Kezar Life Sciences, Inc. - Quarter Report: 2020 June (Form 10-Q)

75

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

For the quarterly period ended June 30, 2020

OR

For the transition period from ______________ to ______________

Commission File Number: 001-38542

Kezar Life Sciences, Inc.

(Exact Name of Registrant as Specified in its Charter)

4000 Shoreline Court, Suite 300

South San Francisco, CA, 94080

(650) 822-5600

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

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

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

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 August 4, 2020, the registrant had 46,256,284 shares of common stock, $0.001 par value per share, outstanding.

Table of Contents

i

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements. In some cases, you can identify these statements by forward-looking words such as “believe,” “may,” “will,” “estimate,” “continue,” “anticipate,” “intend,” “could,” “should,” “would,” “potential,” “project,” “plan,” “expect,” “seek,” “should,” “target” or similar expressions, or the negative or plural of these words or expressions. These forward-looking statements include statements concerning the following:   

These statements are only current predictions and are subject to known and unknown risks, uncertainties and other factors that may cause our or our industry’s actual results, levels of activity, performance or achievements to be materially different from those anticipated by the forward-looking statements. We discuss many of these risks in greater detail under the heading “Risk Factors” and elsewhere in this report. You should not rely upon forward-looking statements as predictions of future events.

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Except as required by law, we are under no duty to update or revise any of the forward-looking statements in this report, whether as a result of new information, future events or otherwise, after the date of this report.

Unless the context otherwise requires, the terms “Kezar,” “Kezar Life Sciences,” “the Company,” “we,” “us,” “our” and similar references in this Quarterly Report on Form 10-Q refer to Kezar Life Sciences, Inc. and our wholly owned Australian subsidiary, Kezar Life Sciences Australia Pty Ltd.

1

PART I—FINANCIAL INFORMATION

Item 1. Financial Statements.

KEZAR LIFE SCIENCES, INC.

Condensed Consolidated Balance Sheets

(in thousands, except share and per share amounts)

See accompanying notes to the unaudited interim condensed consolidated financial statements

2

KEZAR LIFE SCIENCES, INC.

Condensed Consolidated Statements of Operations

(Unaudited)

(In thousands, except share and per share amounts)

See accompanying notes to the unaudited interim condensed consolidated financial statements

3

KEZAR LIFE SCIENCES, INC.

Condensed Consolidated Statements of Comprehensive Loss

(Unaudited)

(In thousands)

See accompanying notes to the unaudited interim condensed consolidated financial statements

4

KEZAR LIFE SCIENCES, INC.

Condensed Consolidated Statements of Stockholders' Equity

(Unaudited)

(In thousands, except share amounts)

See accompanying notes to the unaudited interim condensed consolidated financial statements

5

KEZAR LIFE SCIENCES, INC.

Condensed Consolidated Statements of Cash Flows

(Unaudited)

(In thousands)

See accompanying notes to the unaudited interim condensed consolidated financial statements 

6

Kezar Life Sciences, Inc

Notes to Unaudited Condensed Consolidated Financial Statements

1. Organization and Description of the Business

Description of Business

Kezar Life Sciences, Inc. (the “Company,” “we,” “us,” or “our”) was incorporated in the state of Delaware in February 2015 and commenced operations in June 2015. The Company is a clinical-stage biotechnology company, discovering and developing novel small molecule therapeutics to treat unmet needs in autoimmunity and cancer. The Company’s principal operations are in South San Francisco, California, and it operates in one segment.

Liquidity

Since commencing operations in mid-2015, substantially all of the Company’s efforts have been focused on research, development, and the advancement of the Company’s lead product candidate, KZR-616. The Company’s ultimate success depends on the outcome of the ongoing research and development activities. The Company has not yet generated product sales and as a result has experienced operating losses since inception and had an accumulated deficit of $103.8 million as of June 30, 2020. The Company expects to incur additional losses in the future to conduct research and development and will need to raise additional capital to fully implement management’s business plan. The Company intends to raise such capital through the issuance of additional equity, and potentially through borrowings, strategic alliances with partner companies and other licensing transactions. However, if such financing is not available at adequate levels, the Company may need to reevaluate its operating plans. Management believes that its existing cash, cash equivalents and marketable securities will be sufficient to fund the Company’s cash requirements for at least 12 months following the issuance of these financial statements.

In July 2019, the Company entered into an Open Market Sale Agreement ^SM (the “ATM Agreement”) with Jefferies LLC (“Jefferies”), pursuant to which the Company could offer and sell, from time to time at its sole discretion through Jefferies, as its sales agent, shares of common stock having an aggregate offering price of up to $50.0 million. The ATM Agreement was terminated in June 2020. Prior to the termination, the Company did not sell any shares of its common stock pursuant to the ATM Agreement. Accordingly, the $50.0 million of securities unsold pursuant to the ATM Agreement became available for issuance on the Company’s shelf registration statement on Form S-3 (File No. 333-232542).

On February 4, 2020, the Company completed an underwritten public offering of 18,965,385 shares of its common stock, which includes the full exercise of the underwriters’ option to purchase additional shares of common stock, and, to certain investors in lieu thereof, pre-funded warrants to purchase 2,884,615 shares of its common stock at an exercise price of $0.001 per share (the “February Offering”). The public offering price of our common stock was $2.60 per share and the public offering price of each pre-funded warrant was $2.599 per underlying share. The net proceeds from the February offering were approximately $53.4 million, after deducting underwriting discounts and commissions and other offering expenses paid by us. The Company’s existing stockholder, Morningside Ventures Investments Ltd, together with its affiliate, and certain of the Company’s officers and directors purchased an aggregate of approximately $22.9 million of common stock in the offering.

On June 11, 2020, the Company completed an underwritten public offering of 7,590,909 shares of its common stock and, to certain investors in lieu thereof, pre-funded warrants to purchase 909,091 shares of its common stock at an exercise price of $0.001 per share (the “June Offering”). The public offering price of our common stock was $5.50 per share and the public offering price of each pre-funded warrant was $5.499 per underlying share. The net proceeds from the June Offering were approximately $43.7 million, after deducting underwriting discounts and commissions and other offering expenses paid by us. In July 2020, the underwriters exercised an option to purchase an additional 427,707 shares of common stock, for net proceeds of approximately $2.2 million, after deducting underwriting discounts and commissions and other offering expenses paid by us. The Company’s existing stockholder, Equal Talent Investments Limited, an affiliate of Morningside Venture Investments Ltd, and one of the Company’s directors purchased an aggregate of approximately $8.5 million of common stock in the June Offering.

2. Summary of Significant Accounting Policies

Significant Accounting Policies

The Company’s significant accounting policies are disclosed in the audited consolidated financial statements for the year ended December 31, 2019 and the notes thereto, which are included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2019, filed with the U.S. Securities and Exchange Commission (“SEC”) on March 12, 2020 (the “Annual Report”), and there have been no material changes during the six months ended June 30, 2020.

7

Basis of Presentation and Consolidation

The condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States (“GAAP”) and include the Company’s accounts and those of its wholly owned Australian subsidiary, Kezar Life Sciences Australia Pty Ltd., which is a proprietary company limited by shares. All intercompany balances and transactions have been eliminated upon consolidation.

The condensed consolidated balance sheet at December 31, 2019 has been derived from the audited consolidated financial statements at that date but does not include all information and footnotes required by GAAP for complete financial statements. These unaudited condensed consolidated financial statements should be read in conjunction with the audited financial statements included in the Annual Report.

Unaudited Interim Condensed Consolidated Financial Statements

The accompanying financial information as of June 30, 2020 is unaudited. The condensed consolidated financial statements included in this report reflect all adjustments (consisting only of normal recurring adjustments) that our management considers necessary for the fair statement of the results of operations for the interim periods covered and of our financial condition at the date of the interim balance sheet. The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with GAAP for interim financial information. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. The results for interim periods are not necessarily indicative of the results for the entire year or any other interim period. The accompanying condensed consolidated financial statements and related financial information should be read in conjunction with the audited financial statements and the related notes thereto included in our Annual Report.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of expenses during the reporting period. Significant items subject to such estimates and assumptions include the useful lives of fixed assets, stock-based compensation, and accrued research and development costs. Management bases its estimates on historical experience and on various other market-specific relevant assumptions that management believes to be reasonable under the circumstances. Actual results may differ from those estimates.

We also anticipate that the COVID-19 pandemic will have an impact on the clinical and pre-clinical development timelines for our clinical and pre-clinical programs.  Estimates and assumptions about future events and their effects cannot be determined with certainty and therefore require the exercise of judgment. As of the date of issuance of these financial statements, the Company is not aware of any specific event or circumstance that would require the Company to update its estimates, assumptions and judgments or revise the carrying value of its assets or liabilities. These estimates may change as new events occur and additional information is obtained and are recognized in the consolidated financial statements as soon as they become known. Actual results could differ from those estimates and any such differences may be material to the Company’s financial statements.

Significant Risks and Uncertainties

With the global spread of the ongoing COVID-19 pandemic in the first quarter of 2020, we have implemented business continuity plans designed to address and mitigate the impact of the COVID-19 pandemic on our business.  The extent to which the COVID-19 pandemic impacts our business, our pre-clinical and clinical development and regulatory efforts, our corporate development objectives and the value of and market for our common stock, will depend on future developments that are highly uncertain and cannot be predicted with confidence at this time, such as the ultimate duration of the pandemic, travel restrictions, quarantines, social distancing and business closure requirements in the United States, Europe and other countries, and the effectiveness of actions taken globally to contain and treat the disease.  The global economic slowdown, the overall disruption of global healthcare systems and the other risks and uncertainties associated with the pandemic could have a material adverse effect on our business, financial condition, results of operations and growth prospects.

In addition, we are subject to other challenges and risks specific to our business and our ability to execute on our strategy, as well as risks and uncertainties common to companies in the biotechnology industry with development operations, including, without limitation, risks and uncertainties associated with: obtaining regulatory feedback regarding our product candidates; delays or problems in the supply of our product candidates; loss of single source suppliers or their failure to comply with manufacturing regulations; identifying, acquiring or in-licensing additional technologies or product candidates; clinical development and the inherent uncertainty of clinical success; the challenges of protecting and enhancing our intellectual property rights; and complying with applicable regulatory requirements. In addition, to the extent the ongoing COVID-19 pandemic adversely affects our business and results of operations, it may also have the effect of heightening many of the other risks and uncertainties discussed above.

8

Cash and Cash Equivalents

The Company considers all highly liquid investments with original maturities of three months or less at the time of purchase to be cash equivalents. Cash equivalents are stated at fair value.

Marketable Securities

All marketable securities have been classified as “available-for-sale” in accordance with the Company’s investment policy and cash management strategy. Short-term marketable securities mature within one-year from the balance sheet date. Investments in marketable securities are recorded at fair value, with any unrealized gains and losses reported within accumulated other comprehensive income as a separate component of stockholders’ deficit until realized or until a determination is made that an other-than-temporary decline in market value has occurred. If a credit loss does exist for available-for-sale debt securities and should be recognized, an allowance will be recorded rather than a write-down of the amortized cost basis. The amortized cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization and accretion, together with interest on securities, are included in interest income on the Company’s condensed consolidated statements of operations.

Leases

At lease commencement, the Company records a lease liability based on the present value of lease payments over the expected lease term. The Company calculates the present value of lease payments using the discount rate implicit in the lease, unless that rate cannot be readily determined. In that case, the Company uses its incremental borrowing rate, which is the rate of interest that the Company would have to pay to borrow on a collateralized basis an amount equal to the lease payments over the expected lease term. The Company records a corresponding right-of-use (“ROU”) lease asset based on the lease liability, adjusted for any lease incentives received and any initial direct costs paid to the lessor prior to the lease commencement date.

After lease commencement, the Company measures its leases as follows: (i) the lease liability based on the present value of the remaining lease payments using the discount rate determined at lease commencement; and (ii) the ROU lease asset based on the remeasured lease liability, adjusted for any unamortized lease incentives received, any unamortized initial direct costs and the cumulative difference between rent expense and amounts paid under the lease agreement. Any lease incentives received and any initial direct costs are amortized on a straight-line basis over the expected lease term. Rent expense is recorded on a straight-line basis over the expected lease term.

The Company elected the short-term lease recognition exemption for all leases that qualify. This means, for those leases that qualify, the Company will not recognize ROU assets or lease liabilities, and this includes not recognizing ROU assets or lease liabilities for existing short-term leases of those assets in transition. The Company did not elect to apply the practical expedient to not separate lease and non-lease components for all of its leases.

Accounting Pronouncements Adopted in 2020

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326) as well as subsequent amendments to the initial guidance under ASU 2018-19, ASU 2019-04 and ASU 2019-05 (collectively Topic 326). Topic 326 requires the measurement and recognition of expected credit losses for financial assets. Under the new guidance, an entity will recognize as an allowance its estimate of expected credit losses. The Company adopted the new standard using the modified retrospective approach as of January 1, 2020 and the adoption did not have a material impact on its condensed consolidated financial statements.

In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement, which modifies the disclosure requirements on fair value measurements. The amendment of ASU No. 2018-13 removes disclosure requirements from Topic 820 in the areas of: (1) the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy; (2) the policy for timing of transfers between levels; and (3) the valuation processes for Level 3 fair value measurements. The Company adopted the new standard as of January 1, 2020 and the adoption did not have a material impact on its condensed consolidated financial statements.

In December 2019, the FASB issued ASU No. 2019-12, Income Taxes: Simplifying the Accounting for Income Taxes, which removes certain exceptions to the general principles found in ASC740, Income Taxes. As part of the simplification, along with other exceptions, it removes the exception to the incremental approach for intraperiod tax allocation in the event of a loss from continuing operations and income or a gain from other items. The Company early adopted ASU 2019-20 as of January 1, 2020 and the adoption did not have a material impact on its condensed consolidated financial statements.

9

3. Fair Value Measurements

Financial assets and liabilities are recorded at fair value. The carrying amount of certain financial instruments, including cash and cash equivalents, marketable securities, other current assets, accounts payable and accrued liabilities, approximate fair value due to their relatively short maturities. Assets and liabilities recorded at fair value on a recurring basis in the condensed consolidated balance sheets are categorized based upon the level of judgment associated with the inputs used to measure their fair values. Fair value is defined as the exchange price that would be received for an asset or an exit price that would be paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The authoritative guidance on fair value measurements establishes a three-tier fair value hierarchy for disclosure of fair value measurements as follows:

Level 1: Quoted prices in active markets for identical assets or liabilities.

Level 2: Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3: Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

Assets and liabilities measured at fair value are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires management to make judgments and consider factors specific to the asset or liability.

The Company applies fair value accounting for all financial assets and liabilities and nonfinancial assets and liabilities that are required to be recognized or disclosed at fair value in the financial statements. The Company determines the fair value of Level 1 assets using quoted prices in active markets for identical assets. The Company reviews trading activity and pricing for Level 2 investments as of each measurement date. Level 2 inputs, which are obtained from various third-party data providers, represent quoted prices for similar assets in active markets and were derived from observable market data, or, if not directly observable, were derived from or corroborated by other observable market data.

In certain cases, where there is limited activity or less transparency around inputs to valuation, securities are classified as Level 3 within the valuation hierarchy. The Company does not have any assets or liabilities measured using Level 3 inputs as of June 30, 2020 or December 31, 2019.

The following table summarizes the Company’s financial assets measured at fair value on a recurring basis and classified under the appropriate level of the fair value hierarchy as described above (in thousands):

10

4. Available-for-Sale Securities

The following table is a summary of available-for-sale securities recorded in cash and cash equivalents or marketable securities in the Company’s condensed consolidated balance sheets (in thousands):

As of June 30, 2020 and December 31, 2019, the Company has not recognized an allowance for credit losses on any securities in an unrealized loss position.

The following table displays additional information regarding gross unrealized losses and fair value by major security type for available-for-sale securities in an unrealized loss position as of June 30, 2020 and December 31, 2019 (in thousands):

The Company currently does not intend to sell these securities prior to maturity and does not consider these investments to be other-than-temporarily impaired at June 30, 2020. There were no sales of available-for-sale securities in any of the periods presented.

As of June 30, 2020, the amortized cost and estimated fair value of the Company’s available-for-sale securities by contractual maturity are shown below (in thousands):

11

5. Balance Sheet Components

Property and Equipment, Net

Property and equipment consisted of the following (in thousands):

Depreciation expense was $0.3 million and $0.5 million for the three and six months ended June 30, 2020, respectively, compared to $0.2 million and $0.4 million for the three and six months ended June 30, 2019, respectively.

Accrued Liabilities

Accrued liabilities consisted of the following (in thousands):

6. Lease

In August 2017, the Company entered into a lease agreement to lease 24,357 square feet of combination laboratory and office space in South San Francisco, California. This lease expires in February 2025.

The contractually specified minimum rent and annual rent increases for the operating lease are included in the measurement of the ROU asset and related lease liabilities. Under the lease arrangement, we may be required to pay directly, or reimburse the lessor for real estate taxes, insurance, utilities, maintenance and other operating costs. Such amounts are generally variable and therefore not included in the measurement of the ROU asset and related lease liability but are instead recognized as variable lease expense in our Condensed Consolidated Statements of Operations when they are incurred. The operating lease agreement has one option to extend the lease term for a period of five years at the fair market rate at the time of the extension. The option to extend the lease was not recognized as part of the Company’s lease liability and ROU asset as the Company determined the renewal rent costs are uncertain and the option is not reasonably certain to be exercised.

Because the rate implicit in the lease is not readily determinable, the Company uses its incremental borrowing rate to determine the present value of the lease payments. The Company recorded lease liabilities and ROU asset for its office lease based on the present value of lease payments over the expected lease term. As of June 30, 2020, the weighted average remaining lease term was 4.67 years and the weighted average discount rate used to determine the operating lease liability was 10.0%.

12

Information related to the Company’s ROU asset and related lease liabilities were as follows (in thousands):

7. Pre-Funded Warrants

On February 4, 2020, the Company completed an underwritten public offering of 18,965,385 shares of its common stock including the full exercise of the underwriters’ option to purchase additional shares of common stock, and pre-funded warrants to purchase 2,884,615 shares of its common stock. The public offering price of the common stock was $2.60 per share and the public offering price of the pre-funded warrants was $2.599 per underlying share. The net proceeds from the public offering were approximately $53.4 million, after deducting underwriting discounts and commissions and other offering expenses paid by the Company.

On June 11, 2020, the Company completed an underwritten public offering of 7,590,909 shares of its common stock and pre-funded warrants to purchase 909,091 shares of its common stock. The public offering price of the common stock was $5.50 per share and the public offering price of the pre-funded warrants was $5.499 per underlying share. The net proceeds from the public offering were approximately $43.7 million after deducting underwriting discounts and commissions and other offering expenses paid by the Company.

Each pre-funded warrant entitles the holder to purchase shares of common stock at an exercise price of $0.001 per share and expires 20 years from the date of issuance. These warrants were recorded as a component of stockholders’ equity within additional paid-in capital. Per the terms of the warrant agreement, a holder of the outstanding warrant is not entitled to exercise any portion of the pre-funded warrant if, upon exercise of such portion of the warrant, the holder’s ownership of our common stock (together with its affiliates) or the combined voting power of our securities beneficially owned by such holder (together with its affiliates) would exceed 9.99% after giving effect to the exercise (“Maximum Ownership Percentage”). Upon at least 61 days’ prior notice to us by the warrant holder, any warrant holder may increase or decrease the Maximum Ownership Percentage to any other percentage not to exceed 19.99%. As of June 30, 2020, no shares underlying the pre-funded warrants have been exercised.

The following table represents a summary of the pre-funded warrants outstanding as of the date identified.

8. Stock-Based Compensation

Stock Incentive Plans

13

2018 Equity Incentive Plan

In June 2018, the Company’s board of directors adopted and its stockholders approved the 2018 Equity Incentive Plan (the “2018 Plan”), which became effective as of June 20, 2018, at which point no further grants could be made under the 2015 Equity Incentive Plan (the “2015 Plan”) described below. Under the 2018 Plan, the Company may grant incentive stock options (“ISOs”), nonstatutory stock options (“NSOs”), stock appreciation rights, restricted stock awards, restricted stock units and other stock-based awards. As of June 30, 2020, options to purchase 2,648,968 shares of common stock were outstanding and 1,348,693 shares were available for future issuance under the 2018 Plan.

Initially, subject to adjustment as provided in the 2018 Plan, the aggregate number of shares of the Company’s common stock authorized for issuance pursuant to stock awards under the 2018 Plan was 4,000,000 shares, which is the sum of (i) 1,600,692 shares plus (ii) the number of shares reserved and available for issuance under the 2015 Plan at the time the 2018 Plan became effective and (iii) the number of shares subject to stock options or other stock awards granted under the 2015 Plan that expire, terminate are forfeited or otherwise not issued, or are withheld to satisfy a tax withholding obligation in connection with an award or to satisfy a purchase or exercise price of an award (such as upon the expiration or termination of a stock award prior to vesting). The number of shares of the Company’s common stock reserved for issuance under the 2018 Plan automatically increases on January 1 of each year, beginning on January 1, 2019 and continuing through and including January 1, 2028, by 5% of the total number of shares of capital stock outstanding on December 31 of the preceding calendar year, or a lesser number of shares determined by the Company’s board of directors prior to such increase. The maximum number of shares that may be issued upon the exercise of ISOs under the 2018 Plan is 12,500,000 shares.

2015 Equity Incentive Plan

The Company’s 2015 Plan provided for the granting of ISOs and NSOs to employees, directors and consultants at the discretion of its board of directors. The 2015 Plan was terminated as to future awards in June 2018, although it continues to govern the terms of options that remain outstanding under the 2015 Plan.

No additional stock awards will be granted under the 2015 Plan, and all outstanding stock awards granted under the 2015 Plan that are repurchased, forfeited, expire or are cancelled will become available for grant under the 2018 Plan in accordance with its terms.

Options granted under the 2015 Plan expire no later than 10 years from the date of grant. Options granted under the 2015 Plan vest over periods determined by the Company’s board of directors, generally over four years. The 2015 Plan allows for early exercise of certain options prior to vesting. Upon termination of employment, the unvested shares are subject to repurchase at the original exercise price. As of June 30, 2020 options to purchase 1,829,074 shares of common stock were outstanding under the 2015 Plan.

2018 Employee Stock Purchase Plan

In June 2018, the Company’s board of directors adopted and its stockholders approved the 2018 Employee Stock Purchase Plan (the “ESPP”), which became effective as of June 20, 2018. The ESPP is intended to qualify as an “employee stock purchase plan” within the meaning of Section 423 of the U.S. Internal Revenue Code of 1986, as amended. The number of shares of common stock initially reserved for issuance under the ESPP was 200,000 shares. The ESPP provides for an annual increase on January 1 of each year, beginning on January 1, 2019 and continuing through and including January 1, 2028, equal to the lesser of (i) 1% of the shares of common stock outstanding on the last day of the prior fiscal year or (ii) 375,000 shares, or a lesser number of shares determined by the Company’s board of directors prior to such increase. As of June 30, 2020, 83,083 shares of common stock had been issued under the ESPP and 500,141 shares remained available for future issuance under the ESPP. The price per share of common stock to be paid by an ESPP participant on the applicable purchase date of an offering period shall be equal to 85% of the lesser of the fair market value of a share of common stock on (i) the applicable offering date or (ii) the applicable purchase date. The Company’s board of directors authorized an initial six-month offering period beginning on November 16, 2018 and ending on May 15, 2019. The Company’s board of directors has subsequently authorized additional six-month offering periods, with the most recent offering period beginning on May 16, 2020.

14

Stock Option Activity

The following table summarizes activity under the Company’s stock option plans and related information (in thousands, except share and per share amounts):

The weighted average grant date fair value of options granted during the six months ended June 30, 2020 was $2.68 per share. The aggregate intrinsic value of exercised stock options during the three and six months ended June 30, 2020 was $12,000 and $22,000, respectively. The aggregate intrinsic value is calculated as the difference between the exercise price and the estimated fair value of the Company’s common stock at the date of exercise.

Stock-Based Compensation Expense

Total stock-based compensation expense recognized by function was as follows (in thousands):

As of June 30, 2020, the unrecognized stock-based compensation cost was $11.7 million with an estimated weighted average amortization period of 2.7 years

The fair value of the stock options granted is calculated using the Black-Scholes option-pricing model with the following range of assumptions:

9. Income Taxes

No provision for income taxes was recorded for the three and six months ended June 30, 2020 and 2019, respectively. Deferred tax assets generated from the Company’s net operating losses have been fully reserved, as the Company believes it is not more likely than not that the benefit will be realized.

In December 2015, the Protecting Americans from Tax Hikes Act of 2015 (the “PATH Act”) was signed into law, which created several new research and development (“R&D”) tax credit provisions, including allowing qualified small businesses to utilize the R&D credit against the employer’s portion of payroll tax up to a maximum of $250,000 per year. The Company qualified as a small business under the PATH Act for 2016, 2017, 2018 and 2019. During the three and six months ended June 30, 2020, the Company utilized $108,000 and $264,000, respectively, of R&D tax credits as a reduction of payroll expenses to offset its payroll tax liabilities, compared to $79,000 and $172,000 for the three and six months ended June 30, 2019, respectively. The remaining R&D tax credits available for future payroll tax liabilities have been recorded as deferred tax assets with a full valuation allowance.

15

10. Net Loss Per Share

Net Loss Per Share

The following table sets forth the calculation of basic and diluted net loss per share during the periods presented (in thousands, except share and per share data):

Basic net loss per common share is calculated by dividing net loss by the weighted-average number of shares of common stock and pre-funded warrants outstanding during the period, without consideration of common share equivalents. Diluted net loss per common share is computed by dividing net loss by the weighted-average number of shares of common stock, pre-funded warrants and common share equivalents outstanding for the period. The pre-funded warrants are included in the computation of basic and diluted net loss per common share as the exercise price is negligible and the pre-funded warrants are fully vested and exercisable. Common share equivalents are only included in the calculation of diluted net loss per common share when their effect is dilutive.

Potential dilutive securities, which include, vested and unvested options to purchase common stock and unvested common stock outstanding that were exercised early have been excluded from the computation of diluted net loss per share as the effect is antidilutive. Therefore, the denominator used to calculate both basic and diluted net loss per common share is the same in all periods presented.

The following outstanding shares of common stock equivalents were excluded from the computation of the diluted net loss per share for the periods presented because their effect would have been anti-dilutive:

11. Subsequent Event

In July 2020, the Company issued an additional 427,707 shares of common stock, pursuant to the exercise by the underwriters of their option to purchase additional shares of common stock in the June Offering, for net proceeds of approximately $2.2 million, after deducting underwriting discounts and commissions and other offering expenses paid by us.

16

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

You should read the following management’s discussion and analysis of our financial condition and results of operations in conjunction with our unaudited condensed consolidated financial statements and related notes thereto included in Part I, Item 1 of this Quarterly Report on Form 10-Q, and with our audited consolidated financial statements and related notes thereto for the year ended December 31, 2019 included in our Annual Report on Form 10-K, as filed with the U.S. Securities and Exchange Commission, or the SEC, on March 12, 2020, or the Annual Report.

Overview

We are a clinical-stage biotechnology company, discovering and developing novel small molecule therapeutics to treat unmet needs in autoimmunity and cancer. Our lead product candidate, KZR-616, a first-in-class selective immunoproteasome inhibitor, has completed testing in healthy volunteers, and we are now leveraging its broad therapeutic potential in Phase 2 clinical trials in severe autoimmune diseases of high unmet need. We are also enrolling the final cohort of patients in the Phase 1b portion of the MISSION trial, a Phase 1b/2 clinical trial in systemic lupus erythematosus, also known as lupus or SLE, and lupus nephritis.

We believe that the immunoproteasome is a validated target for the treatment of a wide variety of autoimmune diseases given the compelling published activity seen with non-selective proteasome inhibitors administered to patients with severe autoimmune diseases. Based on results from our Phase 1a studies in healthy volunteers and the preliminary results from the Phase 1b portion of the MISSION trial, KZR-616 has largely avoided adverse effects associated with currently marketed non-selective proteasome inhibitors, as exhibited in clinical studies conducted by third parties, including side effects which we believe prevent them from being utilized as a chronic treatment in autoimmune disorders. In addition, we have seen encouraging clinical activity and biomarker data in SLE patients and in two of two patients with active lupus nephritis. We intend to develop KZR-616 to address underserved autoimmune diseases. We acquired exclusive worldwide rights to KZR-616 and an accompanying library of similar molecules pursuant to an exclusive license agreement with Onyx Therapeutics, Inc., or Onyx, a wholly owned subsidiary of Amgen, Inc., or Amgen, in June 2015, or the Onyx License Agreement. Patent coverage for KZR-616 extends to at least 2034.

Additionally, we are advancing our novel research platform targeting the Sec61 translocon and the protein secretion pathway to discover and develop small molecule therapeutics targeting oncology indications. Our first clinical candidate in this program, KZR-261, has demonstrated broad anti-tumor activity in preclinical models of both solid and hematologic malignancies. KZR-261 is undergoing preclinical studies and manufacturing activities in support of an investigational new drug, or IND, application, which we anticipate submitting to the U.S. Food and Drug Administration, or FDA, in the first quarter of 2021 for a Phase 1 clinical trial in solid tumors. We believe this discovery platform has the potential to yield oral small molecule candidates that, if successfully developed and approved, could serve as alternatives to currently marketed biologic therapeutics to act as cytotoxic anti-cancer agents or to block the secretion of novel targets of interest in immuno-oncology or inflammation.

Since the commencement of our operations, we have devoted substantially all our resources to performing research and development activities in support of our product development efforts, hiring personnel, raising capital to support and expand such activities and providing general and administrative support for these operations. We do not have any products approved for sale and have not generated any revenue from product sales. We have funded our operations to date primarily from the issuance and sale of equity securities. Our ability to generate product revenue sufficient to achieve profitability will depend heavily on the successful development and eventual commercialization of one or more of our current or future product candidates and programs. We have incurred significant operating losses since our inception. Our net losses were $35.1 million and $19.5 million for the year ended December 31, 2019 and the six months ended June 30, 2020, respectively, and we expect to continue to incur significant losses for the foreseeable future. As of June 30, 2020, we had an accumulated deficit of $103.8 million. We anticipate that a substantial portion of our capital resources and efforts in the foreseeable future will be focused on discovering new potential therapeutics, completing the necessary development, obtaining regulatory approval and preparing for potential commercialization of our product candidates.

We expect to continue to incur significant expenses and increasing operating losses for at least the next several years. Our net losses may fluctuate significantly from period to period, depending on the timing of our planned clinical trials and expenditures on other research and development activities. We expect our expenses will increase substantially over time as we:

17

Second Quarter and Other Recent Highlights

On June 3, 2020, we provided updated preliminary results from the Phase 1b portion of the MISSION trial of KZR-616. Among patients completing treatment, improvements (decrease in score) were observed across seven measures of disease activity in a majority of patients from baseline to week 13, and improvement in disease activity persisted following the end-of-treatment. Additionally, step-up dosing to 60 mg of KZR-616 improved overall tolerability, including the mitigation of early dose effects of nausea and vomiting. Most treatment emergent adverse events, or TEAEs, have been mild or moderate and were found to occur early in treatment and diminish with later doses. The most common TEAEs were transient injection site reactions. There have been no clinically significant laboratory adverse events observed in the Phase 1b portion of the trial. Two SLE patients with biopsy-proven proliferative lupus nephritis were included in the Phase 1b portion of MISSION.  Following treatment with KZR-616, both patients showed a greater than 50% reduction in proteinuria as measured by urine protein to creatinine ratio, or UPCR, as well as reductions in SLEDAI (Systemic Lupus Erythematosus Disease Activity Index) and reductions in anti-dsDNA (double-stranded DNA) antibody levels.

On June 11, 2020, we completed an underwritten public offering of 7,590,909 shares of our common stock and, to certain investors in lieu thereof, pre-funded warrants to purchase 909,091 shares of our common stock at an exercise price of $0.001 per share, or the June Offering. The public offering price of our common stock was $5.50 per share and the public offering price of the pre-funded warrants was $5.499 per underlying share. The net proceeds from the public offering were approximately $43.7 million, after deducting underwriting discounts and commissions and other offering expenses paid by us. Our existing stockholder, Equal Talent Investments Limited, an affiliate of Morningside Venture Investments Ltd, and one of our directors purchased an aggregate amount of approximately $8.5 million of common stock in the June Offering. In July 2020, we issued an additional 427,707 shares of common stock, pursuant to the exercise by the underwriters of their option to purchase additional shares of common stock, for net proceeds of approximately $2.2 million, after deducting underwriting discounts and commissions and other offering expenses paid by us.

Impacts of COVID-19 and Clinical Development Updates

Following the global outbreak of COVID-19, we have placed a priority on the health and safety of our employees and those involved with our clinical trials. In March, we implemented remote working policies for our employees, which have continued through the date of this report. We have been in close communication with the investigators and site staff participating in our clinical trials with KZR-616.  While the situation is still rapidly evolving, the feedback we have received from investigators speaks to different degrees of slowdown in clinical activities depending on the nature of the site and its geographic location. For example, some private specialty clinics have been less impacted than large academic medical centers, most of which have been unable to screen new patients as their resources are focused on care for patients with COVID-19.  As a result of this slowdown, we anticipate delays in our previously anticipated clinical development timelines and data release milestones for KZR-616. The extent of these delays cannot be predicted with confidence at the time of this Quarterly Report on Form 10-Q.

We have been working closely with all of our clinical sites to assess COVID-19 impacts and to provide them with guidance for patients to safely continue on study. Based upon the updated results from the Phase 1b portion of MISSION and the recent slowdown in recruitment and enrollment activities across our clinical trials due to the COVID-19 pandemic, we have been actively reviewing and adapting some of our clinical trial plans in order to optimize the development pathway for KZR-616. Based on the positive safety and tolerability, pharmacology, and clinical activity results seen to date with KZR-616, we are focusing our development efforts on subcutaneous once-weekly dosing at 45 mg and 60 mg.

We have amended the clinical trial protocol for the Phase 2 portion of the MISSION clinical trial to expedite the advancement of KZR-616 into the next phase of development. This trial is now open for enrollment under the new amendment. The primary endpoint has been changed from safety and tolerability to an efficacy endpoint of renal response measured by 50% or greater reduction in UPCR at six months, which has been observed to be predictive of long-term outcomes in patients with lupus nephritis. Additionally, the inclusion/exclusion criteria have been expanded to include patients with lupus nephritis with histologic Class III or IV +/- Class V being treated with current standard-of-care regardless of background therapy. The clinical trial is expected to enroll 20 patients and is open-label with a single treatment arm evaluating a 60 mg dose (with first dose of 30 mg) of KZR-616 administered subcutaneously

18

once weekly for 24 weeks. A 12-month extension study is also being planned. Interim data are expected in late 2021. Upon the successful completion of the Phase 2 portion of MISSION, we intend to initiate a robust late-stage randomized placebo-controlled trial in patients with active, proliferative lupus nephritis.

The Phase 2 PRESIDIO trial of KZR-616 in dermatomyositis and polymyositis continues to enroll.  A 12-month open-label extension study is being planned and will be available for patients completing the trial.

The Phase 2 MARINA trial in autoimmune hemolytic anemia, or AIHA, and immune thrombocytopenia, or ITP, has been withdrawn. Despite the strong interest from investigators and the patient community, a combination of COVID-related slowdowns in screening activities and the need to amend the study protocol to reduce high screen failure rates factored into this decision. No new clinical data has informed this decision. We continue to believe that KZR-616 has the potential to be effective in autoimmune cytopenias, such as AIHA and ITP, supported by the likely role of the immunoproteasome in these serious diseases.  Data from the clinical development of KZR-616 in other indications will inform the optimal strategy for the development of this product candidate in these indications.

Our preclinical and manufacturing work with KZR-261 is ongoing, and we remain on track to submit an IND application in the first quarter of 2021.  

We did not apply for the Paycheck Protection Program loan under the CARES Act. Furthermore, because we have utilized our R&D credits against the employer’s portion of payroll tax under the PATH Act, we are not leveraging the employer payroll tax deferral under the CARES Act. As more information around the ongoing COVID-19 pandemic emerges, we will continue to re-evaluate our operating plans and adjust overall expenses as necessary to further extend our cash runway.

Our Pipeline

The following table sets forth the status and initial focus of our lead product candidate and protein secretion program:

Financial Operations Overview

Research and Development Expenses

Research and development expenses consist primarily of costs incurred for the development of our product candidates, which include:

19

We expense all research and development costs in the periods in which they are incurred. Costs for certain development activities are recognized based on an evaluation of the progress to completion of specific tasks using information and data provided to us by our vendors, collaborators and third-party service providers.

We are eligible under the AusIndustry Research and Tax Development Tax Incentive Program to obtain a cash amount from the Australian Taxation Office. The tax incentive is available to us on the basis of specific criteria with which we must comply related to research and development expenditures in Australia. These research and development tax incentives are recognized as contra research and development expense when the right to receive has been attained and funds are considered to be collectible. The amounts are determined based on a cost-reimbursement basis, and the incentive is related to our research and development expenditures and is due to us regardless of whether any Australian tax is owed. Amounts related to the AusIndustry Research and Development Tax Incentive Program are recognized when there is reasonable assurance that the incentive will be received, the relevant expenditure has been incurred by our Australian subsidiary, Kezar Life Sciences Australia Pty Ltd, a proprietary company limited by shares, and the amount of the consideration can be reliably measured.

The following table summarizes our research and development expenses incurred during the respective periods (in millions):

We expect our research and development expenses to increase substantially for the foreseeable future as we continue to invest in research and development activities related to the development of our product candidates and our preclinical programs, including advancement into later stages of development. The process of conducting the necessary clinical research to obtain regulatory approval is costly and time-consuming, and the successful development of our product candidates is highly uncertain. As a result, we are unable to determine the duration and completion costs of our research and development projects or when and to what extent we will generate revenue from the commercialization and sale of any of our product candidates.

General and Administrative Expenses

Our general and administrative expenses consist primarily of personnel costs, allocated facilities costs and other expenses for outside professional services, including legal, human resource, information technology and audit services. Personnel costs consist of salaries, benefits and stock-based compensation. We expect to incur additional expenses as we increase the size of our administrative function to support the growth of our business.

Interest Income

Our interest income consists of interest income earned on our cash, cash equivalents and marketable securities.

20

Results of Operations

Comparison of the Three Months Ended June 30, 2020 and 2019

Research and Development Expenses

Research and development expenses increased by $0.2 million for the three months ended June 30, 2020, compared to the three months ended June 30, 2019. The increase was primarily due to an increase of $0.3 million in preclinical expenses related to the Protein Secretion program and an increase of $0.8 million in personnel expenses due to an increase in headcount and salaries, partially offset by a decrease of $0.7 million in manufacturing expenses mainly due to the completion of KZR-616 manufacturing in 2019 and a decrease of $0.3 million in supplies and clinical expenses driven by the slowdown in research and clinical activities due to COVID-19. In addition, the Australian Research and Development Tax Incentive credit earned for the three months ended June 30, 2020 decreased by $0.1 million compared to the same period in 2019, which is recorded as a reduction in our research and development expenses.

General and Administrative Expenses

General and administrative expenses increased by $0.3 million for the three months ended June 30, 2020, compared to the three months ended June 30, 2019. The increase was primarily due to an increase of $0.2 million in stock-based compensation and an increase of $0.1 million in personnel expenses due to an increase in headcount and salaries.

Interest Income

Interest income decreased by $0.3 million for the three months ended June 30, 2020, compared to the three months ended June 30, 2019. The decrease was due to lower interest rates.

Comparison of the Six Months Ended June 30, 2020 and 2019