinical trials for and potentially commercialize A-101 45% Topical Solution for the treatment of common warts, to complete the clinical development of ATI-501 and ATI-502, to develop our preclinical compounds, to support our discovery efforts, and to pursue in-licenses or acquisitions of other drug candidates.  We also expect to incur significant expenses related to the commercialization of ESKATA and RHOFADE, including product manufacturing, sales, marketing, advertising and distribution costs.  In addition, in 2019 we plan to invest in a new research facility for our drug discovery operations.  Additional funds may not be available on a timely basis, on commercially acceptable terms, or at all, and such funds, if raised, may not be sufficient to enable us to continue to implement our long-term business strategy. If we are unable to raise sufficient additional capital, we could be forced to curtail our planned operations and the pursuit of our growth strategy.

 

We may not be able to generate sufficient cash to service our indebtedness, including the Loan and Security Agreement with Oxford. 

 

In October 2018, we entered into a loan and security agreement, or the Loan and Security Agreement, with Oxford Finance LLC, or Oxford, pursuant to which we borrowed $30.0 million on October 31, 2018, and can draw an additional $35.0 million until March 31, 2019. Our obligations under the Loan and Security Agreement are secured by substantially all of our assets except for our intellectual property, and we may not encumber our intellectual property without Oxford's prior written consent. The Loan and Security Agreement contains negative covenants restricting our activities, including limitations on dispositions, mergers or acquisitions, incurring indebtedness or liens, paying dividends or making investments and other specified business transactions. The Loan and Security Agreement also contains specified financial covenants related to us achieving specified minimum consolidated revenues in future periods. Our obligations under the Loan and Security Agreement are subject to acceleration upon the occurrence of specified events of default, including a material adverse change in our business, operations or financial or other condition. We may also enter into other debt agreements in the future which may contain similar or more restrictive terms. 

 

Our ability to make scheduled monthly payments or to refinance our debt obligations depends on numerous factors, including the amount of our cash reserves and our actual and projected financial and operating performance. These amounts and our performance are subject to certain financial and business factors, as well as prevailing economic and competitive conditions, some of which may be beyond our control. We cannot assure you that we will maintain a level of

cash reserves or cash flows from operating activities sufficient to permit us to pay the principal, premium, if any, and interest on our existing or future indebtedness. If our cash flows and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay capital expenditures, sell assets or operations, seek additional capital or restructure or refinance our indebtedness. We cannot assure you that we would be able to take any of these actions, or that these actions would permit us to meet our scheduled debt service obligations. Failure to comply with the covenants and conditions of the Loan and Security Agreement, including our failure to achieve the minimum revenue covenants, could result in an event of default, which could result in an acceleration of amounts due under the Loan and Security Agreement. We may not have sufficient funds or may be unable to arrange for additional financing to repay our indebtedness or to make any accelerated payments, and Oxford could seek to enforce security interests in the collateral securing such indebtedness, which would harm our business. 

 

Because our long-term indebtedness bears interest at rates that fluctuate with changes in certain prevailing short-term interest rates, we are vulnerable to interest rate increases.

Our long-term indebtedness bears interest at a fluctuating interest rate based on the London interbank offered rate for deposits of U.S. dollars (LIBOR).  LIBOR tends to fluctuate based on general interest rates, rates set by the Federal Reserve and other central banks, the supply of and demand for credit in the London interbank market and general economic conditions. On July 27, 2017, the Financial Conduct Authority (the authority that regulates LIBOR) announced that it intends to stop compelling banks to submit rates for the calculation of LIBOR after 2021. It is unclear whether new methods of calculating LIBOR will be established such that it continues to exist after 2021. The U.S. Federal Reserve, in conjunction with the Alternative Reference Rates Committee, is considering replacing U.S. dollar LIBOR with a newly created index, calculated with a broad set of short-term repurchase agreements backed by treasury securities. It is not possible to predict the effect of these changes, other reforms or the establishment of alternative reference rates in the United States or elsewhere. To the extent these interest rates increase, our interest expense will increase, in which event we may have difficulties making interest payments and funding our other fixed costs, and our available cash flow for general corporate requirements may be adversely affected.

 

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

 

Until such time, if ever, as we can generate substantial revenue, we expect to finance our cash needs through a combination of equity offerings, debt financings and license and collaboration agreements. To the extent that we raise additional capital through the sale of equity securities 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.

 

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 technologies, future revenue streams, products or drug candidates 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 drug development or future commercialization efforts or grant rights to third parties to develop and market technologies, products or drug candidates that we would otherwise prefer to develop and market ourselves.

 

We have a limited operating history and a limited history of commercializing drugs, which may make it difficult for you to evaluate the success of our business to date and to assess our future viability.

 

We commenced operations in 2012, and our operations to date have been largely focused on raising capital, developing ESKATA for the treatment of raised SKs, including undertaking preclinical studies and conducting clinical trials, and acquiring new drug candidates and related intellectual property. We launched ESKATA in the United States in May 2018 and acquired RHOFADE in November 2018. We have had limited time to demonstrate our ability to successfully manufacture a drug on a commercial scale, or arrange for a third party to do so on our behalf, or conduct sales and marketing activities necessary for successful commercialization of these products. Consequently, any predictions you make about our future success or viability may not be as accurate as they could be if we had a longer operating history or

a longer history of commercializing drugs. We may also encounter unforeseen expenses, difficulties, complications, delays and other known or unknown factors in achieving our business objectives.

 

Our estimates of variable consideration related to revenue recognition from product sales are difficult to estimate, and if our estimates differ significantly from actual product sales, we will be required to record an adjustment in a subsequent period.

 

Our estimates of variable consideration related to revenue recognition from product sales are difficult to estimate as they are based on multiple assumptions which may prove to be incorrect.  For example, we pay certain third-party payors rebates with respect to the utilization of RHOFADE which are based on contractual percentages applied to the amount of RHOFADE prescribed to patients who are covered by the plan or the organization with which the third-party payor contracts.  We have a savings card program to provide assistance to eligible patients with out-of-pocket costs for the patient’s usage of RHOFADE.  Reductions to product sales for the savings card program are estimated based on actual and expected program utilization.  We recognize revenue from product sales at the point the customer obtains control, which generally occurs upon delivery, and also include estimates of variable consideration in the same period revenue is recognized.  Components of variable consideration include trade discounts and allowances, product returns, government rebates, discounts and rebates, other incentives such as patient co-pay assistance, and other fee for service amounts.  Our estimates of variable consideration are based on assumptions relating to, among other things, the mix of patients who purchase RHOFADE who are fully insured, underinsured and uninsured and the utilization of our savings card program, rebates, discounts and other pricing concessions and fees. If our estimates of variable consideration differ significantly from actual product sales, we will be required to record an adjustment in a subsequent period to reported product sales and earnings.

 

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

 

Despite the implementation of security measures, our internal computer systems, and those of third parties on which we rely, are vulnerable to damage from computer viruses, malware, natural disasters, terrorism, war, telecommunication and electrical failures, cyber-attacks or cyber-intrusions over the Internet, attachments to emails, persons inside our organization, or persons with access to systems inside our organization. The risk of a security breach or disruption, particularly through cyber-attacks or cyber intrusion, including by computer hackers, foreign governments, and cyber terrorists, has generally increased as the number, intensity and sophistication of attempted attacks and intrusions from around the world have increased. If such an event were to occur and cause interruptions in our operations, it could result in a material disruption of our drug development programs. For example, the loss of clinical trial data from completed or ongoing or planned clinical trials could result in delays in our marketing approval efforts and significantly increase our costs to recover or reproduce the data. To the extent that any disruption or security breach was to result in a loss of or damage to our data or applications, or inappropriate disclosure of confidential or proprietary information, we could incur material legal claims and liability, damage to our reputation, and the further development or commercialization of our drug candidates could be delayed.

 

Risks Related to the Development of Our Drug Candidates

 

If we are unable to successfully develop, receive marketing approval for and commercialize our drug candidates, or experience significant delays in doing so, our business will be harmed.

 

We have invested significant efforts and financial resources in the development of our drug candidates and the identification of potential drug candidates. Our ability to generate substantial revenue from our drug candidates will depend heavily on the successful development, marketing approval and eventual commercialization of these drug candidates. The success of any drug candidates that we develop, including A-101 45% Topical Solution, ATI-501 and ATI-502, will depend on several factors, including:

 

 

Whether marketing approval will be granted is unpredictable and depends upon numerous factors, including the substantial discretion of the regulatory authorities. Our drug candidates’ success in clinical trials will not guarantee marketing approval. If, following submission, our NDA for any drug candidate is not accepted for substantive review, or even if it is accepted for substantive review, the FDA or other comparable foreign regulatory authorities may require that we conduct additional studies or clinical trials, provide additional data, take additional manufacturing steps, or require other conditions before they will reconsider or approve our application. If the FDA or other comparable foreign regulatory authorities require additional studies, clinical trials or data, we would incur increased costs and delays in the marketing approval process, which may require us to expend more resources than we have available. In addition, the FDA or other comparable foreign regulatory authorities may not consider sufficient any additional required studies, clinical trials, data or information that we perform and complete or generate, or we may decide to abandon the program.

 

It is possible that our drug candidates currently in development will never obtain marketing approval, even if we expend substantial time and resources seeking such approval. If we do not achieve one or more of these factors in a timely manner or at all, we could experience significant delays or an inability to successfully commercialize our drug candidates, which would harm our business.

 

Clinical drug development involves a lengthy and expensive process, with an uncertain outcome. We may incur additional costs or experience delays in completing, or ultimately be unable to complete, the development and commercialization of our drug candidates.

 

The risk of failure for our drug candidates is high. It is impossible to predict when or if any of our drug candidates will prove effective or safe in humans or will receive marketing approval. Before obtaining regulatory approval for the sale of any drug candidate, we must complete preclinical development and then conduct extensive clinical trials to demonstrate the safety and efficacy of our drug candidates in humans for use in the target indication. Clinical testing is expensive, difficult to design and implement, can take many years to complete and is inherently uncertain as to outcome.

A failure of one or more clinical trials can occur at any stage of testing. The outcome of preclinical testing and early clinical trials may not be predictive of the success of later clinical trials, and interim results of a clinical trial do not necessarily predict final results. Moreover, preclinical and clinical data are often susceptible to varying interpretations and analyses, and many companies that have believed their drug candidates performed satisfactorily in preclinical studies and clinical trials have nonetheless failed to obtain marketing approval of their drugs.

 

We may experience numerous unforeseen events during or as a result of clinical trials that could delay or prevent our ability to receive marketing approval or commercialize our drug candidates, including:

 

 

We could also encounter delays if a clinical trial is suspended or terminated by us, by the institutional review boards of the institutions in which such trials are being conducted, by the data safety monitoring board for such trial or by the FDA or other regulatory authorities. Such authorities may impose such a suspension or termination due to a number of factors, including failure to conduct the clinical trial in accordance with regulatory requirements or our clinical protocols, inspection of the clinical trial operations or trial site by the FDA or other regulatory authorities resulting in the imposition of a clinical hold, unforeseen safety issues or adverse side effects, failure to demonstrate a benefit from using a drug, changes in governmental regulations or administrative actions or lack of adequate funding to continue the clinical trial.  If we experience delays in the completion of, or termination of, any clinical trial of our drug candidates, the commercial prospects of our drug candidates will be harmed, and our ability to generate product revenues from any of these drug candidates will be delayed. In addition, any delays in completing our clinical trials will increase our costs, slow down our drug candidate development and approval process and jeopardize our ability to commence product sales and generate revenues. Any of these occurrences may harm our business, financial condition and prospects significantly. In addition, many of the factors that cause, or lead to, a delay in the commencement or completion of clinical trials may also ultimately lead to the denial of marketing approval of our drug candidates. If we are required to conduct additional clinical trials or other testing of our drug candidates beyond those that we currently contemplate, if we are unable to successfully complete clinical trials of our drug candidates or other testing, if the results of these trials or tests are not favorable or if there are safety concerns, we may:

 

 

Our drug development costs will also increase if we experience delays in testing or 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 drug candidates or allow our competitors to bring drugs to market before we do and impair our ability to successfully commercialize our drug candidates.

 

If we experience delays or difficulties in the enrollment of subjects in clinical trials, our receipt of necessary marketing approvals could be delayed or prevented.

 

Successful and timely completion of clinical trials will require that we enroll a sufficient number of subjects. Subject enrollment, a significant factor in the timing of clinical trials, is affected by many factors including the size and nature of the patient population. Trials may be subject to delays as a result of subject enrollment taking longer than anticipated or subject withdrawal. We may not be able to initiate or continue clinical trials for our drug candidates if we are unable to locate and enroll a sufficient number of eligible patients to participate in these trials as required by the FDA or similar regulatory authorities outside the United States. We cannot predict how successful we will be at enrolling subjects in future clinical trials. Subject enrollment is affected by other factors including:

 

 

Our inability to enroll a sufficient number of subjects for clinical trials would result in significant delays and could require us or them to abandon one or more clinical trials altogether. Enrollment delays in these clinical trials may result in increased development costs for our drug candidates, which would cause the value of our company to decline and limit our ability to obtain additional financing. Furthermore, we rely on and expect to continue to rely on CROs and clinical

trial sites to ensure the proper and timely conduct of our clinical trials and we will have limited influence over their performance.

 

Our clinical trials may fail to demonstrate the safety and efficacy of our drug candidates, or serious adverse or unacceptable side effects may be identified during the development of our drug candidates, which could prevent or delay marketing approval and commercialization, increase our costs or necessitate the abandonment or limitation of the development of some of our drug candidates.

 

Before obtaining marketing approvals for the commercial sale of our drug candidates, we must demonstrate through lengthy, complex and expensive preclinical testing and clinical trials that our drug candidates are both safe and effective for use in each target indication, and failures can occur at any stage of testing. Clinical trials often fail to demonstrate safety and efficacy of the drug candidate studied for the target indication.

 

If our drug candidates are associated with side effects in clinical trials or have characteristics that are unexpected, we may need to abandon their development or limit development to more narrow uses in which the side effects or other characteristics are less prevalent, less severe or more acceptable from a risk-benefit perspective. The FDA or an institutional review board may also require that we suspend, discontinue, or limit our clinical trials based on safety information. Such findings could further result in regulatory authorities failing to provide marketing authorization for our drug candidates. Many drug candidates that initially showed promise in early stage testing have later been found to cause side effects that prevented further development of the drug candidate.

 

Additionally, if we or others identify undesirable side effects caused by our drugs, a number of potentially significant negative consequences could result, including:

 

 

Any of these events could prevent us from achieving or maintaining market acceptance of the particular drug candidate and could significantly harm our business, results of operations and prospects.

 

Changes in methods of drug candidate manufacturing or formulation may result in additional costs or delay.

 

As drug candidates are developed through preclinical studies to late-stage clinical trials towards approval and commercialization, it is common that various aspects of the development program, such as manufacturing methods and formulation, are altered along the way in an effort to optimize processes and results. Such changes carry the risk that they will not achieve these intended objectives, and may also require additional testing, FDA notification or FDA approval.  Any of these changes could cause our drug candidates to perform differently and affect the results of planned clinical trials or other future clinical trials conducted with the altered materials.  This could delay completion of clinical trials, require the conduct of bridging clinical trials or the repetition of one or more clinical trials, increase clinical trial costs, delay approval of our drug candidates and jeopardize our ability to commence sales and generate revenue.

 

We may not be successful in our efforts to increase our pipeline of drug candidates, including by in-licensing or acquiring additional drug candidates for other dermatological conditions.

 

A key element of our strategy is to build and expand our pipeline of drug candidates. In addition, we intend to in-license or acquire additional drug candidates for other dermatological conditions to build a fully integrated biopharmaceutical company. We may not be able to identify or develop drug candidates that are safe, tolerable and effective. Even if we are successful in continuing to build our pipeline, the potential drug candidates that we identify, in-license or acquire may not be suitable for clinical development, including as a result of being shown to have harmful side effects or other characteristics that indicate that they are unlikely to be drugs that will receive marketing approval and achieve market acceptance.

 

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

 

Because we have limited financial and management resources, we focus on development programs and drug candidates that we identify for specific indications. As such, we are currently primarily focused on the development of A-101 45% Topical Solution for the treatment of common warts, ATI-501 and ATI-502 for the treatment of AA and ATI-450 for the treatment of rheumatoid arthritis.  As a result, we may forego or delay pursuit of opportunities with other drug 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 drugs or profitable market opportunities. Our spending on current and future development programs and drug candidates for specific indications may not yield any commercially viable drugs. If we do not accurately evaluate the commercial potential or target market for a particular drug candidate, we may relinquish valuable rights to that drug 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 drug candidate.

 

Risks Related to the Commercialization of ESKATA, RHOFADE and Our Drug Candidates

 

ESKATA, RHOFADE and any of our drug candidates that receive marketing approval may fail to achieve the degree of market acceptance by physicians, patients, third-party payors and others in the medical community necessary for commercial success.

 

ESKATA, RHOFADE and any of our drug candidates that receive marketing approval, may fail to gain sufficient market acceptance by physicians, patients, third-party payors and others in the medical community. If ESKATA, RHOFADE and our drug candidates do not achieve an adequate level of acceptance, we may not generate significant revenue and we may not become profitable. The degree of market acceptance of ESKATA, RHOFADE and, if approved, any drug candidate, will depend on a number of factors, including:

 

 

We have a savings card program for RHOFADE to provide assistance to eligible patients with out-of-pocket costs for the patient’s usage of RHOFADE. Changes to or elimination of the savings card program could adversely affect the frequency with which health care providers prescribe RHOFADE, the availability of RHOFADE at pharmacies and the demand for and use of RHOFADE by patients.  

 

If we are unable to establish effective sales, marketing and distribution capabilities for ESKATA and RHOFADE, or a drug candidate that may receive marketing approval, we may not be successful in commercializing ESKATA or RHOFADE or those drug candidates if and when they are approved.

 

To achieve commercial success for ESKATA and RHOFADE and any drug candidate for which we may obtain marketing approval, we will need to build a focused sales and marketing infrastructure to market or co-promote ESKATA and RHOFADE and, if approved, some of our drug candidates in the United States.  We have begun this process and have hired a sales force for ESKATA and RHOFADE, but there are risks involved with establishing our own sales, marketing and distribution capabilities. For example, recruiting and training a sales force is expensive and time consuming and could delay any drug launch. If the commercial launch of a drug candidate for which we recruit a sales force and establish marketing capabilities is delayed or does not occur for any reason, we would have prematurely or unnecessarily incurred

these commercialization expenses. This may be costly, and our investment would be lost if we cannot retain or reposition our sales and marketing personnel.  Factors that may inhibit our efforts to commercialize our drugs on our own include:

 

 

If we are unable to establish our own effective sales, marketing and distribution capabilities and enter into arrangements with third parties to perform these services, our revenue and our profitability, if any, are likely to be lower than if we were to sell, market and distribute any drugs that we develop ourselves. In addition, we may not be successful in entering into arrangements with third parties to sell, market and distribute our drug candidates or may be unable to do so on terms that are favorable to us. We likely will have little control over such third parties, and any of them may fail to devote the necessary resources and attention to sell and market our drugs effectively. If we do not establish effective sales, marketing and distribution capabilities, either on our own or in collaboration with third parties, we will not be successful in commercializing our products or drug candidates.

 

We face substantial competition, which may result in others discovering, developing or commercializing drugs before or more successfully than we do.

 

The development and commercialization of new drugs is highly competitive. We face competition with respect to our current products, and will face competition with respect to any drug candidates that we may seek to develop or commercialize in the future, from many different sources, including major pharmaceutical, biotechnology and specialty pharmaceutical companies, academic institutions and governmental agencies and public and private research institutions.

 

With respect to ESKATA for the treatment of raised SKs, we are aware of two biopharmaceutical companies developing drug candidates which target SK, one company that is developing a device to target SK, and another company that currently markets a line of cosmetic products targeting skin conditions, including SK. We are also aware of early research being conducted with Akt inhibitors as a potential treatment for SK.

 

With respect to RHOFADE for the treatment of persistent facial erythema (redness) due to rosacea, we are aware of one other drug that is approved for this indication: MIRVASO (brimonidine) topical gel, 0.33%, which was approved by the FDA in 2013, is currently marketed by Galderma Laboratories, L.P.

 

With respect to A-101 45% Topical Solution for the treatment of common warts, we are aware of one company that received a CE Mark approval for an over-the-counter treatment for the non-surgical removal of warts, and four companies developing drug candidates for the treatment of common warts. In addition, other drugs have been used off-label as treatments for common warts.

 

With respect to ATI-501 and ATI-502 for the treatment of AA, we anticipate competing with sensitizing agents such as diphencyprone, and topical, intralesional and systemic corticosteroids, which have been found to occasionally reduce symptoms of AA. Other treatments utilized for patchy AA include anthralin and minoxidil solution. We may also compete with companies developing chemical agents to be used in topical immunotherapies, as well as companies developing biologics, immunosuppressive agents, laser therapy, phototherapy, other JAK inhibitors and prostaglandin analogues to treat AA.

 

With respect to ATI-502 for the treatment of vitiligo, we are aware of one other company developing a topical JAK inhibitor for the treatment of vitiligo.

 

Our commercial opportunity could be reduced or eliminated if our competitors develop and commercialize drugs that are safer, more effective, have fewer or less severe side effects, are more convenient or are less expensive than ESKATA, RHOFADE or any other drug that we may develop. Our competitors also may obtain FDA or other regulatory approval for their drugs more rapidly than we may obtain approval for our drug candidates, which could result in our competitors establishing a strong market position before we are able to enter the market.

 

Many of the companies against which we are competing, or against which we may compete in the future, have significantly greater financial resources and expertise in research and development, manufacturing, preclinical and clinical development, obtaining regulatory approvals and marketing approved drugs than we do. Mergers and acquisitions in the pharmaceutical and biotechnology industries may result in even more resources being concentrated among a smaller number of our competitors. Smaller or early-stage companies may also prove to be significant competitors, particularly through collaborative arrangements with large and established companies. These competitors also compete with us in recruiting and retaining qualified scientific and management personnel and establishing clinical trial sites and patient registration for clinical trials, as well as in acquiring technologies complementary to, or that may be necessary for, our programs.

 

We expect third-party payors generally will not cover the use of ESKATA for the treatment of raised SKs and, accordingly, our success will be dependent upon the willingness of patients to pay out of pocket for ESKATA.

 

We do not expect third-party payors to cover and reimburse providers who use ESKATA on patients for the treatment of raised SKs. Third-party payors generally do not reimburse the provider for the product used to remove non-malignant lesions, including SK. In addition, they do not generally reimburse providers for the procedure removing such lesions, since the procedure is considered to be cosmetic in nature, unless there is a medical need to remove the lesion such as confirming a diagnosis with a biopsy or treating SK that are causing the patient physical discomfort. We anticipate that in some cases, ESKATA will be used to remove SK lesions that are inflamed and causing the patient discomfort. Any reduction in reimbursement for the procedure to remove inflamed SK may result in a higher percentage of patients needing to pay out of pocket for ESKATA. Accordingly, the commercial success of ESKATA depends on the extent to which patients will be willing to pay out of pocket for the in-office procedure. 

 

The success of RHOFADE and A-101 45% Topical Solution for the treatment of common warts or our other drug candidates, if approved, will depend significantly on coverage and adequate reimbursement or the willingness of patients to pay for these products.

 

In the case of RHOFADE, we believe our success will depend on continued coverage and adequate reimbursement, and in the case of A-101 45% Topical Solution for the treatment of common warts or our other drug candidates, if approved, on obtaining and maintaining coverage and adequate reimbursement, for a prescription treatment or in the absence of coverage and adequate reimbursement, on the extent to which patients will be willing to pay out of pocket for our prescription drug products.

 

Third-party payors determine which prescription drug products they will cover and establish reimbursement levels. Reimbursement by a third-party payor may depend upon a number of factors, including: the third-party payor’s determination that a product is safe, effective, and medically necessary; appropriate for the specific patient; cost-effective; supported by peer-reviewed medical journals or current clinical practice guidelines; and whether there are competitive products, either branded or generic, and the pricing of those products.  Many private third-party payors, such as managed care plans, manage access to drug products’ coverage partly to control costs for their plans, and may use drug formularies and medical policies to limit their exposure.  Obtaining and maintaining favorable reimbursement can be a time-consuming and expensive process, and we may not be able to negotiate or continue to negotiate reimbursement or pricing terms for our products with third-party payors at levels that are profitable to us, or at all.  

 

In addition to uncertainties surrounding coverage policies, there are periodic changes to reimbursement.  Third-party payors regularly update reimbursement amounts and also from time to time revise the methodologies used to determine reimbursement amounts.  Accordingly, these updates could impact the demand for RHOFADE or A-101 45% Topical Solution for the treatment of common warts or our other drug candidates, if approved. Our products may not be considered cost effective, and government and third-party private health insurance coverage and reimbursement may not be available to patients or sufficient to allow us to sell our products on a competitive and profitable basis.  Our results of operations could be adversely affected by the Affordable Care Act and by other health care reforms that may be enacted or adopted in the future.  In addition, increasing emphasis on managed care in the United States will continue to put pressure on the pricing of pharmaceutical products.  Cost control initiatives could decrease the price that we or any potential partners could receive for any of our products and could adversely affect our profitability.  We cannot predict how pending and future health care legislation will impact our business, and any changes in coverage and reimbursement that further restricts coverage of our products or drug candidates could harm our business.

 

Foreign governments also have their own health care reimbursement systems, which vary significantly by country and region, and we cannot be sure that coverage and adequate reimbursement will be made available with respect to our products under any foreign reimbursement system.  In some foreign countries, including major markets in the European Union and Japan, the pricing of prescription pharmaceuticals is subject to governmental control.  In these countries, pricing negotiations with governmental authorities can take up to 12 months or longer after the receipt of regulatory marketing approval for a product.  To obtain reimbursement or pricing approval in some countries, we may be required to conduct a pharmacoeconomic study that compares the cost-effectiveness of our product to other available therapies.  Such pharmacoeconomic studies can be costly and the results uncertain.  Our business could be harmed if reimbursement of our products is unavailable or limited in scope or amount or if pricing is set at unsatisfactory levels.

 

Product liability lawsuits against us could cause us to incur substantial liabilities and to limit commercialization of any of our products or drug candidates that we may develop.

 

We face an inherent risk of product liability exposure related to the testing of our drug candidates in human clinical trials and an even greater risk relating to the commercialization of ESKATA and RHOFADE. If we cannot successfully defend ourselves against claims that our drug candidates or drugs caused injuries, we will incur substantial liabilities. Regardless of merit or eventual outcome, product liability claims may result in:

 

 

We currently hold $10 million in product liability insurance coverage in the aggregate, with a per incident limit of $10 million, which may not be adequate to cover all liabilities that we may incur. Insurance coverage is increasingly expensive. We may need to increase our insurance coverage and we may not be able to maintain insurance coverage at a reasonable cost or in an amount adequate to satisfy any liability that may arise.

 

Risks Related to Our Dependence on Third Parties

 

We will rely on third parties to conduct our future clinical trials for drug candidates, and those third parties may not perform satisfactorily, including failing to meet deadlines for the completion of such trials.

 

We engage CROs to conduct clinical trials of our drug candidates. We expect to continue to rely on third parties, such as clinical data management organizations, medical institutions and clinical investigators, to conduct those clinical trials. If any of our relationships with these third parties terminate, we may not be able to timely enter into arrangements with alternative third parties or to do so on commercially reasonable terms, if at all. In addition, any third parties conducting our clinical trials will not be our employees, and except for remedies available to us under our agreements with such third parties, we cannot control whether or not they devote sufficient time and resources to our clinical programs. If these third parties do not successfully carry out their contractual duties or obligations or meet expected deadlines, if they need to be replaced or if the quality or accuracy of the clinical data they obtain is compromised due to the failure to adhere to our clinical protocols, regulatory requirements or for other reasons, our clinical trials may be extended, delayed or terminated and we may not be able to obtain marketing approval for or successfully commercialize our drug candidates. Consequently, our results of operations and the commercial prospects for our drug candidates would be harmed, our costs could increase substantially and our ability to generate revenue could be delayed significantly.

 

Switching or adding CROs involves substantial cost and requires management time and focus. In addition, there is a natural transition period when a new CRO commences work. As a result, delays occur, which can materially impact our ability to meet our desired clinical development timelines. Though we intend to carefully manage our relationships with our CROs, there can be no assurance that we will not encounter challenges or delays in the future or that these delays or challenges will not have a material adverse impact on our business, financial condition and prospects.

 

We rely on these parties for execution of our preclinical studies and clinical trials, and generally do not control their activities. 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. Moreover, the FDA requires us to comply with standards, commonly referred to as good clinical practices, or 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. We also are required to register ongoing clinical trials and post the results of completed clinical trials on a government-sponsored database, ClinicalTrials.gov, within specified timeframes. Failure to do so can result in fines, adverse publicity and civil and criminal sanctions. If we or any of our CROs fail to comply with applicable GCPs, the clinical data generated in our clinical trials may be deemed unreliable and the FDA, EMA or comparable foreign regulatory authorities may require us to perform additional clinical trials before approving our marketing applications. We cannot assure you that upon inspection by a given regulatory authority, such regulatory authority will determine that any of our clinical trials complies with GCP regulations. In addition, our clinical trials must be conducted with product produced under cGMP regulations. Our failure to comply with these regulations may require us to repeat clinical trials, which would delay the marketing approval process.

 

We also rely on other third parties to store and distribute drug supplies for the commercialization of ESKATA and RHOFADE and for our clinical trials. Any performance failure on the part of our distributors could delay clinical development or marketing approval of our drug candidates or commercialization of our drugs, producing additional losses and depriving us of potential revenue.

 

We contract with third parties for the manufacture of commercial quantities of ESKATA and RHOFADE and for the supply of our drug candidates for preclinical and clinical testing. This reliance on third parties increases the risk that we will not have sufficient quantities of ESKATA, RHOFADE or our drug candidates or such quantities at an acceptable cost, which could delay, prevent or impair our development or commercialization efforts.

 

We do not have any manufacturing facilities. We currently rely, and expect to continue to rely, on third parties for the manufacture of commercial quantities of ESKATA and RHOFADE and supply of our drug candidates for preclinical and clinical testing.  For example, we have entered into an exclusive, ten-year, automatically renewable supply agreement with PeroxyChem, a manufacturer of hydrogen peroxide, to provide the active pharmaceutical ingredient that can be used in ESKATA for the treatment of raised SKs, a manufacturing and supply agreement with a third party for the finished dosage form of RHOFADE, and an exclusive commercial supply agreement with James Alexander for the manufacture of the finished dosage form of ESKATA. This reliance on third parties increases the risk that we will not have sufficient quantities of our products or drug candidates at an acceptable cost and/or quality, which could delay, prevent or impair our ability to timely conduct our clinical trials or our other development or commercialization efforts.

 

The facilities used by our contract manufacturers to manufacture our products and drug candidates must be approved by the FDA or other regulatory authorities pursuant to inspections that will be conducted after we submit our NDA or comparable marketing application to the FDA or other regulatory authority. We do not have control over a supplier’s or manufacturer’s compliance with laws, regulations and applicable cGMP standards and other laws and regulations, such as those related to environmental health and safety matters. If our contract manufacturers cannot successfully manufacture material that conforms to our specifications and the strict regulatory requirements of the FDA or others, they will not be able to secure and maintain regulatory approval for their manufacturing facilities. In addition, we have no control over the ability of our contract manufacturers to maintain adequate quality control, quality assurance and qualified personnel. If the FDA or a comparable foreign regulatory authority does not approve these facilities for the manufacture of our drug candidates or if it withdraws any such approval for our products or drug candidates in the future, we may need to find alternative manufacturing facilities, which would significantly impact our ability to commercialize our products and to develop, obtain regulatory approval for or market, if approved, our drug candidates.

   

We may be unable to establish any agreements with future third-party manufacturers or to do so on acceptable terms. Even if we are able to establish agreements with third-party manufacturers, reliance on third-party manufacturers entails additional risks, including:

 

 

Third-party manufacturers may not be able to comply with cGMP regulations or similar regulatory requirements outside the United States. Our failure, or the failure of our third-party manufacturers, to comply with applicable regulations could result in sanctions being imposed on us, including clinical holds, 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 products. 

 

Our products and drug candidates that we may develop may compete with other products and drug candidates for access to manufacturing facilities. There are a limited number of manufacturers that operate under cGMP regulations and that might be capable of manufacturing for us. Any performance failure on the part of our existing or future manufacturers could delay clinical development or marketing approval. We do not currently have arrangements in place for redundant supply or a second source for the components of ESKATA or RHOFADE. 

 

If our current contract manufacturers cannot perform as agreed, we may be required to replace such manufacturers. We may incur added costs and delays in identifying and qualifying any such replacement.

 

We expect to continue to depend on third-party contract manufacturers for the foreseeable future. Our current and anticipated future dependence upon others for the manufacture of our products and drug candidates may adversely affect our future profit margins and our ability to commercialize any drug candidates that receive marketing approval on a timely and competitive basis.

 

We may seek collaborations with third parties for the development or commercialization of our drug candidates. If those collaborations are not successful, we may not be able to capitalize on the market potential of these drug candidates.

 

We may seek third-party collaborators for the development and commercialization of our drug candidates, including for the commercialization of any of our drug candidates that are approved for marketing outside the United States. Our likely collaborators for any collaboration arrangements include large and mid-size pharmaceutical companies, regional and national pharmaceutical companies and biotechnology companies. If we do enter into any such arrangements with any third parties, we will likely have limited control over the amount and timing of resources that our collaborators dedicate to the development or commercialization of our drug candidates. Our ability to generate revenue from these arrangements will depend on our collaborators’ abilities to successfully perform the functions assigned to them in these arrangements.

 

Collaborations involving our drug candidates would pose the following risks to us:

 

 

Collaboration agreements may not lead to development or commercialization of drug candidates in the most efficient manner or at all. If a present or future collaborator of ours were to be involved in a business combination, the continued pursuit and emphasis on our drug development or commercialization program could be delayed, diminished or terminated. 

 

If we are not able to establish collaborations, we may have to alter our development and commercialization plans.

 

Our drug development programs and the potential commercialization of our drug candidates will require substantial additional capital. For some of our drug candidates, we may decide to collaborate with pharmaceutical and biotechnology companies for the development and potential commercialization of those drug candidates.

 

We face significant competition in seeking appropriate collaborators. Whether we reach a definitive agreement for a collaboration will depend, among other things, upon our assessment of the collaborator’s resources and expertise, the terms and conditions of the proposed collaboration and the proposed collaborator’s evaluation of a number of factors. Those factors may include the design or results of clinical trials, the likelihood of approval by the FDA or similar regulatory authorities outside the United States, the potential market for the subject drug candidate, the costs and complexities of manufacturing and delivering such drug candidate to patients, the potential of competing products, the existence of uncertainty with respect to our ownership of technology, which can exist if there is a challenge to such ownership without regard to the merits of the challenge and industry and market conditions generally. The collaborator may also consider alternative drug candidates or technologies for similar indications that may be available to collaborate on and whether such

a collaboration could be more attractive than the one with us for our drug candidate. Collaborations are complex and time-consuming to negotiate and document. In addition, there have been a significant number of recent business combinations among large pharmaceutical companies that have resulted in a reduced number of potential future collaborators.

 

We may not be able to negotiate collaborations on a timely basis, on acceptable terms, or at all. If we are unable to do so, we may have to curtail the development of such drug candidate, reduce or delay its development program or one or more of our other development programs, delay its potential commercialization or reduce the scope of any sales or marketing activities, or increase our expenditures and undertake development or commercialization activities at our own expense. If we elect to increase our expenditures to fund development or commercialization activities on our own, we may need to obtain additional capital, which may not be available to us on acceptable terms or at all. If we do not have sufficient funds, we may not be able to further develop our drug candidates or bring them to market and generate revenue.

 

Our sublease could terminate if the master lease is terminated for any reason, thus terminating our rights to our corporate headquarters.

 

We sublease space for our corporate headquarters.  While the term of the sublease extends until October 2023, if for any reason the master lease is terminated or expires prior to October 2023, our sublease will also automatically terminate.  In such an event, we would need to obtain a new direct lease with the master landlord or negotiate and enter into a new lease for office space at a different location, which we may not be able to do on commercially reasonable terms, if at all.

 

Risks Related to Our Intellectual Property

 

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

 

Our success depends in large part on our ability to obtain and maintain patent protection in the United States and other countries with respect to our products and drug candidates. We seek to protect our proprietary position by filing patent applications in the United States and abroad related to our products and drug candidates. 

 

The patent prosecution process is expensive and time-consuming, however, and we may not be able to file and prosecute all necessary or desirable patent applications at a reasonable cost or in a timely manner. It is also possible that we will fail to identify patentable aspects of our development output before it is too late to obtain patent protection. We may not have the right to control the preparation, filing and prosecution of patent applications, or to maintain the rights to patents licensed to third parties. Therefore, these patents and applications may not be prosecuted and enforced in a manner consistent with the best interests of our business.

 

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

 

Moreover, we may be subject to a third-party preissuance submission of prior art to the U.S. Patent and Trademark Office, or USPTO, or become involved in opposition, derivation, reexamination, inter partes review, post-grant review or interference proceedings challenging our patent rights or the patent rights of others. An adverse determination in any such submission, proceeding or litigation could reduce the scope of, or invalidate, our patent rights, allow third parties to

commercialize our technology or drugs and compete directly with us, without payment to us, or result in our inability to manufacture or commercialize drugs without infringing third-party patent rights. In addition, if the breadth or strength of protection provided by our patents and patent applications that we own, or license is threatened, it could dissuade companies from collaborating with us to license, develop or commercialize current or future drug candidates. 

 

Even if our patent applications that we own or license issue as patents, they may not issue in a form that will provide us with any meaningful protection, prevent competitors from competing with us or otherwise provide us with any competitive advantage. Our competitors may be able to circumvent our patents by developing similar or alternative technologies or drugs in a non-infringing manner. For example, the patents and patent applications that we exclusively license from Columbia University that are primarily directed to methods of treating hair loss disorders with JAK inhibitors may not issue, have issued and or may issue with claims directed to the use of specific JAK inhibitors that we do not intend to commercialize, or may not issue with claims directed to the use of JAK inhibitors that our competitors may commercialize.

 

In addition, the issuance of a patent is not conclusive as to its inventorship, scope, validity or enforceability, and our patents may be challenged in the courts or patent offices in the United States and abroad. Such challenges may result in loss of exclusivity or freedom to operate or in patent claims being narrowed, invalidated or held unenforceable, in whole or in part, which could limit our ability to stop others from using or commercializing similar or identical technology and drugs, or limit the duration of the patent protection of our technology and drugs. Our issued U.S. patents, with claims directed to treatment of SK and acrochordons with high-concentration hydrogen peroxide of at least 23%, including ESKATA and A-101 45% Topical Solution, are scheduled to expire in 2022, and our issued U.S. patents with claims directed to high-concentration hydrogen peroxide formulations, including ESKATA and A-101 45% Topical Solution, and methods of use and applicators for the same are scheduled to expire in 2035. The issued U.S. patents that we exclusively license from Allergan relating to methods of treating erythema associated with rosacea by topically administering oxymetazoline or other alpha-1 adrenoreceptor agonists, which cover the approved use of RHOFADE, expire between January 2024 and May 2028. The issued U.S. patent that covers cream formulations of oxymetazoline, including RHOFADE, expires in December 2031. The issued U.S. patents relating to methods of treating facial erythema associated with rosacea by topically administering once or twice daily 1% or 1.5% oxymetazoline expire in June 2035. The patents and applications that we exclusively sublicense from Allergan that may relate to RHOFADE expire in May 2024. Certain issued U.S. patents relating to our JAK inhibitors, ATI-501 and ATI-502, are scheduled to expire in 2023 and additional U.S. patents, with claims specifically directed to such JAK inhibitors, are scheduled to expire in 2030. The issued U.S. and Japanese patents that we exclusively license from Columbia University with claims directed to the use of third party JAK inhibitors for the treatment of hair loss disorders, including AA and AGA, and inducing hair growth, expire in 2031. We currently do not have any patents issued directed to our soft-JAK inhibitors, but any claims that may issue would expire in 2038. Our issued U.S. patent covering our lead inhibitors of the MK-2 signaling pathway inhibitor, expires in 2034 and other issued patents covering different MK-2 signaling pathway inhibitors expire in 2031 and 2032. Our issued patents covering our novel inhibitors of ITK expire between 2035 and 2038. Given the amount of time required for the development, testing and regulatory review of new drug candidates, patents protecting such candidates might expire before or shortly after such candidates are commercialized. As a result, our patent portfolio may not provide us with sufficient rights to exclude others from commercializing drugs similar or identical to ours.

 

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

 

Competitors may infringe our issued patents or other intellectual property. Our pending applications cannot be enforced against third parties practicing the technology claimed in such applications unless and until a patent issues from such applications. To counter infringement or unauthorized use, we may be required to file infringement claims, which can be expensive and time-consuming. Any claims we assert against perceived infringers could provoke these parties to assert counterclaims against us alleging that we infringe their patents or that our patents are invalid or unenforceable. Grounds for a validity challenge could be an alleged failure to meet any of several statutory requirements, including lack of novelty, obviousness, non-enablement or insufficient written description. Grounds for an unenforceability assertion could be an allegation that someone connected with prosecution of the patent withheld relevant information from the USPTO or made a misleading statement during prosecution. Third parties may also raise similar claims before the USPTO, in post-grant proceedings such as ex parte reexaminations, inter partes review, or post-grant review, or oppositions or similar administrative proceedings outside the United States, in parallel with litigation or, even outside the context of litigation. The outcome following legal assertions of invalidity and unenforceability is unpredictable. With respect to the

validity question, for example, we cannot be certain that there is no invalidating prior art of which we and the patent examiner were unaware during prosecution. If a defendant were to prevail on a legal assertion of invalidity or unenforceability, we would lose at least part, and perhaps all, of the patent protection on our products and drug candidates. Such a loss of patent protection would harm our business. 

 

In such a proceeding, a court or administrative board may decide that a patent of ours is invalid or unenforceable, in whole or in part, construe the patent's claims narrowly or refuse to stop the other party from using the technology at issue on the grounds that our patents do not cover the technology. An adverse result in any such proceeding could put one or more of our patents at risk of being invalidated or interpreted narrowly. We may find it impractical or undesirable to enforce our intellectual property against some third parties. For instance, we are aware of third parties that have marketed high-concentration hydrogen peroxide solutions over the internet for the treatment of SK and warts. These parties do not appear to have regulatory authority, and we have not authorized them in any way to market these products. However, to date we have refrained from seeking to enforce our intellectual property rights against these third parties due to the transient nature of their activities.  

 

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

 

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

 

We are aware that a third party generic pharmaceutical company completed a Phase 3 clinical trial in March 2018 evaluating the reduction in erythema in adults with moderate to severe facial erythema associated with rosacea with a 1% oxymetazoline topical cream in comparison to an oxymetazoline reference listed drug. While conducting such a clinical trial may not be an act of patent infringement in the United States, such a clinical trial could serve as the basis for the third party to file an ANDA or 505(b)(2) application for a generic of RHOFADE that relies in whole or in part on studies conducted by Allergan, which could trigger a potential patent infringement lawsuit. If we were to bring a patent infringement lawsuit against such a third party for infringing any of the U.S. patents relating to methods of treating erythema associated with rosacea by topically administering oxymetazoline that we exclusively license from Allergan, we may be required to join Allergan as a party to such a lawsuit. In addition, if we were to bring a patent infringement lawsuit against a third party for infringing certain patents that we sublicense from Allergan relating to the use of oxymetazoline for treating rosacea or purpura by topical application, we may also be required to join Allergan and another third party as parties to such a lawsuit. Any such lawsuit could result in the invalidation of, or render unenforceable, some or all of the relevant patent claims or a finding of non-infringement and the approval of a generic version of RHOFADE sooner than anticipated.

 

With respect to ATI-501 and ATI-502, if we do not elect to exercise our first right to do so, Rigel may enforce the licensed patents relating to ATI-501 and ATI-502 against any infringing third party in the field of dermatology. In addition, Rigel has the first right, but not the obligation, to enforce the licensed patents relating to ATI-501 and ATI-502 against any infringing party outside of the field of dermatology. With respect to the licensed patents from Columbia University, Columbia University has the first right to initiate, control and defend any proceedings related to the validity, enforceability or infringement of the licensed patent rights and in doing so, has no obligation to assert more than one licensed patent in one jurisdiction against a third party. With respect to the licensed patents from Columbia University, if Columbia University does not elect to exercise its first right to do so, we may enforce the licensed patent rights relating to an infringement of the licensed patent rights against any infringing third party.

 

The RHOFADE patents that we exclusively license from Allergan are subject to a cross-license agreement with a third party, which place obligations and limitations on our ability to prosecute, maintain and enforce such patents solely as they relate to an alpha adrenoreceptor agonist that is not oxymetazoline. 

 

We exclusively license from Allergan a family of U.S. patents and applications relating to methods of treating erythema associated with rosacea by topically administering oxymetazoline or other alpha-1 adrenoreceptor agonists, which expire between January 2024 and May 2028. This patent family covers the approved use of RHOFADE. This patent family is also subject to an exclusive license granted by Allergan to a third party, which places obligations and limitations

on our ability to prosecute, maintain and enforce such patents solely as they relate to an alpha adrenoreceptor agonist that is not oxymetazoline.

 

If we breach our license agreement with Rigel, it could compromise our development and commercialization efforts for our JAK inhibitors ATI-501 and ATI-502.

 

In August 2015, we entered into an exclusive license agreement with Rigel, which grants us the rights to certain patent rights and other intellectual property owned by them relating to the JAK inhibitors ATI-501 and ATI-502 in the field of dermatology. If we materially breach or fail to perform any provision under this license agreement, including failure to make payments to Rigel when due for royalties and failure to use commercially reasonable efforts to develop and commercialize a JAK inhibitor, Rigel has the right to terminate our license, and upon the effective date of such termination, our right to practice the licensed Rigel’s patent rights and other intellectual property would end. Any uncured, material breach under the license agreement could result in our loss of rights to practice the patent rights and other intellectual property licensed to us under the license agreement with Rigel. 

 

If we breach our agreement with the Selling Stockholders of Vixen, it could compromise our development and commercialization efforts for our JAK inhibitors.

 

In March 2016, we entered into a stock purchase agreement with the stockholders of Vixen, pursuant to which we purchased all of the stock of Vixen and assumed its license agreement with Columbia University.  If we fail to use commercially reasonable efforts to develop and commercialize a JAK inhibitor for AA and a JAK inhibitor for AGA, the license agreement with Columbia University will be transferred to the Selling Stockholders of Vixen following any adverse resolution of any dispute relating thereto.  Upon the effective date of such transfer, our right to practice the licensed Columbia University patent rights and know-how would end. 

 

If we breach our agreement with Columbia University, it could compromise our development and commercialization efforts for our JAK inhibitors.

 

In March 2016, as part of the Vixen acquisition, we assumed a license agreement with Columbia University, which grants us the right under certain patent rights and know-how owned by Columbia University relating to the use of JAK inhibitors to treat hair-loss disorders. If we materially breach or fail to perform any provision under this license agreement, including failure to make payments to Columbia University when due for royalties and failure to use commercially reasonable efforts to develop and commercialize a licensed product, Columbia University has the right to terminate our license, and upon the effective date of such termination, our right to practice the licensed Columbia University patent rights and know-how would end. Any uncured, material breach under the license agreement could result in our loss of rights to practice the patent rights and know-how licensed to us under the license agreement, and, to the extent such patent rights and know-how relate to our JAK inhibitors, it could compromise our development and commercialization efforts for ATI-501 or ATI-502. 

 

We may not be able to protect our intellectual property rights throughout the world.

 

Filing, prosecuting and defending patents on our products and drug candidates in all countries throughout the world would be prohibitively expensive, and our intellectual property rights in some countries outside the United States can be less extensive than those in the United States. For example, the use of ESKATA for the treatment of raised SKs is currently covered by patents in the United States, Australia, India and New Zealand, but not in the European Union or other countries. The use of A-101 45% Topical Solution for the treatment of warts is currently covered by issued patents in the United States, Australia, India and New Zealand, but not in the European Union or other countries. A U.S. patent is issued, and patent applications are pending in the United States, the European Union and other foreign countries directed to high-concentration hydrogen peroxide formulations, including ESKATA and A-101 45% Topical Solution and methods of use. With respect to RHOFADE, the family of patents and applications relating to methods of treating erythema associated with rosacea by topically administering oxymetazoline or other alpha-1 adrenoreceptor agonists, which expire between January 2024 and May 2028, is not filed outside of the United States. Accordingly, the patent protection for RHOFADE outside of the United States is based upon a family of patents and applications in the United States, the European Union and other major foreign markets that cover certain cream formulations of oxymetazoline, including RHOFADE, which expires in December 2031 and a family of patents and applications in the United States, the European Union and other major foreign markets relating to methods of treating facial erythema associated with rosacea by topically administering once or twice daily 1% or 1.5% oxymetazoline, which expires in June 2035. The approved use of RHOFADE

may also be covered by certain patents and applications in the United States, the European Union and other major foreign markets that expire in May 2024, which we exclusively sublicense from Allergan.

 

Our JAK inhibitors, ATI-501 and ATI-502, are currently covered in patents and applications in the United States, the European Union, and other major foreign markets. Additionally, U.S. and Japanese patents have issued in the patent portfolio licensed from Columbia University, which are directed to the use of certain third party JAK inhibitors for the treatment of hair loss disorders and applications are pending in the United States, the European Union, Japan and South Korea. In addition, the laws of some foreign countries do not protect intellectual property rights to the same extent as federal and state laws in the United States. Consequently, we may not be able to prevent third parties from practicing our invention in such countries. Competitors may use our technologies in jurisdictions where we have not obtained patent protection to develop their own products and may export otherwise infringing products to territories where we have patent protection, but enforcement rights are not as strong as those in the United States. These products may compete with our products and drug candidates and our patents or other intellectual property rights may not be effective or sufficient to prevent them from competing. 

 

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

 

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

 

We may need to license intellectual property from third parties, and such licenses may not be available or may not be available on commercially reasonable terms.

 

A third party may hold intellectual property, including patent rights that are important or necessary to the development of our products and drug candidates. For example, we exclusively license patents from Allergan related to the use of alpha-1 adrenergic agonists for the treatment of erythema related to rosacea, which cover the approved use of RHOFDADE, and we exclusively license intellectual property from Rigel in the field of dermatology related to our JAK inhibitors,  ATI-501 and ATI-502.  We also exclusively license intellectual property from Columbia University related to the use of JAK inhibitors for the treatment of hair loss disorders.  It may be necessary for us to use the patented or proprietary technology of third parties to commercialize our products and drug candidates, in which case we would be required to obtain a license from these third parties on commercially reasonable terms, or our business could be harmed, possibly materially. 

 

Our third-party licensors may develop JAK inhibitors, including those related to our drug candidates, outside of the field of dermatology.

 

We exclusively license intellectual property from Rigel in order to develop, use, manufacture, sell and commercialize ATI-501 and ATI-502 in the field of dermatology. Rigel has retained the rights under such intellectual property to develop, use, manufacture, sell and commercialize ATI-501 and ATI-502 outside of the field of dermatology. If Rigel were to commercialize such JAK inhibitors outside the field of dermatology, such a product could possibly be used off-label for a dermatology indication, which could negatively impact sales of our drug candidates, if approved. Rigel also retained the intellectual property rights to develop, use, manufacture, sell and commercialize other structurally similar JAK inhibitors. If Rigel commercializes a structurally similar JAK inhibitor, such a product could directly compete with our drug candidates, if approved. 

 

Third parties may initiate legal proceedings alleging that we are infringing their intellectual property rights, the outcome of which would be uncertain and could have a material adverse effect on the success of our business.

 

Our commercial success depends upon our ability to develop, manufacture, market and sell our products or drug candidates and use our proprietary technologies without infringing the proprietary rights of third parties. There is considerable intellectual property litigation in the biotechnology and pharmaceutical industries. We may become party to, or threatened with, future adversarial proceedings or litigation regarding intellectual property rights with respect to our drugs and technology, including interference or derivation proceedings before the USPTO. Numerous U.S. and foreign issued patents and pending patent applications owned by third parties exist in the fields in which we are developing our drug candidates. Third parties may assert infringement claims against us based on existing patents or patents that may be granted in the future.

 

If we are found to infringe a third party’s intellectual property rights, we could be required to obtain a license from such third party to continue developing and marketing our drugs and technology. However, we may not be able to obtain any required license on commercially reasonable terms or at all. Even if we were able to obtain a license, it could be non-exclusive, thereby giving our competitors access to the same technologies licensed to us. We could be forced, including by court order, to cease commercializing the infringing technology or drug. In addition, we could be found liable for monetary damages, including treble damages and attorneys’ fees if we are found to have willfully infringed a patent. A finding of infringement could hinder current commercialization efforts of our products or prevent us from commercializing our drug candidates, if approved, or force us to cease some of our business operations. In the event of a successful claim of infringement against us, we may have to pay substantial damages, including treble damages and attorneys’ fees for willful infringement, pay royalties, redesign our infringing product or obtain one or more licenses from third parties, which may be impossible or require substantial time and monetary expenditure. Claims that we have misappropriated the confidential information or trade secrets of third parties could have a similar negative impact on our business.

 

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

 

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

 

In addition, while it is our policy to require our employees and contractors who may be involved in the development of intellectual property to execute agreements assigning such intellectual property to us, we may be unsuccessful in executing such an agreement with each party who in fact develops intellectual property that we regard as our own. Our and their assignment agreements may not be self-executing or may be breached, and we may be forced to bring claims against third parties, or defend claims they may bring against us, to determine the ownership of what we regard as our intellectual property.

 

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

 

Intellectual property litigation could cause us to spend substantial resources and distract our personnel from their normal responsibilities.

 

Even if resolved in our favor, litigation or other legal proceedings relating to intellectual property claims may cause us to incur significant expenses, and could distract our technical and management personnel from their normal responsibilities. In addition, there could be public announcements of the results of hearings, motions or other interim proceedings or developments and if securities analysts or investors perceive these results to be negative, it could have a substantial adverse effect on the price of our common stock. Such litigation or proceedings could substantially increase our operating losses and reduce the resources available for development activities or any future sales, marketing or distribution activities. We may not have sufficient financial or other resources to conduct such litigation or proceedings

adequately. Some of our competitors may be able to sustain the costs of such litigation or proceedings more effectively than we can because of their greater financial resources. Some of our competitors are larger than we are and have substantially greater resources. They are, therefore, likely to be able to sustain the costs of complex patent litigation longer than we could. Accordingly, despite our efforts, we may not be able to prevent third parties from infringing upon or misappropriating our intellectual property. Litigation could result in substantial costs and diversion of management resources, which could harm our business. In addition, the uncertainties associated with litigation could compromise our ability to raise the funds necessary to continue our clinical trials, continue our internal research programs, or in-license needed technology or other drug candidates. Uncertainties resulting from the initiation and continuation of patent litigation or other proceedings could compromise our ability to compete in the marketplace, including compromising our ability to raise the funds necessary to continue our clinical trials, continue our research programs, license necessary technology from third parties, or enter into development collaborations that would help us commercialize our drug candidates. 

 

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

 

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

 

The validity, scope and enforceability of any of our patents that cover ESKATA, RHOFADE, A-101 45% Topical Solution or any of our other drug candidates can be challenged by competitors.

 

The likelihood that a third party will challenge our patents covering ESKATA or RHOFADE is increased because these are marketed products. The challenge may come in the form of a patent office proceeding, such as an inter partes review, challenging the validity of the patents or a district court proceeding, such as a paragraph IV litigation arising out of the filing of an ANDA. 

 

If a third party files an ANDA or 505(b)(2) application for a generic of ESKATA or RHOFADE, and relies in whole or in part on studies conducted by or for us, the third party will be required to certify to the FDA that either: (1) there is no patent information listed in the FDA’s Orange Book with respect to our NDA for the applicable approved drug; (2) the patents listed in the Orange Book have expired; (3) the listed patents have not expired, but will expire on a particular date and approval is sought after patent expiration; or (4) the listed patents are invalid or will not be infringed by the manufacture, use or sale of the third party's generic drug. A certification that the new drug will not infringe the Orange Book-listed patents for the applicable approved drug, or that such patents are invalid, is called a paragraph IV certification. If the third party submits a paragraph IV certification to the FDA, a notice of the paragraph IV certification must also be sent to us once the third party's ANDA is accepted for filing by the FDA. We may then initiate a lawsuit to defend the patents identified in the notice. The filing of a patent infringement lawsuit within 45 days of receipt of the notice automatically prevents the FDA from approving the third party’s ANDA until the earliest of 30 months or the date on which the patent expires, the lawsuit is settled, or the court reaches a decision in the infringement lawsuit in favor of the third party. If we do not file a patent infringement lawsuit within the required 45-day period, the third party’s ANDA will not be subject to the 30-month stay of FDA approval. Litigation or other proceedings to enforce or defend intellectual property rights are often very complex in nature, may be very expensive and time-consuming, may divert our management's attention from our core business, and may result in unfavorable results that could limit our ability to prevent third parties from competing with ESKATA or RHOFADE. We are aware that a third party generic pharmaceutical company completed a Phase 3 clinical trial in March 2018 evaluating the reduction in erythema in adults with moderate to severe facial erythema associated with rosacea with a 1% oxymetazoline topical cream in comparison to an oxymetazoline reference listed drug. Such a clinical trial could serve as the basis for filing an ANDA or 505(b)(2)

application for a generic of RHOFADE that relies in whole or in part on studies conducted by Allergan, triggering the potential for a paragraph IV certification and subsequent patent infringement lawsuit. Any such lawsuit could result in the invalidation of, or render unenforceable, some or all of the relevant patent claims or a finding of non-infringement and the approval of a generic version of RHOFADE sooner than anticipated. 

 

If A-101 45% Topical Solution, our JAK inhibitors, or any of our other drug candidates advance through development or is approved by the FDA, one or more third parties may challenge the current patents, or patents that may issue in the future, within our portfolio covering these drug candidates. Any such challenge could result in the invalidation of, or render unenforceable, some or all of the relevant patent claims or a finding of non-infringement.  

 

If we do not obtain protection under the Hatch-Waxman Act by extending the patent term and obtaining data exclusivity for our products and drug candidates, our business may be materially harmed.

 

Our commercial success will largely depend on our ability to obtain and maintain patent and other intellectual property in the United States and other countries with respect to our proprietary technology, products, drug candidates and our target indications.  Our issued U.S. patent with claims directed to treatment of SK with ESKATA is scheduled to expire in 2022 and our issued U.S. formulation patent with claims directed to high-concentration hydrogen peroxide formulations, including ESKATA and A-101 45% Topical Solution, and methods of use is scheduled to expire in 2035.  Certain issued U.S. patents relating to our JAK inhibitors, ATI-501 and ATI-502, are scheduled to expire in 2023 and additional U.S. patents, with claims specifically directed to such JAK inhibitors, are scheduled to expire in 2030.  The issued U.S. and Japanese patents licensed from Columbia University relating to the use of certain third party JAK inhibitor for the treatment of hair loss disorders, including AA and AGA, and inducing hair growth, expire in 2031.  Our issued U.S. patent covering our lead inhibitors of the MK-2 signaling pathway inhibitor, expires in 2034 and other issued patents covering different MK-2 signaling pathway inhibitors expire in 2031 and 2032. Our issued patents covering our novel inhibitors of ITK expire between 2035 and 2038. Given the amount of time required for the development, testing and regulatory review of new drug candidates, patents protecting our drug candidates might expire before or shortly after such candidates begin to be commercialized. We expect to seek extensions of patent terms in the United States and, if available, in other countries where we are prosecuting patents.

 

Depending upon the timing, duration and specifics of FDA marketing approval of our drug candidates, one or more of our U.S. patents may be eligible for limited patent term extension under the Hatch-Waxman Act for a drug candidate. The Hatch-Waxman Act permits a patent extension term of up to five years beyond the normal expiration of the patent as compensation for patent term lost during development and the FDA regulatory review process, which is limited to the approved indication (or any additional indications approved during the period of extension). However, the total patent term including the period of extension cannot exceed 14 years from the product’s approval date.  Furthermore, this extension is limited to only one patent per regulatory review period that covers the approved product. However, the applicable authorities, including the FDA and the USPTO in the United States, and any equivalent regulatory authority in other countries, may not agree with our assessment of whether such extensions are available, and may refuse to grant extensions to our patents, or may grant more limited extensions than we request. We may not be granted an extension because of, for example, failing to apply within applicable deadlines, failing to apply prior to expiration of relevant patents or otherwise failing to satisfy applicable requirements. Moreover, the applicable time period or the scope of patent protection afforded could be less than we request. We believe that ESKATA is eligible for patent term extension and we have filed an application with the USPTO requesting patent term extension for one patent that covers ESKATA; however, the USPTO and/or the FDA may disagree with our interpretation. 

 

If we are unable to extend the expiration date of our existing patents or obtain new patents with longer expiry dates, our competitors may be able to take advantage of our investment in development and clinical trials by referencing our clinical and preclinical data to obtain approval of competing products following our patent expiration and launch their product earlier than might otherwise be the case.  For example, even if we obtain new chemical entity, or NCE, exclusivity for ESKATA, we could be subject to generic competition as early as the end of the applicable exclusivity period, if our patent portfolio does not have sufficient term or scope to prevent such generic competition.

 

Any trademarks we have obtained or may obtain may be infringed or successfully challenged, resulting in harm to our business.

 

We expect to rely on trademarks as one means to distinguish any of our products that are approved for marketing from the products of our competitors. Once we select new trademarks and apply to register them, our trademark

applications may not be approved. Third parties may oppose or attempt to cancel our trademark applications or trademarks, or otherwise challenge our use of the trademarks. In the event that our trademarks are successfully challenged, we could be forced to rebrand our drugs, which could result in loss of brand recognition and could require us to devote resources to advertising and marketing new brands. Our competitors may infringe our trademarks and we may not have adequate resources to enforce our trademarks.

 

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

 

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

 

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

 

The degree of future protection afforded by our intellectual property rights is uncertain because intellectual property rights have limitations, and may not adequately protect our business, or permit us to maintain our competitive advantage. The following examples are illustrative:

 

 

Risks Related to Regulatory Approval of Our Drug Candidates and Other Legal Compliance Matters

 

If we are not able to obtain, or if there are delays in obtaining, required regulatory approvals, we will not be able to commercialize our drug candidates, and our ability to generate revenue will be materially impaired.

 

Our drug candidates and the activities associated with their development and commercialization, including their design, testing, manufacture, safety, efficacy, recordkeeping, labeling, storage, approval, advertising, promotion, sale and distribution, are subject to comprehensive regulation by the FDA and other regulatory agencies in the United States and by the European Commission and EU Member State Competent Authorities and similar regulatory authorities outside the United States. Failure to obtain marketing approval for a drug candidate will prevent us from commercializing the drug candidate. Other than the approval of ESKATA in the United States, Sweden, United Kingdom, Iceland and Belgium, we have not received approval to market any of our drug candidates from regulatory authorities in any jurisdiction. We have only limited experience in filing and supporting the applications necessary to gain marketing approvals. Securing marketing approval requires the submission of extensive preclinical and clinical data and supporting information to regulatory authorities for each therapeutic indication to establish the drug candidate’s safety and efficacy. Securing

marketing approval also requires the submission of information about the drug manufacturing process to, and inspection of manufacturing facilities by, the regulatory authorities. Our drug candidates may not be effective, may be only moderately effective or may prove to have undesirable or unintended side effects, toxicities or other characteristics that may preclude our obtaining marketing approval or prevent or limit commercial use. If any of our drug candidates receive marketing approval, the accompanying label may limit the approved use of our drug in this way, which could limit sales of the drug. 

 

The process of obtaining marketing approvals, both in the United States and abroad, is expensive and may take many years if additional clinical trials are required, if approval is obtained at all, and can vary substantially based upon a variety of factors, including the type, complexity and novelty of the drug candidates involved. Changes in marketing approval policies during the development period, changes in or the enactment of additional statutes or regulations, or changes in regulatory review for each submitted drug application, may cause delays in the approval or rejection of an application. Regulatory authorities have substantial discretion in the approval process and may refuse to accept any application or may decide that our data is insufficient for approval and require additional preclinical, clinical or other studies. In addition, varying interpretations of the data obtained from preclinical and clinical testing could delay, limit or prevent marketing approval of a drug candidate. Any marketing approval we ultimately obtain may be limited or subject to restrictions or post-approval commitments that render the approved drug not commercially viable.

 

If we experience delays in obtaining approval or if we fail to obtain approval of our drug candidates, the commercial prospects for our drug candidates may be harmed and our ability to generate revenue will be materially impaired.

 

Failure to obtain marketing approval in international jurisdictions would prevent our drug candidates from being marketed abroad.

 

In order to market and sell our drugs in the European Union and any other jurisdictions, we must obtain separate marketing approvals and comply with numerous and varying regulatory requirements. The approval procedure varies among countries and can involve additional testing. The time required to obtain approval may differ substantially from that required to obtain FDA approval. The regulatory approval process outside the United States generally includes all of the risks associated with obtaining FDA approval. In addition, in many countries outside the United States, it is required that the drug be approved for reimbursement before the drug can be approved for sale in that country. We may not obtain approvals from regulatory authorities outside the United States on a timely basis, if at all. Approval by the FDA does not ensure approval by regulatory authorities in other countries or jurisdictions, and approval by one regulatory authority outside the United States does not ensure approval by regulatory authorities in other countries or jurisdictions or by the FDA. However, failure to obtain approval in one jurisdiction may impact our ability to obtain approval elsewhere. We may not be able to file for marketing approvals and may not receive necessary approvals to commercialize our drug candidates in any market.

 

A variety of risks associated with marketing our drug candidates internationally could harm our business.

 

We are seeking marketing approval for ESKATA outside of the United States, and we may also seek marketing approval for RHOFADE or our drug candidates currently in development and, accordingly, we expect that we will be subject to additional risks related to operating in foreign countries if we obtain the necessary approvals, including:

 

 

These and other risks associated with our international operations may compromise our ability to achieve or maintain profitability.

 

ESKATA, RHOFADE or any drug candidate for which we obtain marketing approval, could be subject to post-marketing restrictions or recall or withdrawal from the market, and we may be subject to penalties if we fail to comply with regulatory requirements or if we experience unanticipated problems with our drug candidates, when and if any of them are approved.

 

ESKATA, RHOFADE or any drug candidate for which we obtain marketing approval, along with the manufacturing processes, post-approval clinical data, labeling, advertising and promotional activities for such drug candidate, 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, cGMP requirements relating to manufacturing, quality control, quality assurance and corresponding maintenance of records and documents, requirements regarding the distribution of samples to physicians and recordkeeping. Even if marketing approval of a drug candidate is granted, the approval may be subject to limitations on the indicated uses for which the drug candidate may be marketed or to the conditions of approval, including the requirement to implement a risk evaluation and mitigation strategy. If any of our drug candidates receives marketing approval, the accompanying label may limit the approved use of our drug, which could limit sales of the drug.

 

The FDA may also impose requirements for costly post-marketing studies or clinical trials and surveillance to monitor the safety or efficacy of the drug. The FDA closely regulates the post-approval marketing and promotion of drugs to ensure drugs are marketed only for the approved indications and in accordance with the provisions of the approved labeling. The FDA imposes stringent restrictions on manufacturers’ communications regarding off-label use and if we do not market our drugs for their approved indications, we may be subject to enforcement action for off-label marketing. Violations of the FDCA relating to the promotion of prescription drugs may lead to investigations alleging violations of federal and state health care fraud and abuse laws, as well as state consumer protection laws.

 

In addition, later discovery of previously unknown adverse events or other problems with our drugs, manufacturers or manufacturing processes, or failure to comply with regulatory requirements, may have negative consequences, including:

 

 

Non-compliance with the European Union’s requirements regarding safety monitoring or pharmacovigilance, and with requirements related to the development of drugs for the pediatric population, can also result in significant financial penalties. Similarly, failure to comply with the European Union’s requirements regarding the protection of personal information can also lead to significant penalties and sanctions.

 

Our relationships with third-party payors, health care professionals and customers in the United States and elsewhere may be subject, directly or indirectly, to applicable anti-kickback, fraud and abuse, false claims, physician payment transparency, health information privacy and security and other health care laws and regulations, which could expose us to significant penalties.

 

Health care providers, physicians and third-party payors in the United States and elsewhere will play a primary role in the recommendation and prescription of any of our drugs and drug candidates for which we obtain marketing approval. Our arrangements with third-party payors, health care professionals and customers may expose us to broadly applicable fraud and abuse and other health care laws and regulations, including, without limitation, the federal Anti-Kickback Statute and the federal civil False Claims Act, that may constrain the business or financial arrangements and relationships through which we sell, market and distribute any drugs for which we obtain marketing approval. In addition, we may be subject to transparency laws and patient privacy regulation by the federal government and by the U.S. states and foreign jurisdictions in which we conduct our business. The applicable federal, state and foreign health care laws and regulations that may affect our ability to operate include the following:

 

 

 

 

 

 

 

Efforts to ensure that our business arrangements with third parties will comply with applicable health care laws and regulations may involve substantial costs. It is possible that governmental authorities will conclude that our business practices, including our relationships with physicians and other health care providers, some of whom may recommend, purchase and/or prescribe our products, may not comply with current or future statutes, regulations or case law involving applicable fraud and abuse or other health care laws and regulations. By way of example, some of our consulting arrangements with physicians may not meet all of the criteria of the personal services safe harbor under the federal Anti-Kickback Statute. Accordingly, they may not qualify for safe harbor protection from government prosecution. A business arrangement that does not substantially comply with a safe harbor, however, is not necessarily illegal under the Anti-Kickback Statute, but may be subject to additional scrutiny by the government.

 

If our operations are found to be in violation of any of these laws or any other governmental regulations that may apply to us, we may be subject to significant civil, criminal and administrative penalties, including, without limitation, damages, fines, disgorgement, individual imprisonment, exclusion from participation in government health care programs, such as Medicare and Medicaid, additional reporting requirements and oversight if we become subject to a corporate integrity agreement or similar agreement to resolve allegations of non-compliance with these laws and the curtailment or restructuring of our operations, which could have a material adverse effect on our business. If any of the physicians or other health care providers or entities with whom we expect to do business is found not to be in compliance with applicable

laws, it may be subject to criminal, civil or administrative sanctions, including exclusions from participation in government health care programs, which could also materially affect our business.

 

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

 

In the United States, and some foreign jurisdictions, there have been a number of legislative and regulatory changes and proposed changes regarding the health care system that could prevent or delay marketing approval of our drug candidates, restrict or regulate post-approval activities and affect our ability to profitably sell any products or drug candidates for which we obtain marketing approval.

 

Among policy makers and payors in the United States and elsewhere, there is significant interest in promoting changes in health care systems with the stated goals of containing health care costs, improving quality and/or expanding access. In the United States, the pharmaceutical industry has been a particular focus of these efforts and has been significantly affected by major legislative initiatives.  The Affordable Care Act, which was signed into law in March 2010, is a sweeping law intended to broaden access to health insurance, reduce or constrain the growth of health care spending, enhance remedies against fraud and abuse, add new transparency requirements for the health care and health insurance industries, impose new taxes and fees on the health industry and impose additional health policy reforms.

 

Among the provisions of the Affordable Care Act of importance to our products and potential drug candidates are the following:

 

 

Since its enactment there have been judicial and Congressional challenges to, as well efforts by the Trump Administration to repeal or replace certain aspects of the Affordable Care Act. As a result, there have been delays in the implementation of, and action taken to repeal or replace, certain aspects of the Affordable Care Act.  For example, since January 2017, President Trump has signed two executive orders and other directives designed to delay, circumvent, or loosen certain requirements mandated by the Affordable Care Act. Concurrently, Congress has considered legislation that would repeal or repeal and replace all or part of the Affordable Care Act. While Congress has not passed comprehensive repeal legislation, two bills affecting the implementation of certain taxes under the Affordable Care Act have been signed into law. The Tax Cuts and Jobs Act of 2017 includes a provision that repealed, effective January 1, 2019, the tax-based shared responsibility payment imposed by the Affordable Care Act on certain individuals who fail to maintain qualifying health coverage for all or part of a year that is commonly referred to as the “individual mandate”.  Additionally, on January

22, 2018, President Trump signed a continuing resolution on appropriations for fiscal year 2018 that delayed the implementation of certain Affordable Care Act-mandated fees, including the so-called “Cadillac” tax on certain high cost employer-sponsored insurance plans, the annual fee imposed on certain health insurance providers based on market share, and the medical device excise tax on non-exempt medical devices. Further, the Bipartisan Budget Act of 2018, or the BBA, among other things, amended the Affordable Care Act, effective January 1, 2019, to close the coverage gap in most Medicare drug plans, commonly referred to as the “donut hole”.  In July 2018, CMS published a final rule permitting further collections and payments to and from certain Affordable Care Act qualified health plans and health insurance issuers under the Affordable Care Act risk adjustment program in response to the outcome of federal district court litigation regarding the method CMS uses to determine this risk adjustment. On December 14, 2018, a Texas U.S. District Court Judge ruled that the Affordable Care Act is unconstitutional in its entirety because the “individual mandate” was repealed by Congress as part of the Tax Cuts and Jobs Act of 2017. While the Texas U.S. District Court Judge, as well as the Trump Administration and CMS, has stated that the ruling will have no immediate effect pending appeal of the decision, it is unclear how this decision, subsequent appeals, and other efforts to repeal and replace the Affordable Care Act will impact the Affordable Care Act. We continue to evaluate the impact of the Affordable Care Act and efforts to repeal or replace the Affordable Care Act on our business.

 

In addition, other legislative changes have been proposed and adopted since the Affordable Care Act was enacted. These changes included aggregate reductions to Medicare payments to providers of 2% per fiscal year that became effective on April 1, 2013 and, due to subsequent legislative amendments to the statute, including the BBA, will stay in effect through 2027 unless additional Congressional action is taken.  The American Taxpayer Relief Act of 2012, which was signed into law in January 2013, among other things, further reduced Medicare payments to several providers, and increased the statute of limitations period for the government to recover overpayments to providers from three to five years. Any similar new laws may result in additional reductions in Medicare and other health care funding, which could have a material adverse effect on customers for ESKATA and RHOFADE and, if approved, our drug candidates, and, accordingly, our financial operations.

 

We expect that the Affordable Care Act, as well as other health care reform measures that may be adopted in the future, may result in more rigorous coverage criteria and in additional downward pressure on the price that we receive for any approved drug. Any reduction in reimbursement from Medicare or other government programs may result in a similar reduction in payments from private payors. The implementation of cost containment measures or other health care reforms may prevent us from being able to generate revenue, attain profitability, or commercialize our drugs.

 

Legislative and regulatory proposals have been made to expand post-approval requirements and restrict sales and promotional activities for drugs.  In addition, there has been heightened governmental scrutiny in the United States of pharmaceutical pricing practices in light of the rising cost of prescription drugs and biologics. Such scrutiny has resulted in several recent Congressional inquiries and proposed and enacted federal and state legislation designed to, among other things, bring more transparency to drug pricing, review the relationship between pricing and manufacturer patient programs, and reform government program reimbursement methodologies for drugs. At the federal level, the Trump Administration’s budget proposal for fiscal year 2019 contains further drug price control measures that could be enacted during the 2019 budget process or in other future legislation, including, for example, measures to permit Medicare Part D plans to negotiate the price of certain drugs under Medicare Part B, to allow some states to negotiate drug prices under Medicaid, and to eliminate cost sharing for generic drugs for low-income patients. Further, the Trump Administration released a “Blueprint”, or plan, to lower drug prices and reduce out-of-pocket costs of drugs that contains additional proposals to increase drug manufacturer competition, increase the negotiating power of certain federal health care programs, incentivize manufacturers to lower the list price of their drugs, and reduce the out of pocket costs of drug products paid by consumers. HHS has already started the process of soliciting feedback on some of these measures and, at the same time, is immediately implementing others under its existing authority. For example, in September 2018, CMS announced that it will allow Medicare Advantage plans the option to use step therapy for Part B drugs beginning January 1, 2019, and in October 2018, CMS proposed a new rule that would require direct-to-consumer television advertisements of prescription drugs and biological products, for which payment is available through or under Medicare or Medicaid, to include in the advertisement the Wholesale Acquisition Cost, or list price, of that drug or biological product. On January 31, 2019, the HHS Office of Inspector General proposed modifications to the federal Anti-Kickback Statute discount safe harbor for the purpose of reducing the cost of drug products to consumers which, among other things, if finalized, will affect discounts paid by manufacturers to Medicare Part D plans, Medicaid managed care organizations and pharmacy benefit managers working with these organizations. While some of these and other proposed measures may require authorization through additional legislation to become effective, Congress and the Trump Administration have both stated that they will continue to seek new legislative and/or administrative measures to control drug costs. At the state level,

legislatures have become increasingly active in passing legislation and implementing regulations designed to control pharmaceutical and biological product pricing, including price or patient reimbursement constraints, discounts, restrictions on certain drug access and marketing cost disclosure and transparency measures, and, in some cases, designed to encourage importation from other countries and bulk purchasing  We cannot be sure whether additional legislative changes will be enacted, or whether the FDA regulations, guidance or interpretations will be changed, or what the impact of such changes on the marketing approvals of our drug candidates, if any, may be. In addition, increased scrutiny by the U.S. Congress of the FDA’s approval process may significantly delay or prevent marketing approval, as well as subject us to more stringent drug labeling and post-marketing testing and other requirements.

 

If ESKATA is not granted NCE exclusivity from the FDA, our period of marketing exclusivity for ESKATA will be shorter than previously anticipated, and our business could be harmed. 

 

Under the FDCA, as amended by the Hatch-Waxman Act, a drug that is granted regulatory approval may be eligible for five years of marketing exclusivity in the United States following regulatory approval if that drug is classified as an NCE.  A drug can be classified as an NCE if the FDA has not previously approved any other drug containing the same active moiety. 

 

The FDA published a determination on the marketing exclusivity of ESKATA in a cumulative supplement to its Orange Book and determined that ESKATA is eligible for a three-year period of exclusivity for a new product, which would continue until December 14, 2020, rather than the five-year exclusivity for an NCE.  While we believe we are entitled to an NCE determination for ESKATA, to date the FDA has not agreed with our position. Although we have appealed the FDA’s decision, there can be no assurance that ESKATA will be granted NCE exclusivity, or that the FDA will make a determination on such appeal of their exclusivity decision in a timely manner. 

 

NCE marketing exclusivity, if granted, would preclude approval during the five-year exclusivity period of certain 505(b)(2) applications or ANDAs that rely upon the FDA’s findings of safety and efficacy for ESKATA.  However, such an application may be submitted after four years if it contains a certification of patent invalidity or non-infringement. In this case, we may be afforded the benefit of a 30-month stay against the launch of such a competitive product that would extend from the end of the five-year exclusivity period, and may also be afforded other extensions under applicable regulations, including a judicial extension if applicable requirements are met. If we are not able to gain or exploit the period of marketing exclusivity, we may face significant competitive threats from other manufacturers, including the manufacturers of generic alternatives. Further, even if ESKATA is considered to be an NCE and we are able to gain five-year marketing exclusivity, another company could challenge that decision to seek to overturn the FDA’s determination.

 

ESKATA has been granted three years of new product exclusivity under the Hatch-Waxman Amendments. A three-year period of exclusivity is granted under the Hatch-Waxman Amendments for a drug product that contains an active moiety that has been previously approved when the application contains reports of new clinical investigations (other than bioavailability studies) conducted by the sponsor that were essential to approval of the application.  Our clinical trials of ESKATA were new clinical investigations that were essential to the approval of our NDA.  We are entitled to at least three-year exclusivity even if the FDA determines that the hydrogen peroxide moiety was previously approved because our clinical investigations were essential for the approval of our new drug product, ESKATA. 

 

Such three-year exclusivity protection precludes the FDA from approving a marketing application for 505(b)(2) NDA or ANDA for the same conditions of approval as ESKATA for a period of three years from the date of ESKATA’s FDA approval, i.e., through December 14, 2020 although the FDA may accept and commence review of such applications during the exclusivity period. This three-year form of exclusivity may also not prevent the FDA from approving an NDA that relies only on its own data to support the change or innovation.  Any loss of exclusive marketing rights for ESKATA through introduction of generic or competing products would harm our financial position.

 

Governments outside the United States tend to impose strict price controls, which may adversely affect our revenue, if any.

 

In some countries, particularly the countries of the European Union, the pricing of prescription pharmaceuticals is subject to governmental control. In these countries, pricing negotiations with governmental authorities can take considerable time after the receipt of marketing approval for a drug. To obtain coverage and reimbursement or pricing approval in some countries, we may be required to conduct a clinical trial that compares the cost-effectiveness of our drug candidate to other available procedures. If reimbursement of our drugs is unavailable or limited in scope or amount, or if pricing is set at unsatisfactory levels, our business could be harmed, possibly materially. 

 

If we fail to comply with environmental, health and safety laws and regulations, we could become subject to fines or penalties or incur costs that could harm our business.

 

We are subject to numerous environmental, health and safety laws and regulations, including those governing laboratory procedures and the handling, use, storage, treatment and disposal of hazardous materials and wastes. Our operations involve the use of hazardous and flammable materials, including chemicals and biological materials. Our operations also produce hazardous waste products. We generally contract with third parties for the disposal of these materials and wastes. We cannot eliminate the risk of contamination or injury from these materials. In the event of contamination or injury resulting from our use of hazardous materials, we could be held liable for any resulting damages, and any liability could exceed our resources. We also could incur significant costs associated with civil or criminal fines and penalties for failure to comply with such laws and regulations. 

 

Although we maintain workers’ compensation insurance to cover us for costs and expenses we may incur due to injuries to our employees resulting from the use of hazardous materials, this insurance may not provide adequate coverage against potential liabilities. We do not maintain insurance for environmental liability or toxic tort claims that may be asserted against us in connection with our storage or disposal of biological, hazardous or radioactive materials.

 

In addition, we may incur substantial costs in order to comply with current or future environmental, health and safety laws and regulations. These current or future laws and regulations may impair our development or production efforts. Our failure to comply with these laws and regulations also may result in substantial fines, penalties or other sanctions. 

 

The inherent dangers in production and transportation of hydrogen peroxide could cause disruptions and could expose us to potentially significant losses, costs or liabilities.

 

Our operations are subject to significant hazards and risks inherent in the use and transport of hydrogen peroxide, the active ingredient of ESKATA and A-101 45% Topical Solution. Hydrogen peroxide can decompose in the presence of organic materials and is categorized as an oxidizer and is corrosive. Hydrogen peroxide should be stored in cool, dry, well-ventilated areas and away from any flammable or combustible substances. The hazards and risks associated with producing and transporting hydrogen peroxide include fires, explosions, third-party interference (including terrorism) and mechanical failure of equipment at our facilities or those of our supplier of hydrogen peroxide. The occurrence of any of these events could result in production and distribution difficulties and disruptions, personal injury or wrongful death claims and other damage to properties.

 

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

 

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

 

U.S. economic sanctions and export control laws and regulations prohibit the shipment of certain products and services to countries, governments and persons targeted by U.S. sanctions. While we are currently taking precautions to prevent doing any business, directly or indirectly, with countries, governments and persons targeted by U.S. sanctions and

to ensure that our products and drug candidates, are not exported or used by countries, governments and persons targeted by U.S. sanctions, such measures may be circumvented. 

 

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

 

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

 

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

 

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

 

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

 

Risks Related to Employee Matters and Managing Our Growth

 

Our future success depends on our ability to retain key executives and to attract, retain and motivate qualified personnel.

 

We are highly dependent on the management, development, clinical, financial, legal and business development expertise of Dr. Neal Walker, our Chief Executive Officer, Dr. Stuart Shanler, our Chief Scientific Officer, Dr. David Gordon, our Chief Medical Officer, Frank Ruffo, our Chief Financial Officer, and Kamil Ali-Jackson, our Chief Legal Officer, as well as the other members of our scientific and clinical teams. Although we have entered into employment agreements with certain of our executive officers, each of them may currently terminate their employment with us or resign at any time. We do not maintain “key person” insurance for any of our key executives other than for Dr. Walker. 

 

Recruiting and retaining qualified scientific and clinical personnel and, if we progress the development of our drug pipeline toward scaling up for commercialization, manufacturing and sales and marketing personnel, will also be critical to our success. The loss of the services of our executive officers or other key employees could impede the achievement of our development and commercialization objectives and seriously harm our ability to successfully implement our business strategy. Furthermore, replacing executive officers and key employees may be difficult and may take an extended period of time because of the limited number of individuals in our industry with the breadth of skills and experience required to successfully develop, gain marketing approval of and commercialize drugs. Competition to hire from this limited pool is intense, and we may be unable to hire, train, retain or motivate these key personnel on acceptable terms given the competition among numerous pharmaceutical and biotechnology companies for similar personnel. We also experience competition for the hiring of scientific and clinical personnel from universities and research institutions. In addition, we rely on consultants and advisors, including scientific and clinical advisors, to assist us in formulating our

development and commercialization strategy. Our consultants and advisors may be employed by employers other than us and may have commitments under consulting or advisory contracts with other entities that may limit their availability to us. If we are unable to continue to attract and retain high quality personnel, our ability to pursue our growth strategy will be limited. 

 

We expect to expand our development and regulatory capabilities and implement sales, marketing and distribution capabilities, and as a result, we may encounter difficulties in managing our growth, which could disrupt our operations.

 

As of December 31, 2018, we had 169 full-time and part-time employees. As we progress, we expect to experience growth in the number of our employees and the scope of our operations, particularly in the areas of drug development, regulatory affairs, sales, marketing and distribution. To manage our anticipated future growth, we must continue to implement and improve our managerial, operational and financial systems, expand our facilities and continue to recruit and train additional qualified personnel. Due to our limited financial resources and the limited experience of our management team in managing a company with such anticipated growth, we may not be able to effectively manage the expansion of our operations or recruit and train additional qualified personnel. The expansion of our operations may lead to significant costs and may divert our management and business development resources. Any inability to manage growth could delay the execution of our business plans or disrupt our operations.

 

Our employees, independent contractors, consultants, commercial collaborators, principal investigators, CROs and vendors may engage in misconduct or other improper activities, including non-compliance with regulatory standards and requirements.

 

We are exposed to the risk that our employees, independent contractors, consultants, commercial collaborators, principal investigators, CROs and vendors may engage in fraudulent conduct or other illegal activity. Misconduct by these parties could include intentional, reckless and/or negligent conduct or disclosure of unauthorized activities to us that violates FDA regulations, including those laws requiring the reporting of true, complete and accurate information to the FDA, manufacturing standards, federal and state health care laws and regulations, and laws that require the true, complete and accurate reporting of financial information or data. In particular, sales, marketing and business arrangements in the health care industry are subject to extensive laws and regulations intended to prevent fraud, kickbacks, self-dealing and other abusive practices. These laws and regulations may restrict or prohibit a wide range of pricing, discounting, marketing and promotion, sales commission, customer incentive programs and other business arrangements. Misconduct by these parties could also involve the improper use of individually identifiable information, including, without limitation, information obtained in the course of clinical trials, which could result in regulatory sanctions and serious harm to our reputation. We have adopted a code of business conduct and ethics, but it is not always possible to identify and deter misconduct, and the precautions we take to detect and prevent this activity may not be effective in controlling unknown or unmanaged risks or losses or in protecting us from governmental investigations or other actions or lawsuits stemming from a failure to be in compliance with such laws or regulations. If any such actions are instituted against us, and we are not successful in defending ourselves or asserting our rights, those actions could have a significant impact on our business, including the imposition of significant civil, criminal and administrative penalties, including, without limitation, damages, fines, disgorgement, imprisonment, exclusion from participation in government health care programs, such as Medicare and Medicaid, additional reporting obligations and oversight if we are subject to a corporate integrity agreement or other agreement to resolve allegations of non-compliance with these laws, and the curtailment or restructuring of our operations.

 

We may not realize the anticipated benefits of our acquisition of Confluence.

 

In August 2017, we acquired Confluence, including several preclinical drug candidates and Confluence’s contract research services business. Acquisitions are inherently risky, and we may not realize the anticipated benefits of the acquisition of Confluence.  Specifically, we are subject to the risks that:

 

 

If any of these events were to occur, our ability to achieve the anticipated benefits of the merger could be adversely affected, or could reduce our future earnings or otherwise adversely affect our business and financial results and, as a result, adversely affect the market price of our common stock.

 

We may not realize the anticipated benefits from our acquisition of RHOFADE. 

 

The success of our acquisition of RHOFADE will depend, in large part, on our ability to realize operating synergies from combining RHOFADE with our portfolio of drug candidates and ESKATA. 

 

The failure to successfully integrate and manage the challenges presented by the integration process may result in our failure to achieve some or all of the anticipated benefits of the acquisition. Potential difficulties that may be encountered include the following:

 

 

If any of these events were to occur, our ability to maintain relationships with customers, suppliers and employees or our ability to achieve the anticipated benefits of the acquisition could be adversely affected, or could reduce our future earnings or otherwise adversely affect our business and financial results and, as a result, adversely affect the market price of our common stock. 

  

Risks Related to Ownership of Our Common Stock

 

An active trading market for our common stock may not continue to develop or be sustained.

 

Prior to our initial public offering in October 2015, there was no public market for our common stock. Although our common stock is listed on The Nasdaq Global Select Market, we cannot assure you that an active trading market for our shares will continue to develop or be sustained. If an active market for our common stock does not continue to develop or is not sustained, it may be difficult for investors in our common stock to sell shares without depressing the market price for the shares or to sell the shares at all. 

 

The trading price of the shares of our common stock has been and is likely to continue to be volatile.

 

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

 

 

In addition, in the past, stockholders have initiated class action lawsuits against pharmaceutical and biotechnology companies following periods of volatility in the market prices of these companies’ stock. Such litigation, if instituted against us, could cause us to incur substantial costs and divert management’s attention and resources from our business.

 

If equity research analysts do not publish research or reports, or publish unfavorable research or reports, about us, our business or our market, our stock price and trading volume could decline.

 

The trading market for our common stock is influenced by the research and reports that equity research analysts publish about us or our business, our market and our competitors. Equity research analysts may elect not to initiate or continue to provide research coverage of our common stock, and such lack of research coverage may adversely affect the market price of our common stock. Even if we have equity research analyst coverage, we will not have any control over the analysts or the content and opinions included in their reports. The price of our stock could decline if one or more equity research analysts downgrade our stock or issue other unfavorable commentary or research. If one or more equity research analysts ceases coverage of our company or fails to publish reports on us regularly, demand for our stock could decrease, which in turn could cause our stock price or trading volume to decline. 

 

The issuance of additional stock in connection with financings, acquisitions, investments, our equity incentive plan or otherwise will dilute all other stockholders.

 

Our certificate of incorporation authorizes us to issue up to 100,000,000 shares of common stock and up to 10,000,000 shares of preferred stock with such rights and preferences as may be determined by our board of directors. Subject to compliance with applicable rules and regulations, we may issue our shares of common stock or securities convertible into our common stock from time to time in connection with a financing, acquisition, investment, our equity incentive plan or otherwise. Any such issuance could result in substantial dilution to our existing stockholders and cause the trading price of our common stock to decline. 

 

Sales of a substantial number of shares of our common stock into the market could cause the market price of our common stock to drop significantly, even if our business is doing well.

 

Sales of a substantial number of shares of our common stock in the public market could occur at any time. If our stockholders sell, or the market perceives that our stockholders intend to sell, substantial amounts of our common stock in the public market, the market price of our common stock could decline significantly.

 

In addition, we have filed registration statements on Form S-8 under the Securities Act registering the issuance of shares of common stock subject to options or other equity awards issued or reserved for future issuance under our equity incentive plans. Shares registered under these registration statements are available for sale in the public market subject to

vesting arrangements and exercise of options, and the restrictions of Rule 144 under the Securities Act in the case of our affiliates.

 

Additionally, certain holders of shares of our common stock, or their transferees, have rights, subject to some conditions, to require us to file one or more registration statements covering their shares or to include their shares in registration statements that we may file for ourselves or other stockholders. If we were to register the resale of these shares, they could be freely sold in the public market. If these additional shares are sold, or if it is perceived that they will be sold, in the public market, the trading price of our common stock could decline.

 

Provisions in our corporate charter documents and under Delaware law may prevent or frustrate attempts by our stockholders to change our management and hinder efforts to acquire a controlling interest in us, and the market price of our common stock may be lower as a result.

 

There are provisions in our certificate of incorporation and bylaws that may make it difficult for a third party to acquire, or attempt to acquire, control of our company, even if a change of control was considered favorable by some or all of our stockholders. For example, our board of directors has the authority to issue up to 10,000,000 shares of preferred stock. The board of directors can fix the price, rights, preferences, privileges, and restrictions of the preferred stock without any further vote or action by our stockholders. The issuance of shares of preferred stock may delay or prevent a change of control transaction. As a result, the market price of our common stock and the voting and other rights of our stockholders may be adversely affected. An issuance of shares of preferred stock may result in the loss of voting control to other stockholders.

 

Our charter documents also contain other provisions that could have an anti-takeover effect, including:

 

 

In addition, we are subject to the anti-takeover provisions of Section 203 of the Delaware General Corporation Law, which regulates corporate acquisitions by prohibiting Delaware corporations from engaging in specified business combinations with particular stockholders of those companies. These provisions could discourage potential acquisition proposals and could delay or prevent a change of control transaction. They could also have the effect of discouraging others from making tender offers for our common stock, including transactions that may be in your best interests. These provisions may also prevent changes in our management or limit the price that investors are willing to pay for our stock.

 

Concentration of ownership of our common stock among our existing executive officers, directors and principal stockholders may prevent new investors from influencing significant corporate decisions.

 

Our executive officers, directors and current beneficial owners of 5% or more of our common stock and their respective affiliates beneficially own a substantial portion of our common stock. As a result, these persons, acting together, would be able to significantly influence all matters requiring stockholder approval, including the election and removal of directors, any merger, consolidation, sale of all or substantially all of our assets, or other significant corporate transactions. The interests of this group of stockholders may not coincide with our interests or the interests of other stockholders.

 

We are an “emerging growth company” and, as a result of the reduced disclosure and governance requirements applicable to emerging growth companies, our common stock may be less attractive to investors.

 

We are an “emerging growth company” as defined in the Jumpstart Our Business Startups Act of 2012, or the JOBS Act, and we intend to take advantage of some of the exemptions from reporting requirements that are applicable to other public companies that are not emerging growth companies, including:

 

 

We cannot predict if investors will find our common stock less attractive because we will rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our stock price may be more volatile. We may take advantage of these reporting exemptions until we are no longer an emerging growth company. We will remain an emerging growth company until the earlier of (1) December 31, 2020, (2) the last day of the fiscal year in which we have total annual gross revenue of at least $1.07 billion, (3) the last day of the fiscal year in which we are deemed to be a large accelerated filer, which means the market value of our common stock that is held by non-affiliates exceeds $700 million as of the prior June 30th and (4) any date on which we have issued more than $1.0 billion in non-convertible debt during the prior three-year period.

 

We also qualify as a “smaller reporting company” as defined in Rule 12b-2 of the Exchange Act, and so long as we remain a smaller reporting company, we benefit from some of the same scaled disclosure requirements.

 

Under Section 107(b) of the JOBS Act, 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, we will be subject to the same new or revised accounting standards as other public companies that are not emerging growth companies.

 

If we fail to maintain proper and effective internal controls, our ability to produce accurate financial statements on a timely basis could be impaired.

 

We are subject to the reporting requirements of the Exchange Act, the Sarbanes-Oxley Act and the rules and regulations of the stock market on which our common stock is listed. The Sarbanes-Oxley Act requires, among other things, that we maintain effective disclosure controls and procedures and internal control over financial reporting, and perform system and process evaluation and testing of our internal control over financial reporting to allow management to report on the effectiveness of our internal control over financial reporting. This requires that we incur substantial additional professional fees and internal costs to expand our accounting and finance functions and that we expend significant management efforts.

 

We may identify weaknesses in our system of internal financial and accounting controls and procedures that could result in a material misstatement of our consolidated financial statements. Our internal control over financial reporting will not prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud will be detected.

 

If we are unable to maintain proper and effective internal controls, we may not be able to produce timely and accurate financial statements, and we may conclude that our internal control over financial reporting is not effective. If that were to happen, the market price of our stock could decline, and we could be subject to sanctions or investigations by the stock exchange on which our common stock is listed, the SEC, or other regulatory authorities.

 

We might not be able to utilize a significant portion of our net operating loss carryforwards and research and development tax credit carryforwards.

 

As of December 31, 2018, we had federal and state net operating loss carryforwards of $199.5 million and $212.4 million, respectively, which will begin to expire in 2032.  As of December 31, 2018, we also had federal research and development tax credit carryforwards of $4.9 million which begin to expire in 2032, and state research and development tax credit carryforwards of $0.1 million which begin to expire in 2022. These net operating loss and tax credit carryforwards could expire unused and be unavailable to offset future income tax liabilities. In addition, under Section 382 of the Internal Revenue Code of 1986, as amended, and corresponding provisions of state law, if a corporation undergoes an “ownership change,” which is generally defined as a greater than 50% change, by value, in its equity ownership over a three-year period, the corporation’s ability to use its pre-change net operating loss carryforwards and other pre-change tax attributes to offset its post-change income may be limited.  We have completed an analysis under Section 382 for net operating loss carryforwards generated from July 13, 2012 through December 31, 2016.  Although we have experienced Section 382 ownership changes since 2012, we have concluded that we should have sufficient ability to utilize net operating loss carryforwards accumulated during the periods tested.  We have not yet determined if a Section 382 ownership change has occurred during the year ended December 31, 2017, or for Confluence prior to the acquisition.  In addition, we may experience ownership changes in the future as a result of subsequent shifts in our stock ownership, some of which may be outside of our control. If we determine that an ownership change has occurred and our ability to use our historical net operating loss and tax credit carryforwards is materially limited, it would harm our future operating results by effectively increasing our future tax obligations. 

 

The 2017 comprehensive tax reform bill could adversely affect our business and financial condition.

 

On December 22, 2017, the Tax Cuts and Jobs Act of 2017 was signed into law which significantly revised the Internal Revenue Code of 1986, as amended.  The federal income tax legislation, among other things, contained significant changes to corporate taxation, including reduction of the corporate tax rate from a top marginal rate of 35% to a flat rate of 21%, limitation of the tax deduction for interest expense to 30% of adjusted earnings (except for certain small businesses), limitation of the deduction for net operating losses to 80% of current year taxable income and elimination of net operating loss carrybacks, one time taxation of offshore earnings at reduced rates regardless of whether they are repatriated, elimination of U.S. tax on foreign earnings (subject to certain important exceptions), immediate deductions for certain new investments instead of deductions for depreciation expense over time, and modifying or repealing many business deductions and credits.  Notwithstanding the reduction in the corporate income tax rate, the overall impact of the changes to the federal tax law is uncertain and our business and financial condition could be adversely affected.  In addition, it is uncertain how various states will respond to the changes in the federal tax law.  The impact of this tax reform on holders of our common stock is also uncertain and could be adverse.  We urge our stockholders to consult with their legal and tax advisors with respect to this legislation and the potential tax consequences of investing in or holding our common stock.

 

We have broad discretion in the use of proceeds from our equity financing transactions and may invest or spend the proceeds in ways with which you do not agree and in ways that may not increase the value of your investment.

 

We have broad discretion over the use of proceeds from our equity financing transactions over the last several years. You may not agree with our decisions, and our use of the proceeds may not yield any return on your investment. We expect to use the net proceeds from those transactions to conduct commercial activities for ESKATA and RHOFADE, and to fund the continued research and development of our drug candidates, as well as for working capital and general corporate purposes. Our failure to apply the net proceeds effectively could compromise our ability to pursue our strategy and we might not be able to yield a significant return, if any, on our investment of these net proceeds. Stockholders will not have the opportunity to influence our decisions on how to use these net proceeds.

 

We do not anticipate paying any cash dividends on our common stock in the foreseeable future and our stock may not appreciate in value.

 

We have not declared or paid cash dividends on our common stock to date. We currently intend to retain our future earnings, if any, to fund the development and growth of our business. In addition, the terms of our current loan agreement with Oxford prohibits us, and future debt agreements may also preclude us, from paying dividends. There is no guarantee that shares of our common stock will appreciate in value or that the price at which our stockholders have purchased their shares will be able to be maintained.

 

We will incur increased costs and demands upon management as a result of being a public company.

 

As a public company listed in the United States, we have begun, and will continue, particularly after we cease to be an “emerging growth company,” to incur significant additional legal, accounting and other costs. These additional costs could negatively affect our financial results. In addition, changing laws, regulations and standards relating to corporate governance and public disclosure, including regulations implemented by the SEC and The Nasdaq Stock Market, may increase legal and financial compliance costs and make some activities more time-consuming. These laws, regulations and standards are subject to varying interpretations and, as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies. We intend to invest resources to comply with evolving laws, regulations and standards, and this investment may result in increased general and administrative expenses and a diversion of management’s time and attention from revenue-generating activities to compliance activities. If notwithstanding our efforts to comply with new laws, regulations and standards, we fail to comply, regulatory authorities may initiate legal proceedings against us and our business may be harmed.

 

Failure to comply with these rules might also make it more difficult for us to obtain some types of insurance, including director and officer liability insurance, and we might be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. The impact of these events could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors, on committees of our board of directors or as members of senior management.

 

Our amended and restated certificate of incorporation provides that the Court of Chancery of the State of Delaware is the exclusive forum for certain litigation that may be initiated by our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers or employees.

 

Our amended and restated certificate of incorporation provides that the Court of Chancery of the State of Delaware is the exclusive forum for (i) any derivative action or proceeding brought on our behalf, (ii) any action asserting a claim for breach of a fiduciary duty owed by any of our directors, officers or other employees to us or our stockholders, (iii) any action asserting a claim arising pursuant to any provision of the Delaware General Corporation Law, our amended and restated certificate of incorporation or our amended and restated bylaws or (iv) any action asserting a claim governed by the internal affairs doctrine. The choice of forum provision may limit a stockholder’s ability to bring a claim in a judicial forum that it finds favorable for disputes with us or our directors, officers or other employees, which may discourage such lawsuits against us and our directors, officers and other employees. Alternatively, if a court were to find the choice of forum provision contained in our amended and restated certificate of incorporation to be inapplicable or unenforceable in an action, we may incur additional costs associated with resolving such action in other jurisdictions, which could adversely affect our business and financial condition. 

 

Item 1B. Unresolved Staff Comments

 

None.

 

Item 2. Properties

 

We currently sublease 33,019 square feet of space for our headquarters in Wayne, Pennsylvania.  Subject to the consent of Chesterbrook Partners, LP, the Landlord, as set forth in the lease by and between them and Auxilium Pharmaceuticals, LLC, the Sublandlord, the term of our sublease has a term through October 2023.  If for any reason the lease between the Landlord and Sublandlord is terminated or expires prior to October 2023, our sublease will automatically terminate.  We also lease 21,056 square feet of office and laboratory space in St. Louis, Missouri, which has a term of 10 years which we expect to commence by the end of the first half of 2019. Until we move to that space, we continue to occupy 3,689 square feet of office and laboratory space in St. Louis, Missouri under the terms of a short-term lease.  We believe that our facilities are suitable and adequate to meet our current needs. 

 

Item 3. Legal Proceedings

 

We are not subject to any material legal proceedings.

 

Item 4. Mine Safety Disclosures

 

Not applicable.

 

 

PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

Market Information for Common Stock

 

Our common stock is listed on the Nasdaq Global Select Market under the symbol “ACRS.” 

 

Dividend Policy

 

We have never declared or paid any dividends on our common stock. We anticipate that we will retain all of our future earnings, if any, for use in the operation and expansion of our business and do not anticipate paying cash dividends in the foreseeable future.

 

Stockholders

 

As of March 15, 2019, we had 41,269,643 shares of common stock outstanding held by 71 holders of record. The actual number of stockholders is greater than this number of record holders and includes stockholders who are beneficial owners but whose shares are held in street name by brokers and other nominees. This number of holders of record also does not include stockholders whose shares may be held in trust by other entities.

 

Recent Sales of Unregistered Securities

 

On November 29, 2018, we issued 253,208 shares of our common stock upon the achievement of a specified development milestone in accordance with the terms of the Confluence Agreement to former Confluence equity holders who are “accredited investors,” as that term is defined in the Securities Act, in reliance on the exemption from registration afforded by Section 4(a)(2) of the Securities Act and Rule 506 of Regulation D promulgated under the Securities Act and corresponding provisions of state securities or “blue sky” laws. Each of the former Confluence equity holders who received such shares of our common stock has represented that it was acquiring such shares for investment only and not with a view towards, or for resale in connection with, the public sale or distribution thereof. Such shares have not been registered under the Securities Act and such securities may not be offered or sold in the United States absent registration or an exemption from registration under the Securities Act and any applicable state securities laws.

 

Purchases of Equity Securities by the Issuer and Affiliated Parties

 

None.

 

Item 6. Selected Consolidated Financial Data

 

Not applicable.

 

 

 

 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with the consolidated financial statements and the related notes to those statements included later in this Annual Report. In addition to historical financial information, the following discussion contains forward‑looking statements that reflect our plans, estimates, beliefs and expectations that involve risks and uncertainties. Our actual results and the timing of events could differ materially from those discussed in these forward‑looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Annual Report, particularly in “Item 1A. Risk Factors” and “Special Note Regarding Forward‑Looking Statements.”

 

Overview

 

We are a physician-led biopharmaceutical company focused on dermatological and immuno-inflammatory diseases.  We have two commercial products and a diverse pipeline of drug candidates.

 

Our first commercial product, ESKATA (hydrogen peroxide) topical solution, 40% (w/w), or ESKATA, is a proprietary formulation of high-concentration hydrogen peroxide topical solution which was approved by the U.S. Food and Drug Administration, or FDA, in December 2017 as an office-based prescription treatment for raised seborrheic keratosis, or SK, a common non-malignant skin tumor.  We launched ESKATA in the United States in May 2018.  We also submitted a Marketing Authorization Application, or MAA, for ESKATA in select countries in the European Union, Norway and Iceland in July 2017 using a decentralized procedure.  In February 2019, we received approval from the Swedish Medical Products Agency to market ESKATA (hydrogen peroxide) cutaneous solution, 685 mg for the treatment in adults of SKs that are not pedunculated and have up to a maximum diameter of 15 millimeters each.  We have also received approval to market ESKATA in the United Kingdom, Iceland and Belgium.

 

In November 2018, we acquired RHOFADE (oxymetazoline hydrochloride) cream, 1%, or RHOFADE, which includes an exclusive license to certain intellectual property for RHOFADE, as well as additional intellectual property, from Allergan Sales, LLC, or Allergan.  RHOFADE was approved by the FDA in January 2017 for the topical treatment of persistent facial erythema (redness) associated with rosacea in adults. Persistent facial redness is the most common sign of rosacea in most skin types.

 

We continue to develop our sales, marketing and product distribution capabilities for ESKATA and RHOFADE in order to support our commercialization efforts in the United States.  We plan to continue to deploy sales representatives in approximately 50 territories in the United States which we believe will allow us to reach the health care providers in the United States with the highest potential for prescribing ESKATA and RHOFADE to their patients.

 

We are also developing another high-concentration formulation of hydrogen peroxide, A-101 45% Topical Solution, as a prescription treatment for common warts, also known as verruca vulgaris.  On an annual basis, approximately 2.0 million people in the United States are diagnosed with common warts.

 

Additionally, in 2015, we in-licensed exclusive, worldwide rights from Rigel Pharmaceuticals, Inc., or Rigel, to certain inhibitors of the Janus kinase, or JAK, family of enzymes, for specified dermatological conditions, including alopecia areata, or AA.  AA is an autoimmune dermatologic condition typically characterized by patchy non-scarring hair loss on the scalp and body.  More severe forms of AA include total scalp hair loss, known as alopecia totalis, or AT, and total hair loss on the scalp and body, known as alopecia universalis, or AU. We are also developing these JAK inhibitors for the treatment of vitiligo, androgenetic alopecia, or AGA, also known as male or female pattern baldness, and atopic dermatitis.    

 

In 2016, in connection with the acquisition of Vixen Pharmaceuticals, Inc., or Vixen, we acquired additional intellectual property rights for the development and commercialization of certain JAK inhibitors for specified dermatological conditions.  We intend to continue to in-license or acquire additional drug candidates and technologies to build a fully integrated biopharmaceutical company.

 

In 2017, we acquired Confluence Life Sciences, Inc. (now known as Aclaris Life Sciences, Inc.), or Confluence.  The acquisition of Confluence added small molecule drug discovery and preclinical development capabilities that allowed us to bring early-stage research and development activities in-house that we previously outsourced to third parties.  We intend to leverage the proprietary KINect drug discovery platform to identify potential drug candidates that we may

develop independently or with partners. We also acquired several preclinical drug candidates, including additional topical JAK inhibitors known as soft-JAK inhibitors, inhibitors of the MK-2 signaling pathway and inhibitors of interleukin-2-inducible T cell kinase, or ITK. Soft-JAK inhibitors may be topically applied and active in the skin, but will be rapidly metabolized and inactivated when they enter the bloodstream, which may result in significantly reduced systemic exposure. We also earn revenue from Confluence’s provision of contract research services to third parties. 

 

Since our inception, we have incurred significant operating losses.  Our net loss was $132.7 million for the year ended December 31, 2018 and $68.5 million for the year ended December 31, 2017.  As of December 31, 2018, we had an accumulated deficit of $292.2 million.  We expect to incur significant expenses and operating losses related to product manufacturing, marketing, sales and distribution over the next several years as we continue to commercialize ESKATA and RHOFADE.  In addition, ESKATA and RHOFADE, and our drug candidates if approved, may not achieve commercial success.  We also expect to incur significant expenses and operating losses for the foreseeable future as we advance our drug candidates from discovery through preclinical development and clinical trials. In addition, if we obtain marketing approval for any of our drug candidates, we expect to incur significant commercialization expenses related to product manufacturing, marketing, sales and distribution.  We may also incur expenses in connection with the in-license or acquisition of additional drug candidates. Furthermore, we have incurred and expect to continue to incur significant costs associated with operating as a public company, including legal, accounting, investor relations and other expenses.  As a result, we will need substantial additional funding to support our continuing operations and pursue our growth strategy. 

 

We have historically financed our operations primarily with sales of our convertible preferred stock, as well as net proceeds from our initial public offering, or IPO, in October 2015, subsequent public offerings, and a private placement of our common stock.    Until such time as we can generate significant revenue from product sales, if ever, we expect to finance our operations through the sale of equity, debt financings or other capital sources, including potential collaborations with other companies or other strategic transactions.  We may be unable to raise additional funds or enter into such other agreements or arrangements when needed on commercially acceptable terms, or at all.  If we fail to raise capital or enter into such agreements as, and when, needed, we may have to significantly delay, scale back or discontinue the development and commercialization of one or more of our products or drug candidates or delay our pursuit of potential in-licenses or acquisitions. 

 

 

License Agreement with Rigel

 

In August 2015, we entered into an exclusive, worldwide license and collaboration agreement with Rigel Pharmaceuticals, Inc., or Rigel, for the development and commercialization of products containing two specified JAK inhibitors, ATI-501 and ATI-502, or the Rigel License Agreement.  Under this agreement, we intend to develop these JAK inhibitors for the treatment of AA and other dermatological conditions. We paid Rigel an upfront nonrefundable payment of $8.0 million in September 2015. In addition, we have agreed to make aggregate payments of up to $80.0 million upon the achievement of specified pre-commercialization milestones, such as clinical trials and regulatory approvals. Further, we have agreed to pay up to an additional $10.0 million to Rigel upon the achievement of a second set of development milestones. With respect to any products we commercialize under the Rigel License Agreement, we will pay Rigel quarterly tiered royalties on our annual net sales of each product at a high single digit percentage of annual net sales, subject to specified reductions until the date that all of the patent rights for that product have expired, as determined on a country-by-country and product-by-product basis or, in specified countries under specified circumstances, 10 years from the first commercial sale of such product.

 

The Rigel License Agreement terminates on the date of expiration of all royalty obligations unless earlier terminated by either party for a material breach. We may also terminate the Rigel License Agreement without cause at any time upon advance written notice to Rigel. Rigel, after consultation with us, will be responsible for maintaining and prosecuting the patent rights, and we will have final decision-making authority regarding such patent rights for a product in the United States and the European Union. To the extent that we jointly develop intellectual property, we will confer and decide which party will be responsible for filing, prosecuting and maintaining those patent rights. The Rigel License Agreement also establishes a joint steering committee composed of an equal number of representatives for each party, which will monitor progress in the development of products. 

 

 

 

 

Stock Purchase Agreement with Vixen Pharmaceuticals, Inc. and License Agreement with Columbia University

 

In March 2016, we entered into a stock purchase agreement, or the Vixen Agreement, with Vixen, and JAK1, LLC, JAK2, LLC and JAK3, LLC, or together, the Selling Stockholders, and Shareholder Representative Services LLC as the representative of the Selling Stockholders.  Pursuant to the Vixen Agreement, we acquired all shares of Vixen’s capital stock from the Selling Stockholders, or the Vixen Acquisition. Following the Vixen Acquisition, Vixen became a wholly-owned subsidiary of us. Pursuant to the Vixen Agreement, we paid $0.6 million upfront and issued an aggregate of 159,420 shares of our common stock to the Selling Stockholders. We are obligated to make annual payments of $0.1 million through March 2022, with such amounts being creditable against specified future payments that may be paid under the Vixen Agreement. 

 

Under the Vixen Agreement we are obligated to make aggregate payments of up to $18.0 million to the Selling Stockholders upon the achievement of specified pre-commercialization milestones for three products in the United States, the European Union and Japan, and aggregate payments of up to $22.5 million upon the achievement of specified commercial milestones. With respect to any commercialized products covered by the Vixen Agreement, we are obligated to pay low single-digit royalties on net sales, subject to specified reductions, limitations and other adjustments, until the date that all of the patent rights for that product have expired, as determined on a country-by-country and product-by-product basis or, in specified circumstances, ten years from the first commercial sale of such product. If we sublicense any of Vixen’s patent rights and know-how acquired pursuant to the Vixen Agreement, we will be obligated to pay a portion of any consideration we receive from such sublicenses in specified circumstances. 

 

As a result of the Vixen Acquisition, we became party to the Exclusive License Agreement, by and between Vixen and the Trustees of Columbia University in the City of New York, or Columbia, dated as of December 31, 2015, or, as amended, the Columbia License Agreement.  Under the Columbia License Agreement, we are obligated to pay Columbia an annual license fee of $10,000 subject to specified adjustments for patent expenses incurred by Columbia and creditable against any royalties that may be paid under the Columbia License Agreement. We are also obligated to pay up to an aggregate of $11.6 million upon the achievement of specified commercial milestones, including specified levels of net sales of products covered by Columbia patent rights and/or know-how, and royalties at a sub-single-digit percentage of annual net sales of products covered by Columbia patent rights and/or know-how, subject to specified adjustments. If we sublicense any of Columbia’s patent rights and know-how acquired pursuant to the Columbia License Agreement, we will be obligated to pay Columbia a portion of any consideration received from such sublicenses in specified circumstances.  The royalties, as determined on a country-by-country and product-by-product basis, are payable until the date that all of the patent rights for that product have expired, the expiration of any market exclusivity period granted by a regulatory body or, in specified circumstances, ten years from the first commercial sale of such product.  The Columbia License Agreement terminates on the date of expiration of all royalty obligations thereunder unless earlier terminated by either party for a material breach, subject to a specified cure period. We may also terminate the Columbia License Agreement without cause at any time upon advance written notice to Columbia. 

 

 

Agreement and Plan of Merger with Confluence

 

In August 2017, we entered into an Agreement and Plan of Merger, or the Confluence Agreement, with Confluence, Aclaris Life Sciences, Inc., our wholly-owned subsidiary, or Merger Sub, and Fortis Advisors LLC, as representative of the equity holders of Confluence.  Pursuant to the terms of the Confluence Agreement, the Merger Sub merged with and into Confluence, with Confluence surviving as our wholly-owned subsidiary.  We paid $10.3 million in cash and issued 349,527 shares of our common stock with a fair value of $9.7 million to the Confluence equity holders. 

 

In November 2018, we achieved a development milestone specified in the Confluence Agreement.  The milestone payment to the former Confluence equity holders was comprised of $2.5 million in cash and 253,208 shares of our common stock with a fair value of $2.2 million.  We also agreed to pay the former Confluence equity holders aggregate additional contingent consideration of up to $75.0 million, based upon the achievement of certain regulatory and commercial milestones set forth in the Confluence Agreement.  In addition, we have agreed to pay the former Confluence equity holders specified future royalty payments calculated as a low single-digit percentage of annual net sales, subject to specified reductions, limitations and other adjustments, until the date that all of the patent rights for that product have expired, as determined on a country-by-country and product-by-product basis or, in specified circumstances, ten years from the first commercial sale of such product.  In addition, if we sell, license or transfer any of the intellectual property acquired from Confluence pursuant to the Confluence Agreement to a third party, we will be obligated to pay the former

Confluence equity holders a portion of any incremental consideration (in excess of the development and milestone payments described above) that we receive from such sale, license or transfer in specified circumstances. 

 

 

License, Development and Commercialization Agreement with Cipher Pharmaceuticals Inc.

 

In April 2018, we entered into an exclusive license agreement with Cipher Pharmaceuticals Inc., or Cipher, for the rights to obtain regulatory approval of and commercialize A-101 40% Topical Solution, which we market under the brand name ESKATA in the United States, in Canada for the treatment of SK, or the Cipher License Agreement.  Under the Cipher License Agreement, Cipher is responsible for obtaining marketing approval in Canada for A-101 40% Topical Solution.  We will supply Cipher with finished product, and, if regulatory approval is obtained, Cipher will be responsible for distribution and commercialization of A-101 40% Topical Solution in Canada.  Additionally, Cipher is responsible for all expenses related to regulatory and commercial activities for A-101 40% Topical Solution in Canada.  We received an upfront payment of $1.0 million upon signing of the Cipher License Agreement and $0.5 million upon the achievement of a specified regulatory milestone.  Pursuant to the Cipher License Agreement, we can earn a remaining payment of $0.5 million upon the achievement of a specified regulatory milestone, and aggregate payments of $1.75 million upon the achievement of specified commercial milestones.  Cipher will also be required to pay us a low double-digit percentage royalty on net sales of A-101 40% Topical Solution in Canada.  The term of the Cipher License Agreement expires on the later of the expiration of applicable patents in Canada or the 15th anniversary of the first commercial sale of licensed product in Canada.  Cipher submitted a New Drug Submission for A-101 40% Topical Solution for the treatment of raised SKs, which was accepted for review by Health Canada in December 2018.

 

 

Asset Purchase Agreement with Allergan

 

In November 2018, we completed the acquisition of RHOFADE, which includes an exclusive license to certain intellectual property for RHOFADE, as well as additional intellectual property, from Allergan, pursuant to the Asset Purchase Agreement dated as of October 15, 2018, or as amended, the Asset Purchase Agreement.    

 

At the closing of the acquisition, we paid total cash consideration of $66.1 million, consisting of $59.6 million paid to Allergan and $6.5 million placed in escrow. We have also agreed to pay Allergan a one-time payment of $5.0 million upon the achievement of a specified development milestone related to the potential development of an additional dermatology product.  In addition, we have agreed to pay Allergan specified royalty payments, ranging from a mid-single digit percentage to a mid-teen percentage of net sales, subject to specified reductions, limitations and other adjustments, on a country-by-country basis until the date that the patent rights related to a particular product, such as RHOFADE, have expired or, if later, November 30, 2028. In addition, we have agreed to assume the obligation to pay specified royalties and milestone payments under agreements with Aspect Pharmaceuticals, LLC and Vicept Therapeutics, Inc. Members of our management team, including Neal Walker, Frank Ruffo, Christopher Powala and Stuart Shanler, as well as Stephen Tullman, the chairman of our board of directors, are former stockholders of Vicept Therapeutics, Inc., and Dr. Shanler is also a current member of Aspect Pharmaceuticals, LLC. In their capacities as current or former holders of equity interests in these entities, these individuals may be entitled to receive a portion of the potential future payments payable by us.  We incurred an aggregate expense of approximately $0.2 million and $0 related to royalty payments under these agreements during the years ended December 31, 2018 and 2017, respectively. 

 

RHOFADE was approved by the FDA in January 2017 for the topical treatment of persistent facial erythema (redness) associated with rosacea in adults, and the product became commercially available in the United States in May 2017. 

 

 

Other Third-Party Agreements

 

Under an assignment agreement, pursuant to which we acquired intellectual property, we have agreed to pay royalties on sales of ESKATA, or other related products, at rates ranging in low single-digit percentages of net sales, as defined in the agreement.  Under this assignment agreement, we paid $0.2 million in connection with a specified development milestone, and there are no remaining milestone payment obligations. 

 

In connection with the assignment agreement, we also entered into a finder’s services agreement under which we have made aggregate milestone payments of $3.0 million upon the achievement of specified pre-commercialization milestones, such as clinical trials and regulatory approvals, and commercial milestones as described in the agreement.  We have also agreed to make an additional payment of $3.0 million upon the achievement of a specified commercial milestone.  In addition, we have agreed to pay royalties on sales of ESKATA, or other related products, at a low single-digit percentage of net sales, as defined in the agreement. 

 

Components of Our Results of Operations

 

Revenue

 

Product Sales

 

We promote ESKATA and RHOFADE through our sales force which we believe will allow us to reach the health care providers in the United States with the highest potential for prescribing ESKATA and RHOFADE to their patients. 

 

We sell ESKATA to one wholesaler, McKesson Specialty Care Distribution, or McKesson, which in turn resells ESKATA to health care providers.  We have also entered into agreements with two group purchasing organizations, or GPOs, and may enter into additional agreements with other GPOs and corporate accounts that provide for administrative fees and discounted pricing in the form of volume-based rebates and chargebacks.  We have no sales of ESKATA in countries outside of the United States. 

 

We began commercializing RHOFADE in the United States in December 2018.  We currently rely on Allergan to distribute RHOFADE on our behalf pursuant to the terms of a transition services agreement while we develop our sales, marketing and distribution capabilities to support the commercialization of RHOFADE in the United States.  We sell RHOFADE to wholesalers in the United States, which, in turn, distribute it to pharmacies that will ultimately fill patient prescriptions.  We may also enter into arrangements with health care providers, pharmacy benefit managers, third-party payors, and GPOs which provide for government mandated and/or privately negotiated rebates, chargebacks, and discounts, with respect to the purchase of RHOFADE.  We have no sales of RHOFADE in countries outside of the United States.  

 

Contract Research

 

We earn revenue from the provision of laboratory services to clients through Confluence, our wholly-owned subsidiary.  Contract research revenue is generally evidenced by contracts with clients which are on an agreed upon fixed-price, fee-for-service basis and are generally billed on a monthly basis in arrears for services rendered. 

 

We have also received revenue from grants under the Small Business Innovation Research program of the National Institutes of Health, or NIH.  During the year ended December 31, 2018, we had two active grants from NIH related to early-stage research.  As of December 31, 2018, there were no remaining funds available to us under the grants. 

 

 

Cost of Revenue

 

Cost of revenue consists of the cost of manufacturing the finished product forms of ESKATA and RHOFADE, as well as costs incurred in connection with the provision of contract research services to our clients through Confluence.  Cost of revenue primarily includes:

 

Product sales:

 

 

Contract research:

 

 

Research and Development Expenses

 

Research and development expenses consist of expenses incurred in connection with the discovery and development of our drug candidates. These expenses primarily include:

 

 

Research and development activities are central to our business model.  Drug candidates in later stages of clinical development generally have higher development costs than those in earlier stages of clinical development, primarily due to the increased size and duration of later-stage clinical trials. We expect our research and development expenses to increase significantly over the next several years as we increase personnel costs, including stock-based compensation, continue to conduct clinical trials of A-101 45% Topical Solution for the treatment of common warts, and conduct clinical trials and prepare regulatory filings for our other drug candidates.  We expense research and development costs as incurred.  Our direct research and development expenses primarily consist of external costs including fees paid to CROs, consultants, investigator sites, regulatory agencies and third parties that manufacture our preclinical and clinical trial materials, and are