Zynerba Pharmaceuticals, Inc. - Quarter Report: 2019 June (Form 10-Q)

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

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

 

For the quarterly period ended June 30, 2019

 

OR

 

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

 

For the transition period from to

 

Commission file number: 001-37526

 

Zynerba Pharmaceuticals, Inc.

(Exact name of registrant as specified in its charter)

 

 

(484) 581-7505
(Registrant’s telephone number, including area code)

 

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 and post such files). ☒Yes ☐ No

 

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

 

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 2, 2019, the registrant had 23,198,010 shares of Common Stock, $0.001 par value per share, outstanding.

 

 

 

 

TABLE OF CONTENTS 

 

 

 

 

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

Statements made in this Quarterly Report that are not statements of historical or current facts, such as those under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements discuss our current expectations and projections relating to our financial condition, results of operations, plans, objectives, future performance and business. These statements may be preceded by, followed by or include the words “aim,” “anticipate,” “believe,” “estimate,” “expect,” “forecast,” “intend,” “outlook,” “plan,” “potential,” “project,” “projection,” “seek,” “may,” “could,” “would,” “will,” “should,” “can,” “can have,” “likely,” the negatives thereof and other words and terms of similar meaning.

 

Forward-looking statements are inherently subject to risks, uncertainties and assumptions; they are not guarantees of performance. You should not place undue reliance on these statements. We have based these forward-looking statements on our current expectations and projections about future events. Although we believe that our assumptions made in connection with the forward-looking statements are reasonable, we cannot assure you that the assumptions and expectations will prove to be correct.

 

You should understand that the following important factors could affect our future results and could cause those results or other outcomes to differ materially from those expressed or implied in our forward-looking statements:

 

 

In light of these risks and uncertainties, expected results or other anticipated events or circumstances discussed in this Form 10-Q (including the exhibits hereto) might not occur. We undertake no obligation, and specifically decline any

obligation, to publicly update or revise any forward-looking statements, even if experience or future developments make it clear that projected results expressed or implied in such statements will not be realized, except as may be required by law.

PART I – FINANCIAL INFORMATION

 

Item 1. Consolidated Financial Statements (Unaudited) 

 

ZYNERBA PHARMACEUTICALS, INC.
CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

 

 

See accompanying notes to unaudited consolidated financial statements.

ZYNERBA PHARMACEUTICALS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

 

 

See accompanying notes to unaudited consolidated financial statements.

 

ZYNERBA PHARMACEUTICALS, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(UNAUDITED)

 

 

 

 

 

See accompanying notes to unaudited consolidated financial statements.

ZYNERBA PHARMACEUTICALS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 

 

See accompanying notes to unaudited consolidated financial statements

 

 

 

(1) Nature of Business and Liquidity

 

Zynerba Pharmaceuticals, Inc., together with its subsidiary, Zynerba Pharmaceuticals Pty Ltd (“Zynerba”, the “Company”, “we”), is a clinical stage specialty pharmaceutical company focused on the development of pharmaceutically-produced transdermal cannabinoid therapies for rare and near-rare neuropsychiatric disorders, including Fragile X syndrome, autism spectrum disorder, 22q11.2 deletion syndrome, and a heterogeneous group of rare and ultra-rare epilepsies known as developmental and epileptic encephalopathies. The Company was incorporated on January 31, 2007 under the laws of the State of Delaware as AllTranz, Inc. and changed its name to Zynerba Pharmaceuticals, Inc. in August 2014.

 

The Company has incurred losses and negative cash flows from operations since inception and has an accumulated deficit of $138.2 million as of June 30, 2019. The Company anticipates incurring additional losses until such time, if ever, that it can generate significant revenue from its product candidates currently in development. The Company's primary source of liquidity has been the issuance of equity securities.

 

In June 2017, the Company entered into the Open Market Sales Agreement (the “Sales Agreement”) with Jefferies LLC, (“Jefferies”) pursuant to which the Company sold $50.0 million of its common stock. In the first quarter of 2019, the Company sold and issued 3,439,523 shares of common stock under the Sales Agreement with Jefferies in the open market at a weighted average selling price of $5.44 per share, resulting in gross proceeds of $18.7 million. Net proceeds received after deducting commissions and offering expenses were $18.1 million. In the second quarter of 2019, the Company sold and issued 2,082,031 shares of common stock under the Sales Agreement with Jefferies in the open market at a weighted average selling price of $13.50 per share, resulting in gross proceeds of $28.1 million. Net proceeds received after deducting commissions and offering expenses were $27.0 million. The last sale under the Sales Agreement was made on May 16, 2019. From June 2017 through May 16, 2019, the Company has cumulative gross proceeds of $50.0 million from shares sold in the open market under the Sales Agreement, which has terminated pursuant to its terms.

 

In July 2018, the Company completed a follow-on public offering, selling 4,062,500 shares of its common stock at an offering price of $8.00 per share, resulting in gross proceeds of $32.5 million. Net proceeds received after deducting underwriting discounts and commissions and offering expenses were $29.9 million. 

 

In July 2019, the Australian government’s Department of Industry, Innovation and Science (“AusIndustry”) responded to an Advance Overseas Finding (“AOF”) application submitted by Zynerba that will allow certain research and development expenses incurred with respect to the Company’s product candidate Zygel™ outside of Australia to be eligible for the Australian research and development tax incentive program. As a result of this finding, the Company is eligible to receive a cash refund from the Australian Taxation Office for the qualifying research and development costs expended outside of Australia in 2018, 2019 and 2020. Management believes that this decision will generate an incremental $7.0 to $9.0 million in cash tax credits over the next 18 to 24 months.

 

Management believes that current cash and cash equivalents and the proceeds anticipated from the AOF are sufficient to fund operations and capital requirements into the second half of 2021. Substantial additional financings will be needed by the Company to fund its operations, to complete clinical development of and to commercially develop its product candidates. There is no assurance that such financing will be available when needed or on acceptable terms. 

 

The Company is subject to those risks associated with any clinical stage pharmaceutical company that has substantial expenditures for research and development. There can be no assurance that the Company's research and development projects will be successful, that products developed will obtain necessary regulatory approval, or that any approved product will be commercially viable. In addition, the Company operates in an environment of rapid technological change and is largely dependent on the services of its employees and consultants.

 

(2) Summary of Significant Accounting Policies

 

a. Basis of Presentation

 

The accompanying unaudited interim consolidated financial statements of the Company have been prepared in

accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. The interim unaudited consolidated financial statements have been prepared on the same basis as the consolidated financial statements as of and for the year ended December 31, 2018 included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018 (“2018 Annual Report”), filed with the Securities and Exchange Commission (“SEC”). In the opinion of management, the accompanying consolidated financial statements of the Company include all normal and recurring adjustments (which consist primarily of accruals, estimates and assumptions that impact the consolidated financial statements) considered necessary to present fairly the Company's financial position as of June 30, 2019, its results of operations for the three and six months ended June 30, 2019 and 2018 and cash flows for the six months ended June 30, 2019 and 2018. Operating results for any interim period are not necessarily indicative of results for any future interim period or for the entire year. The accompanying unaudited interim consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in the Company’s 2018 Annual Report.

 

b. Use of Estimates

 

The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and reported amounts of expenses during the reporting period. Actual results could differ from such estimates.

 

c. Incentive and Tax Receivables

 

The Company’s subsidiary, Zynerba Pharmaceuticals Pty Ltd (the “Subsidiary”), is incorporated in Australia. The Subsidiary is eligible to participate in an Australian research and development tax incentive program.  As part of this program, the Subsidiary is eligible to receive a cash refund from the Australian Taxation Office for a percentage of the research and development costs expended by the Subsidiary in Australia. The cash refund is available to eligible companies with an annual aggregate revenue of less than $20.0 million (Australian dollars) during the reimbursable period. The Company’s estimate of the amount of cash refund it expects to receive related to the Australian research and development tax incentive program is included in “Incentive and tax receivables” in the accompanying consolidated balance sheets. As of June 30, 2019, the Company’s estimate of the amount of cash refund it expects to receive in 2019 for 2018 eligible spending as part of this incentive program was $3.1 million and was recorded as a current asset. The Company’s estimate of the amount of cash refund it expects to receive in 2020 for 2019 eligible spending through June 30, 2019 was $1.5 million and was recorded as a non-current asset. 

 

In July 2019, AusIndustry responded to an AOF application submitted by Zynerba that will allow certain research and development expenses incurred with respect to Zygel outside of Australia to be eligible for the Australian research and development tax incentive program. As a result of this finding, the Company is eligible to receive a cash refund from the Australian Taxation Office for the qualifying research and development costs expended outside of Australia in 2018, 2019 and 2020. The anticipated benefit of this AOF decision will be assessed and recorded in the Company’s third quarter consolidated financial statements.

 

In addition, the Subsidiary incurs Goods and Services Tax (“GST”) on services provided by Australian vendors. As an Australian entity, the Subsidiary is entitled to a refund of the GST paid. The Company’s estimate of the amount of cash refund it expects to receive related to GST incurred is included in “Incentive and tax receivables” in the accompanying consolidated balance sheets. As of June 30, 2019, incentive and tax receivables included $0.3 million for refundable GST on expenses incurred with Australian vendors during the three months ended June 30, 2019. 

 

d. Research and Development

 

Research and development costs are expensed as incurred and are primarily comprised of external research and development expenses incurred under arrangements with third parties, such as contract research organizations, contract manufacturing organizations, consultants and employee-related expenses including salaries and benefits. At the end of each reporting period, the Company compares the payments made to each service provider to the estimated progress towards completion of the related project. Factors that the Company considers in preparing these estimates include the number of patients enrolled in studies, milestones achieved and other criteria related to the efforts of its vendors. These

estimates will be subject to change as additional information becomes available. Depending on the timing of payments to vendors and estimated services provided, the Company will record net prepaid or accrued expenses related to these costs. Research and development expenses are recorded net of expected refunds of eligible research and development costs paid pursuant to the Australian research and development tax incentive program and GST incurred on services provided by Australian vendors.  The Company incurred research and development expenses of $14.5 million and $17.5 million for the six months ended June 30, 2019 and 2018, respectively, which were net of $1.5 million and $2.1 million, respectively, associated with the Australian research and development tax incentive program.

 

e. Net Loss Per Share

 

Basic net loss per share is determined using the weighted average number of shares of common stock outstanding during each period. Diluted net income per share includes the effect, if any, from the potential exercise or conversion of securities, such as restricted stock and stock options, which would result in the issuance of incremental shares of common stock. Basic and dilutive computations of net loss per share are the same in periods in which a net loss exists as the dilutive effects of restricted stock and stock options would be anti-dilutive.

 

The following potentially dilutive securities outstanding as of June 30, 2019 and 2018 have been excluded from the computation of diluted weighted average shares outstanding, as their effects on net loss per share for the periods presented would be anti-dilutive:

 

f. Recently Adopted Accounting Pronouncements

 

In 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-02, Leases (Topic 842), Accounting Standards Codification 842 (“ASC 842”), which amends a number of aspects of lease accounting and requires entities to recognize right-of-use assets and lease liabilities on the balance sheet for leases with lease terms of more than 12 months. ASC 842 became effective on January 1, 2019. In July 2018, the FASB issued ASU No. 2018-11, Leases (Topic 842): Targeted Improvements (“ASU 2018-11”), which offered a transition option to entities adopting ASC 842. Under ASU 2018-11, entities can elect to apply ASC 842 using a modified-retrospective adoption approach resulting in a cumulative effect adjustment, if any, to retained earnings at the beginning of the year in which the new lease standard is adopted, rather than adjustments to the earliest comparative period presented in their financial statements.

 

As of January 1, 2019, the Company adopted ASC 842 using the modified-retrospective method and recognized right-of-use assets and corresponding lease liability of $325,683, which represented the present value of the remaining lease payments of $350,507, discounted using the Company’s incremental borrowing rate of 11.17%. In addition, the Company eliminated its deferred rent liability and recorded an adjustment to decrease its right-of-use assets by $12,824. The adoption of the standard did not have an impact on the Company’s consolidated statements of cash flows and had no impact on the Company’s consolidated statement of operations.

 

 

(3) Fair Value Measurements

 

The Company measures certain assets and liabilities at fair value in accordance with Accounting Standards

Codification 820 (“ASC 820”), Fair Value Measurements and Disclosures. ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability (the exit price) in an orderly transaction between market participants at the measurement date. The guidance in ASC 820 outlines a valuation framework and creates a fair value hierarchy that serves to increase the consistency and comparability of fair value measurements and the related disclosures. In determining fair value, the Company maximizes the use of quoted prices and observable inputs. Observable inputs are inputs that market participants would use in pricing the asset or liability based on market data

obtained from independent sources. The fair value hierarchy is broken down into three levels based on the source of inputs as follows:

 

Level 1 — Valuations based on unadjusted quoted prices in active markets for identical assets or liabilities.

 

Level 2 — Valuations based on observable inputs and quoted prices in active markets for similar assets and liabilities.

 

Level 3 — Valuations based on unobservable inputs and models that are supported by little or no market activity.

 

In accordance with the fair value hierarchy described above, the following table sets forth the Company's financial assets measured at fair value on a recurring basis as of June 30, 2019 and December 31, 2018:

 

 

 

(4) Prepaid Expenses and Other Current Assets

 

Prepaid expenses and other current assets consisted of the following as of June 30, 2019 and December 31, 2018:

 

 

 

(5) Property and Equipment

 

Property and equipment consisted of the following as of June 30, 2019 and December 31, 2018:  

 

 

Depreciation expense was $32,924 and $21,586 for the three months ended June 30, 2019 and 2018, respectively, and $62,180 and $48,152 for the six months ended June 30, 2019 and 2018, respectively.

(6) Accrued Expenses

 

Accrued expenses consisted of the following as of June 30, 2019 and December 31, 2018:  

 

 

 

(7) Common Stock

 

In June 2017, the Company entered into the Sales Agreement with Jefferies pursuant to which the Company sold $50.0 million of its common stock. In the first quarter of 2019, the Company sold and issued 3,439,523 shares of common stock under the Sales Agreement with Jefferies in the open market at a weighted average selling price of $5.44 per share, resulting in gross proceeds of $18.7 million. Net proceeds received after deducting commissions and offering expenses were $18.1 million. In the second quarter of 2019, the Company sold and issued 2,082,031 shares of common stock under the Sales Agreement with Jefferies in the open market at a weighted average selling price of $13.50 per share, resulting in gross proceeds of $28.1 million. Net proceeds received after deducting commissions and offering expenses were $27.0 million. The last sale under the Sales Agreement was made on May 16, 2019. From June 2017 through May 16, 2019, the Company has cumulative gross proceeds of $50.0 million from shares sold in the open market under the Sales Agreement, which has terminated pursuant to its terms.

 

In July 2018, the Company completed a follow-on public offering, selling 4,062,500 shares of its common stock at an offering price of $8.00 per share, resulting in gross proceeds of $32.5 million. Net proceeds received after deducting underwriting discounts and commissions and offering expenses were $29.9 million.

 

(8) Stock-Based Compensation

 

The Company maintains the Amended and Restated 2014 Omnibus Incentive Compensation Plan, as amended (the “2014 Plan”), which allows for the granting of incentive stock options, nonqualified stock options, stock appreciation rights, stock awards, stock units, performance units and other stock‑based awards to employees, officers, non-employee directors, consultants, and advisors. In addition, the 2014 Plan provides selected executive employees with the opportunity to receive bonus awards that are considered qualified performance‑based compensation. The 2014 Plan is subject to automatic annual increases in the number of shares authorized for issuance under the 2014 Plan on the first trading day of January each year equal to the lesser of 1.5 million shares or 10% of the number of shares of common stock outstanding on the last trading day of December of the preceding year. As of January 1, 2019, the number of shares of common stock that may be issued under the 2014 Plan was automatically increased by 1.5 million shares, increasing the number of shares of common stock available for issuance under the 2014 Plan to 6,304,869 shares. As of June 30, 2019, 1,881,536 shares were available for future issuance under the 2014 Plan.

 

Options issued under the 2014 Plan have a contractual life of 10 years and may be exercisable in cash or as otherwise determined by the board of directors. The Company has granted options to employees and non‑employee directors. Stock options granted to employees vest 25% upon the first anniversary of the grant date and the balance of unvested options vests in quarterly installments over the remaining three years. Stock options granted annually to non-employee directors vest on the earlier of the one-year anniversary of the grant date, or the date of the Company’s next annual stockholders’ meeting that occurs after the grant date. The Company’s non-employee director compensation policy enables directors to receive stock options in lieu of quarterly cash payments. Any option granted to the directors in lieu of cash compensation vests in full on the grant date. The Company records forfeitures as they occur.

 

During 2018, the Company granted 83,280 performance-based stock options to certain employees. These performance options have a 10-year life and an exercise price equal to the fair value of the Company’s stock at the grant date. During 2019, the Company granted 5,000 performance-based restricted stock awards. Vesting of the performance-based options and restricted stock awards is dependent on meeting certain performance conditions, which relate to the Company’s research and development progress, which were established by the Company’s board of directors. The Company’s board of directors determines if the performance conditions have been met. Stock-based compensation expense for these performance-based grants are recorded when management estimates that the vesting of these shares is probable based on the status of the Company’s research and development programs and other relevant factors. For the six months ended June 30, 2019, none of the performance-based metrics were deemed probable of achievement. Any change in these estimates will result in a cumulative adjustment in the period in which the estimate is changed, so that as of the end of a period, the cumulative compensation expense recognized for an award or grant equals the amount that would be recognized on a straight-line basis as if the current estimates had been utilized since the beginning of the service period. As of June 30, 2019, the aggregate estimated grant date fair values of options and restricted stock awards for which the satisfaction of the related-performance conditions have not been deemed probable were $663,484 and $24,850, respectively.

 

For the six months ended June 30, 2019 and 2018, the Company recorded stock-based compensation expense related to its stock option grants and restricted stock awards, as follows:

 

 

The following table summarizes the stock option activity for the six months ended June 30, 2019:

 

 

The weighted-average grant date fair values of options granted during the six months ended June 30, 2019 and 2018 were $3.37 and $7.94, respectively.

 

The fair values of stock options granted were calculated using the Black-Scholes option pricing model with the following weighted-average assumptions:

 

 

As of June 30, 2019, excluding performance-based stock options that have not been deemed probable, there was $8.8 million of unrecognized stock-based compensation expense related to stock options, which is expected to be recognized over a weighted-average period of 2.21 years.

 

The following table summarizes the restricted stock award activity under the 2014 Plan for the six months ended June 30, 2019:

 

As of June 30, 2019, excluding performance-based restricted stock awards that have not been deemed probable, there was $16,239 of unrecognized stock-based compensation expense related to unvested restricted stock awards, which is expected to be recognized over a weighted-average period of 1.09 years. The Company expects that all 6,600 of unvested, non-performance based, restricted stock awards will vest.

 

(9) Operating Lease Obligations

The Company adopted ASC 842 prospectively using the modified-retrospective method and elected the package of transition practical expedients that does not require reassessment of: (1) whether any existing or expired contracts are or contain leases, (2) lease classification and (3) initial direct costs. In addition, the Company has elected other available practical expedients to not separate lease and nonlease components, which consist principally of common area maintenance charges, and to exclude leases with an initial term of 12 months or less.

The Company leases its headquarters where it occupies 10,877 square feet of office space pursuant to a five-year lease that expires on May 31, 2020. The Company’s lease contains variable lease costs that do not depend on a rate or index and consist primarily of common area maintenance, taxes, and insurance. As the implicit rate was not readily determinable for the Company’s lease, the Company used an estimated incremental borrowing rate, or discount rate, to determine the initial present value of the lease payments. The discount rate for the lease was calculated using a synthetic credit rating model.

As of January 1, 2019, the Company recognized a lease liability of $325,683 and right-of-use assets of $312,859, which was recorded net of a pre-existing deferred rent liability of $12,824. As of June 30, 2019, the Company’s right-of-use asset, net of amortization, was $206,250.

 

Other operating lease information as of June 30, 2019:

 

 

The following is a maturity analysis of the annual undiscounted cash flows of the operating lease liabilities as of June 30, 2019:

 

 

Lease expense for the six months ended June  30, 2019 was comprised of the following:

 

 

Cash payments related to operating leases for the six months ended June 30, 2019 was $122,242.

 

(10)  Subsequent Events

 

In July 2019, AusIndustry responded to an AOF application submitted by Zynerba that will allow certain research and development expenses incurred with respect to Zygel outside of Australia to be eligible for the Australian research and development tax incentive program. As a result of this finding, the Company is eligible to receive a cash refund from the Australian Taxation Office for the qualifying research and development costs expended outside of Australia in 2018, 2019 and 2020. Management believes that this decision will generate an incremental $7.0 to $9.0 million in cash tax credits over the next 18 to 24 months. The anticipated benefit of this AOF decision will be assessed and recorded in the Company’s third quarter consolidated financial statements.

 

 

 

Item 2. 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 together with our unaudited interim consolidated financial statements and related notes appearing elsewhere in this Quarterly Report and the audited consolidated financial statements and notes thereto for the year ended December 31, 2018 and the related Management’s Discussion and Analysis of Financial Condition and Results of Operations, both of which are contained in our 2018 Annual Report.  The following discussion contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results and the timing of certain events could differ materially from those anticipated in these forward-looking statements as a result of many factors.  We discuss factors that we believe could cause or contribute to these differences below and elsewhere in this Quarterly Report, including those set forth under “Cautionary Note Regarding Forward-looking Statements” and “Risk Factors” in this Quarterly Report and our 2018 Annual Report.

 

Overview

 

Company Overview

 

Zynerba Pharmaceuticals is the leader in pharmaceutically-produced transdermal cannabinoid therapies for rare and near-rare neuropsychiatric disorders. We are committed to improving the lives of patients and their families living with severe, chronic health conditions including Fragile X syndrome, or FXS, autism spectrum disorder, or ASD, 22q11.2 deletion syndrome, or 22q, and a heterogeneous group of rare and ultra-rare epilepsies known as developmental and epileptic encephalopathies, or DEE.

 

We are currently evaluating ZygelTM, a patent-protected transdermal cannabidiol, or CBD, gel for the treatment of FXS, DEE, ASD and 22q. In 2017, we completed three Phase 2 clinical trials for Zygel and two of those studies have open-label extensions that are ongoing. In April 2018, we initiated an open-label Phase 2 clinical trial evaluating Zygel in children and adolescent patients with DEE, and in July 2018, we initiated what we believe will be a pivotal clinical trial evaluating Zygel in children and adolescent patients with FXS. In March 2019, we initiated an open-label Phase 2 clinical trial evaluating Zygel in children and adolescent patients with ASD and in May 2019, we initiated an open-label Phase 2 clinical trial evaluating Zygel in children and adolescent patients with 22q.

 

Cannabinoids are a class of compounds derived from Cannabis plants. The two primary cannabinoids contained in Cannabis are CBD and Tetrahydrocannabinol, or THC. Clinical and preclinical data suggest that CBD has positive effects on treating behavioral symptoms of FXS, ASD, 22q and seizures in patients with epilepsy.

 

Zygel

 

Zygel is the first and only pharmaceutically-produced CBD formulated as a permeation‑enhanced gel for transdermal delivery, and the formulation is patent protected through 2030. Two additional patents, directed to methods of treating FXS with synthetic or purified CBD and methods of treating ASD with synthetic CBD, respectively, will expire in 2038. CBD is the primary non‑euphoric component of Cannabis. In preclinical animal studies, Zygel’s permeation enhancer increased delivery of CBD through the layers of the skin and into the circulatory system. These preclinical studies suggest increased bioavailability, consistent plasma levels and the avoidance of first‑pass liver metabolism of CBD when delivered transdermally. In addition, an in vitro study published in Cannabis and Cannabinoid Research in April 2016 demonstrated that CBD is degraded to THC (the major psychoactive cannabinoid in Cannabis) in an acidic environment such as the stomach. As a result, we believe such degradation may lead to increased psychoactive effects if CBD is delivered orally and may be avoided with the transdermal delivery of Zygel, which maintains CBD in a neutral pH. Zygel, which is being developed as a clear gel with once- or twice-daily dosing, is targeting treatment of behavioral symptoms of FXS, ASD and 22q and reduction in seizures in patients with DEE. We have been granted orphan drug designation from the U.S. Food and Drug Administration, or FDA,  for the use of CBD for the treatment of FXS. In May 2019, we received Fast Track designation from the FDA for treatment of behavioral symptoms associated with FXS. The FDA’s Fast Track program is designed to facilitate the development of drugs intended to treat serious conditions and fill unmet medical needs, and can lead to expedited review by FDA in order to get new important drugs to the patient earlier. In our Phase 1 program, Zygel was demonstrated to be safe and well tolerated, provided a favorable CBD pharmacokinetic profile, and no THC was detected in plasma or urine. As of June 2018, the Zygel safety database across all clinical studies conducted by us includes data from 570 volunteers and patients. Across these clinical studies, Zygel has been well tolerated and consistent with previously reported data.

 

In April 2018, we initiated the Phase 2 BELIEVE 1 (Open Label Study to Assess the Safety and Efficacy of Zygel Administered as a Transdermal Gel to Children and Adolescents with Developmental and Epileptic Encephalopathy) clinical trial, a six-month open label multi-dose clinical trial designed to evaluate the efficacy and safety of Zygel in children and adolescents (three to 17 years) with DEE as classified by the International League Against Epilepsy (ILAE) (Scheffer et al. 2017). Enrollment in this study was complete in December 2018 and 48 patients with confirmed DEE are being dosed in the clinical trial, 27% of whom have either Dravet or Lennox-Gastaut syndromes.  Patients received weight-based initial doses of 250 mg or 500 mg daily and during the maintenance phase patients receive up to 1000 mg daily of Zygel. The primary endpoint is change in seizure frequency from baseline. We expect to report top line results from the BELIEVE 1 trial in September of 2019.

 

In July 2018, we initiated the pivotal CONNECT-FX (Clinical study of Cannabidiol (CBD) in Children and Adolescents with Fragile X) clinical trial, a multi-national randomized, double-blind, placebo-controlled, 14-week study that will assess the efficacy and safety of Zygel in children and adolescents ages three through 17 years who have full mutation of the FMR1 gene. Approximately 200 male and female patients with FXS will be enrolled at approximately 20 clinical sites in the United States, Australia, and New Zealand. The study is being conducted in the United States under an Investigational New Drug (IND) application opened with the FDA. Patients will be randomized 1:1 to either trial drug or placebo. Randomization will be stratified by gender, weight, and investigator geographic region. Enrolled patients will receive weight-based doses of 250 mg or 500 mg daily. The primary endpoint is the change from baseline to the end of the treatment period in the Aberrant Behavior Checklist-Community FXS Specific (ABC-C_FXS) Social Avoidance subscale. Key secondary endpoints are the change from baseline to the end of the treatment period in the ABC-C_FXS Irritability subscale score, the ABC-C_FXS Socially Unresponsive/Lethargic subscale score, and improvement in Clinical Global Impression - Improvement (CGI-I) at the end of the treatment period. Based on discussions with the FDA, we will anchor the CGI-I scale to behavioral symptoms of FXS. Consistent with recent guidance from the FDA on capturing the voice of the patient in drug development, additional qualitative data on the clinical relevance of various FXS behaviors to caregivers and patients will be collected. If we obtain positive results from this trial, we plan to request a meeting with the FDA to determine the acceptability of these data as the basis for an NDA filing. We expect to report top line results from the CONNECT-FX trial in the first half of 2020.

 

In March 2019, we initiated the Phase 2 BRIGHT (An Open-Label Tolerability and Efficacy Study of ZYN002 Administered as a Transdermal Gel to Children and Adolescents with Autism Spectrum Disorder) trial, a 14-week open label clinical trial designed to assess the safety, tolerability and efficacy of Zygel for the treatment of behavioral symptoms of ASD. We expect to enroll approximately 36 male and female patients (age four to 17 years) and to report top line data from this study in the first half of 2020.

 

In May 2019, we initiated the open-label Phase 2 INSPIRE (Assessing the Impact of Zygel [Transdermal CBD Gel] on Pediatric Behavioral and Emotional Symptoms of 22q11.2 Deletion Syndrome) trial, a 14-week open label clinical trial designed to assess the safety, tolerability and efficacy of Zygel for treatment of behavioral symptoms of 22q. We expect to enroll approximately 20 male and female patients (age six to 17 years) and to report top line data from this study in the first half of 2020.

Zygel Clinical Development Timelines

 

Our key development programs and expected timelines for the development of Zygel are shown in the chart below:

 

 

We have never been profitable and have incurred net losses since inception. Our net losses were $20.3 million and $24.3 million for the six months ended June 30, 2019 and 2018, respectively. As of June 30, 2019, our accumulated deficit was $138.2 million. We expect to incur losses for the foreseeable future, and we expect these losses to increase as we continue our development of, and seek regulatory approvals for, our product candidates. Because of the numerous risks and uncertainties associated with product development, we are unable to predict the timing or amount of increased expenses or when, or if, we will be able to achieve or maintain profitability.

 

Financial Operations Overview

 

The following discussion sets forth certain components of our consolidated statements of operations as well as factors that impact those items.

 

Revenue 

 

Historically, our revenue consisted of state and federal research grants and fees received from research services for third-party product development. Revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price is fixed or determinable and collectability is reasonably assured. 

 

Research and Development Expenses 

 

Our research and development expenses relating to our product candidates consisted of the following:

 

 

 

 

 

We expense all research and development costs as incurred. Clinical development expenses for our product candidates are a significant component of our current research and development expenses. Generally speaking, expenses associated with clinical trials will increase as our clinical trials progress. Product candidates in later stage clinical development generally have higher research and development expenses than those in earlier stages of development, primarily due to increased size and duration of the clinical trials. We track and record information regarding external research and development expenses for each grant, study or trial that we conduct. We use third-party CROs, CMOs, contractor laboratories and independent contractors in preclinical studies and clinical trials. We recognize the expenses associated with third parties performing these services for us in our preclinical studies and clinical trials based on the percentage of each study completed at the end of each reporting period.

 

For the six months ended June 30, 2019 and 2018, we incurred research and development expenses of $14.5 million and $17.5 million, respectively, which were net of $1.5 million and $2.1 million, respectively, associated with the Australian research and development tax incentive program. As part of this program, we are eligible to receive a cash refund from the Australian Taxation Office for a percentage of our research and development costs expended by Zynerba Pharmaceuticals Pty Ltd, our Australian subsidiary.

 

Excluding the reduction of research and development expenses from the July 2019 Advance Overseas Finding, or AOF, application, as discussed in Footnote 10 of our unaudited consolidated financial statements, we expect research and development expenses to increase in 2019 as compared to 2018 as we continue to advance our clinical trials. These expenditures are subject to numerous uncertainties regarding timing and cost to completion. Completion of our preclinical development and clinical trials may take several years or more and the length of time generally varies according to the type, complexity, novelty and intended use of a product candidate. The cost of clinical trials may vary significantly over the life of a project as a result of differences arising during clinical development, including, among others:

 

 

 

 

 

 

 

Due to the early stages of our research and development, we are unable to determine the duration or completion costs of our development of our product candidates. As a result of the difficulties of forecasting research and development costs of our product candidates as well as the other uncertainties discussed above, we are unable to determine when and to what extent we will generate revenue from the commercialization and sale of an approved product candidate.

 

General and Administrative Expenses 

 

General and administrative expenses consist primarily of salaries, benefits and other related costs, including stock-based compensation, for personnel serving in our executive, finance, legal, human resource, investor relations and commercial functions. Our general and administrative expenses also include facility and related costs not included in research and development expenses, professional fees for legal services, including patent-related expenses, consulting, tax and accounting services, insurance, market research and general corporate expenses. We expect that our general and administrative expenses will increase for the next several years as we increase our headcount with the continued development and potential commercialization of our product candidates.

 

Interest Income

 

Interest income primarily consists of interest earned on balances maintained in our money market bank account. 

 

Foreign Exchange (Loss) Gain

 

Foreign exchange (loss) gain relates to the effect of exchange rates on transactions incurred by our Australian subsidiary.

 

Critical Accounting Estimates

 

Our management’s discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles, or GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reported period. In accordance with GAAP, we base our estimates on historical experience, known trends and events and various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying amounts of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

 

We define our critical accounting policies as those that require us to make subjective estimates and judgments about matters that are uncertain and are likely to have a material impact on our financial condition and results of operations as well as the specific manner in which we apply those principles. Critical accounting estimates and the accounting policies critical to the process of making significant judgments and estimates in the preparation of our consolidated financial statements are discussed in our 2018 Annual Report under Part II, Item 7, “Critical Accounting Policies and Use of Estimates”. During the six months ended June 30, 2019, there have been no material changes to the critical accounting estimates or critical accounting policies discussed in our 2018 Annual Report.

 

Results of Operations

 

Comparison of the Three Months Ended June 30, 2019 and 2018

 

Research and Development Expenses

 

Research and development expenses decreased by $0.3 million, or 4%, to $8.2 million for the three months ended June 30, 2019 from $8.5 million for the three months ended June 30, 2018.  The decrease was primarily related to a  decrease in non-clinical trial costs related to our Zygel program and decreases in employee-related costs and stock-based compensation expense; partially offset by an increase in clinical trial costs related to our Zygel program.

 

General and Administrative Expenses

 

General and administrative expenses decreased by $0.1 million, or 4%, to $3.3 million for the three months ended June 30, 2019 from $3.4 million for the three months ended June 30, 2018.  The decrease was primarily related to lower stock-based compensation expense and a decrease in pre-commercialization expense for our product candidates; slightly offset by higher employee-related costs.

 

Other Income (Expense)

 

During the three months ended June 30, 2019 and 2018, we recognized $0.4 million and $0.2 million, respectively, in interest income. The increase in interest income was primarily related to a higher amount of invested cash resulting from the receipt of $45.1 million in net proceeds from the sale of our shares of common stock under the Sales Agreement with Jefferies during the first half of 2019. During the three months ended June 30, 2019 and 2018, we recognized foreign currency losses of $0.1 million and $0.2 million, respectively. Foreign currency gains and losses are due primarily to the remeasurement of our Australian subsidiary’s assets and liabilities, which are denominated in the local currency to the subsidiary’s functional currency, which is the U.S. dollar. 

 

Comparison of the Six Months Ended June 30, 2019 and 2018

 

Research and Development Expenses

 

Research and development expenses decreased by $3.0 million, or 17%, to $14.5 million for the six months ended June 30, 2019 from $17.5 million for the six months ended June 30, 2018.  The decrease was primarily related to decreases in clinical and non-clinical trial costs related to our Zygel program,  a decrease in manufacturing costs, predominantly due to the discontinuation of the ZYN001 program, and decreases in employee-related costs and stock-based compensation expense.

 

General and Administrative Expenses

 

General and administrative expenses decreased by $0.4 million, or 6%, to $6.4 million for the six months ended June 30, 2019 from $6.9 million for the six months ended June 30, 2018.  The decrease was primarily related to lower costs associated with the recruiting of new employees, lower stock-based compensation expense and a decrease in pre-commercialization expense for our product candidates; slightly offset by higher employee-related costs.

 

Other Income (Expense)

 

During the six months ended June 30, 2019 and 2018, we recognized $0.8 million and $0.4 million, respectively, in interest income. The increase in interest income was related both to a higher average interest rate earned on our investments and to a  higher amount of invested cash resulting from the receipt of $45.1 million in net proceeds from the sale of our shares of common stock under the Sales Agreement with Jefferies during the first half of 2019. During the six months ended June 30, 2019 and 2018, we recognized foreign currency losses of $0.1 million and $0.3 million, respectively. Foreign currency gains and losses are due primarily to the remeasurement of our Australian subsidiary’s assets and liabilities that are denominated in the local currency to the subsidiary’s functional currency, which is the U.S. dollar. 

 

Liquidity and Capital Resources

 

Since our inception in 2007, we have devoted most of our cash resources to research and development and general and administrative activities. We have financed our operations primarily with the proceeds from the sale of equity securities (most notably our IPO in 2015, sales under our “at-the-market” offering in 2016, 2017 and 2019, and our follow-on public offerings in the first quarter of 2017 and the third quarter of 2018, of which our 2018 and 2019 transactions are described below under Equity Financings) and convertible promissory notes, state and federal grants and research services.

 

To date, we have not generated any revenue from the sale of products, and we do not anticipate generating any revenue from the sales of products for the foreseeable future. We have incurred losses and generated negative cash flows from operations since inception. As of June 30, 2019, our principal sources of liquidity were our cash and cash equivalents of  $88.7 million. Our working capital was  $83.6 million as of June 30, 2019.

 

In July 2019, the Australian government’s Department of Industry, Innovation and Science, or AusIndustry, responded to an AOF application submitted by us that will allow certain research and development expenses incurred with respect to Zygel outside of Australia to be eligible for the Australian research and development tax incentive program. As a result of this finding, we are eligible to receive a cash refund from the Australian Taxation Office for the qualifying research and development costs expended outside of Australia in 2018, 2019 and 2020. We believe that this decision will generate an incremental $7.0 to $9.0 million in cash tax credits over the next 18 to 24 months.

 

Management believes that current cash and cash equivalents and the proceeds anticipated from the AOF are sufficient to fund operations and capital requirements beyond the expected NDA submission and potential approval of Zygel for the treatment of FXS and into the second half of 2021.   Substantial additional financings will be needed to fund our operations and to complete clinical development of and to commercially develop our product candidates. There is no assurance that such financing will be available when needed or on acceptable terms.

 

Equity Financings

 

In June 2017, we entered into an Open Market Sales Agreement, or Sales Agreement, with Jefferies LLC, or Jefferies, pursuant to which we sold $50.0 million of our common stock. In the first quarter of 2019, we sold and issued 3,439,523 shares of common stock under the Sales Agreement with Jefferies in the open market at a weighted average selling price of $5.44 per share, resulting in gross proceeds of $18.7 million. Net proceeds received after deducting commissions and offering expenses were $18.1 million. In the second quarter of 2019, we sold and issued 2,082,031 shares of common stock under the Sales Agreement with Jefferies in the open market at a weighted average selling price of $13.50 per share, resulting in gross proceeds of $28.1 million. Net proceeds received after deducting commissions and offering expenses were $27.0 million. The last sale under the Sales Agreement was made on May 16, 2019. From June 2017 through May 16, 2019, we have cumulative gross proceeds of $50.0 million from shares sold in the open market under the Sales Agreement, which has terminated pursuant to its terms.

 

In July 2018, we completed a follow-on public offering, selling 4,062,500 shares of our common stock at an offering price of $8.00 per share, resulting in gross proceeds of $32.5 million. Net proceeds received after deducting underwriting discounts and commissions and offering expenses were $29.9 million.

 

Debt

 

We had no debt outstanding as of June 30, 2019 or December 31, 2018.

 

Future Capital Requirements

 

During the six months ended June 30, 2019, net cash used in operating activities was $16.4 million, and our accumulated deficit as of June 30, 2019 was $138.2 million. Our expectations regarding future cash requirements do not reflect the potential impact of any future acquisitions, mergers, dispositions, joint ventures or investments that we may make in the future. To the extent that we enter into any of those types of transactions, we may need to raise substantial additional capital.

 

We expect to continue to incur substantial additional operating losses for at least the next several years as we continue to develop our product candidates and seek marketing approval and, subject to obtaining such approval, the eventual commercialization of our product candidates. If we obtain marketing approval for any of our product candidates, we will incur significant sales, marketing and manufacturing expenses. In addition, we expect to incur additional expenses to add operational, financial and information systems and personnel, including personnel to support our planned product commercialization efforts. We also expect to continue to incur significant costs to comply with corporate governance, internal controls and similar requirements associated with operating as a public reporting company.

 

Our future use of operating cash and capital requirements will depend on many forward-looking factors, including the following:

 

 

 

 

 

 

 

 

 

 

To the extent that our capital resources are insufficient to meet our future operating and capital requirements, we will need to finance our cash needs through public or private equity offerings, debt financings, collaboration and licensing arrangements or other financing alternatives. We have no committed external sources of funds. Additional equity or debt financing or collaboration and licensing arrangements may not be available on acceptable terms, if at all.

 

If we raise additional funds by issuing equity securities, our stockholders will experience dilution.

 

Cash Flows

 

The following table summarizes our cash flows from operating, investing and financing activities for the six months ended June 30, 2019 and 2018.

 

 

Operating Activities

 

For the six months ended June 30, 2019, cash used in operating activities was $16.4 million compared to $19.3 million for the six months ended June 30, 2018. The decrease from the comparable 2018 period was primarily the result of decreased research and development activities related to our product candidates and a decrease in prepaid manufacturing and prepaid clinical trial costs.

 

Excluding the cash anticipated to be received from the July 2019 AOF application, as discussed in Footnote 10 of our unaudited consolidated financial statements, we expect cash used in operating activities in 2019 to be similar to 2018.

 

Investing Activities

 

For the six months ended June 30, 2019, cash used in investing activities represented the cost of expenditures made for manufacturing equipment. For the six months ended June 30, 2018, cash used in investing activities represented the cost of expenditures made for manufacturing equipment and furniture and fixtures and leasehold improvements associated with our corporate headquarters. 

 

Financing Activities

 

Cash provided by financing activities for the six months ended June 30, 2019 consisted primarily of $45.1 million in net proceeds from sales of our shares of common stock under the Sales Agreement with Jefferies.  

 

Contractual Obligations

 

Other than the changes related to the adoption of the new lease accounting standard as described in Note 9 of our Notes to Unaudited Consolidated Financial Statements, there were no material changes in our contractual obligations since December 31, 2018. Our material contractual obligations consist of commitments under operating lease agreements and the related amounts of our obligations as of December 31, 2018 were disclosed in “Contractual Obligations” in Part II, Item 7 in our 2018 Annual Report.