Arcutis Biotherapeutics, Inc. 10-Q

Item 1. Financial Statements ARCUTIS BIOTHERAPEUTICS, INC. Condensed Balance Sheets (In thousands, except share and par value) September 30, December 31, 2021 2020 (unaudited) ASSETS Current assets: Cash and cash equivalents $ 51,778 $ 65,082 Restricted cash 1,542 1,542 Marketable securities 315,492 219,359 Prepaid expenses and other current assets 12,958 6,843 Total current assets 381,770 292,826 Property, plant, and equipment, net 2,045 2,016 Operating lease right-of-use asset 3,115 3,349 Other assets 78 78 Total assets $ 387,008 $ 298,269 LIABILITIES AND STOCKHOLDERS’ EQUITY Current liabilities: Accounts payable $ 4,871 $ 7,140 Accrued liabilities 13,881 15,462 Operating lease liability 306 — Total current liabilities 19,058 22,602 Operating lease liability, noncurrent 4,924 4,964 Other long-term liabilities 31 82 Total liabilities 24,013 27,648 Commitments and contingencies (Note 7) Stockholders’ equity: Preferred stock, $ 0.0001 par value; 10,000,000 shares authorized at September 30, 2021 and December 31, 2020; no shares issued and outstanding at September 30, 2021 and December 31, 2020; — — Common stock, $ 0.0001 par value; 300,000,000 shares authorized at September 30, 2021 and December 31, 2020; 50,266,730 and 43,677,817 shares issued at September 30, 2021 and December 31, 2020, respectively; 50,134,813 and 43,338,438 shares outstanding at September 30, 2021 and December 31, 2020, respectively 5 4 Additional paid-in capital 699,988 472,569 Accumulated other comprehensive loss ( 18 ) ( 2 ) Accumulated deficit ( 336,980 ) ( 201,950 ) Total stockholders’ equity 362,995 270,621 Total liabilities and stockholders’ equity $ 387,008 $ 298,269 The accompanying notes are an integral part of these unaudited condensed financial statements. 1 Table of Contents ARCUTIS BIOTHERAPEUTICS, INC. Condensed Statements of Operations and Comprehensive Loss (In thousands, except share and per share data) (unaudited) Three Months Ended September 30, Nine Months Ended September 30, 2021 2020 2021 2020 Operating expenses: Research and development $ 40,604 $ 32,743 $ 93,000 $ 87,934 General and administrative 16,474 5,560 42,243 14,647 Total operating expenses 57,078 38,303 135,243 102,581 Loss from operations ( 57,078 ) ( 38,303 ) ( 135,243 ) ( 102,581 ) Other income, net 98 99 213 952 Net loss $ ( 56,980 ) $ ( 38,204 ) $ ( 135,030 ) $ ( 101,629 ) Other comprehensive income (loss): Unrealized gain (loss) on marketable securities 18 4 ( 16 ) 5 Comprehensive loss $ ( 56,962 ) $ ( 38,200 ) $ ( 135,046 ) $ ( 101,624 ) Per share information: Net loss per share, basic and diluted $ ( 1.14 ) $ ( 1.01 ) $ ( 2.75 ) $ ( 3.06 ) Weighted-average shares used in computing net loss per share, basic and diluted 50,097,851 37,748,454 49,136,768 33,214,005 The accompanying notes are an integral part of these unaudited condensed financial statements. 2 Table of Contents ARCUTIS BIOTHERAPEUTICS, INC. Condensed Statements of Convertible Preferred Stock and Stockholders’ Equity (Deficit) (In thousands, except share data) (unaudited) Convertible Preferred Stock Common Stock Additional Paid-In Capital Accumulated Other Comprehensive Income (Loss) Accumulated Deficit Total Stockholders’ Equity (Deficit) Shares Amount Shares Amount Balance—December 31, 2019 24,385,388 $ 166,491 2,120,853 $ — $ 1,244 $ ( 1 ) $ ( 66,272 ) $ ( 65,029 ) Conversion of preferred stock into common stock upon initial public offering ( 24,385,388 ) ( 166,491 ) 24,385,388 2 166,489 — — 166,491 Issuance of shares of common stock for initial public offering, net of issuance costs of $ 16,040 — — 10,781,250 1 167,240 — — 167,241 Issuance of shares of common stock upon the exercise of stock options — — 51,147 — 152 — — 152 Vesting of founder shares subject to repurchase — — 68,931 — — — — — Lapse of repurchase rights related to common stock issued pursuant to early exercises — — 64,428 — 30 — — 30 Stock-based compensation expense — — — — 990 — — 990 Unrealized gain on marketable securities — — — — — 20 — 20 Net loss — — — — — — ( 28,013 ) ( 28,013 ) Balance—March 31, 2020 — $ — 37,471,997 $ 3 $ 336,145 $ 19 $ ( 94,285 ) $ 241,882 Issuance of common stock upon the exercise of stock options — — 14,875 — 25 — — 25 Vesting of founder shares subject to repurchase — — 68,932 — — — — — Lapse of repurchase rights related to common stock issued pursuant to early exercises — — 114,392 — 111 — — 111 Shares issued pursuant to the employee stock purchase plan 19,862 — 287 — — 287 Stock-based compensation expense — — — — 2,049 — — 2,049 Unrealized loss on marketable securities — — — — — ( 19 ) — ( 19 ) Net loss — — — — — — ( 35,412 ) ( 35,412 ) Balance—June 30, 2020 — $ — 37,690,058 $ 3 $ 338,617 $ — $ ( 129,697 ) $ 208,923 Issuance of common stock upon the exercise of stock options — — 28,908 — 34 — — 34 Lapse of repurchase rights related to common stock issued pursuant to early exercises — — 79,923 1 52 — — 53 Stock-based compensation expense — — — — 2,261 — — 2,261 Unrealized gain on marketable securities — — — — — 4 — 4 Net loss — — — — — — ( 38,204 ) ( 38,204 ) Balance—September 30, 2020 — $ — 37,798,889 $ 4 $ 340,964 $ 4 $ ( 167,901 ) $ 173,071 The accompanying notes are an integral part of these unaudited condensed financial statements. 3 Table of Contents ARCUTIS BIOTHERAPEUTICS, INC. Condensed Statements of Convertible Preferred Stock and Stockholders’ Equity (Deficit) (In thousands, except share data) (unaudited) Convertible Preferred Stock Common Stock Additional Paid-In Capital Accumulated Other Comprehensive Income (Loss) Accumulated Deficit Total Stockholders’ Equity (Deficit) Shares Amount Shares Amount Balance—December 31, 2020 — $ — 43,338,438 $ 4 $ 472,569 $ ( 2 ) $ ( 201,950 ) $ 270,621 Issuance of shares of common stock for public offering, net of issuance costs of $ 603 — — 6,325,000 1 207,489 — — 207,490 Issuance of common stock upon the exercise of stock options — — 111,282 — 325 — — 325 Issuance of common stock upon the vesting of restricted stock units — — 32,362 — — — — — Lapse of repurchase rights related to common stock issued pursuant to early exercises — — 79,925 — 53 — — 53 Stock-based compensation expense — — — — 8,503 — — 8,503 Unrealized gain on marketable securities — — — — — 44 — 44 Net loss — — — — — — ( 36,042 ) ( 36,042 ) Balance—March 31, 2021 — $ — 49,887,007 $ 5 $ 688,939 $ 42 $ ( 237,992 ) $ 450,994 Issuance of common stock upon the exercise of stock options — — 62,314 — 710 — — 710 Lapse of repurchase rights related to common stock issued pursuant to early exercises — — 73,623 — 52 — — 52 Shares issued pursuant to the employee stock purchase plan — — 22,658 — 478 — — 478 Stock-based compensation expense — — — — 4,340 — — 4,340 Unrealized loss on marketable securities — — — — — ( 78 ) — ( 78 ) Net loss — — — — — — ( 42,008 ) ( 42,008 ) Balance—June 30, 2021 — $ — 50,045,602 $ 5 $ 694,519 $ ( 36 ) $ ( 280,000 ) $ 414,488 Issuance of common stock upon the exercise of stock options — — 30,297 — 63 — — 63 Issuance of common stock upon the vesting of restricted stock units — — 5,000 — — — — — Lapse of repurchase rights related to common stock issued pursuant to early exercises — — 53,914 — 43 — — 43 Stock-based compensation expense — — — — 5,363 — — 5,363 Unrealized gain on marketable securities — — — — — 18 — 18 Net Loss — — — — — — ( 56,980 ) ( 56,980 ) Balance—September 30, 2021 — $ — 50,134,813 $ 5 $ 699,988 $ ( 18 ) $ ( 336,980 ) $ 362,995 The accompanying notes are an integral part of these unaudited condensed financial statements. 4 Table of Contents ARCUTIS BIOTHERAPEUTICS, INC. Condensed Statements of Cash Flows (In thousands) (unaudited) Nine Months Ended September 30, 2021 2020 CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $ ( 135,030 ) $ ( 101,629 ) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation 318 87 Non-cash lease expense 234 202 Net amortization/accretion on marketable securities 2,569 ( 307 ) Stock-based compensation expense 18,206 5,300 Changes in operating assets and liabilities: Prepaid expenses and other current assets ( 6,115 ) ( 369 ) Accounts payable ( 2,146 ) 3,682 Accrued liabilities ( 1,220 ) 12,602 Operating lease liabilities 266 ( 30 ) Net cash used in operating activities ( 122,918 ) ( 80,462 ) CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of marketable securities ( 244,268 ) ( 179,364 ) Proceeds from maturities of marketable securities 145,550 73,600 Purchases of property and equipment ( 734 ) ( 168 ) Net cash used in investing activities ( 99,452 ) ( 105,932 ) CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of common stock upon exercise of stock options 1,098 307 Proceeds from initial public offering, net of issuance costs — 168,642 Proceeds from issuance of common stock, net of issuance costs 207,490 — Proceeds from issuance of common stock pursuant to employee stock purchase plan 478 287 Payment of financing costs — ( 471 ) Net cash provided by financing activities 209,066 168,765 Net decrease in cash, cash equivalents, and restricted cash ( 13,304 ) ( 17,629 ) Cash, cash equivalents, and restricted cash at beginning of period 66,624 63,336 Cash, cash equivalents, and restricted cash at end of period $ 53,320 $ 45,707 SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING INFORMATION: Right-of-use asset obtained in exchange for lease liability $ — $ 3,645 Reduction in right-of-use asset upon reassessment of lease term $ — $ 139 The accompanying notes are an integral part of these unaudited condensed financial statements. 5 Table of Contents ARCUTIS BIOTHERAPEUTICS, INC. Notes to Condensed Financial Statements (unaudited) 1. Organization and Description of Business Arcutis Biotherapeutics, Inc., or the Company, is a late-stage biopharmaceutical company focused on developing meaningful innovations in immuno-dermatology to address the urgent needs of patients living with immune-mediated dermatological diseases and conditions. The Company’s current portfolio is comprised of highly differentiated topical treatments with significant promise to treat immune-mediated dermatological diseases and conditions. The Company believes it has built the industry's leading platform for dermatologic product development. The Company’s strategy is to focus on validated biological targets and to use our platform and deep dermatology expertise to develop differentiated products that have the potential to address the major shortcomings of existing therapies in its targeted indications. The Company believes this strategy uniquely positions it to rapidly advance its goal of bridging the treatment innovation gap in dermatology while maximizing its probability of technical success. On January 17, 2020, the Company's board of directors approved a 1-for-2.0007 reverse stock split of the Company’s capital stock and the Company filed a certificate of amendment to its restated certificate of incorporation to effect the split. The par value and authorized shares of common stock and convertible preferred stock were not adjusted as a result of the reverse split. All share and per share information included in the accompanying financial statements has been adjusted to reflect this reverse stock split. Initial Public Offering and Follow-On Financings On February 4, 2020, the Company closed an initial public offering (IPO) issuing and selling 10,781,250 shares of common stock at a public offering price of $ 17.00 per share, including 1,406,250 shares sold pursuant to the underwriters’ full exercise of their option to purchase additional shares. The aggregate net proceeds received by the Company from the offering were approximately $ 167.2 million, after deducting underwriting discounts, commissions, and offering related transaction costs . Upon the closing of the IPO, all of the outstanding shares of convertible preferred stock automatically converted into shares of common stock. Subsequent to the closing of the IPO, there were no shares of convertible preferred stock outstanding. On October 6, 2020, the Company completed a public offering of 4,000,000 shares of common stock at an offering price of $ 25.00 per share, receiving aggregate net proceeds of approximately $ 93.4 million after deducting the underwriting discounts, commissions, and offering related transaction costs. In addition, the Company concurrently sold 1,400,000 shares of common stock in a private placement exempt from the registration requirements of the Securities Act of 1933, as amended, at a price per share equal to the public offering price, receiving net proceeds of $ 35.0 million. On February 5, 2021, the Company completed a public offering of 6,325,000 shares of stock at an offering price of $ 35.00 per share, including 825,000 shares sold pursuant to the underwriters full exercise of their option to purchase additional shares. The aggregate net proceeds received by the Company were approximately $ 207.5 million, after deducting underwriting discounts, commissions, and offering related transaction costs. At-the-Market (ATM) Offerings On May 6, 2021, the Company entered into a sales agreement (Sales Agreement) with Cowen and Company, LLC (Cowen), under which the Company may from time to time issue and sell shares of its common stock through ATM offerings for an aggregate offering price of up to $ 100 million. Cowen will act as the Company's sales agent for the ATM program and is entitled to compensation for its services equal to 3 % of the gross proceeds of any shares of common stock sold under the Sales Agreement. The Company has not yet issued or sold any shares of common stock through the ATM. 6 Table of Contents ARCUTIS BIOTHERAPEUTICS, INC. Notes to Condensed Financial Statements (unaudited) Liquidity The Company has incurred significant losses and negative cash flows from operations since its inception and had an accumulated deficit of $ 337.0 million and $ 202.0 million as of September 30, 2021 and December 31, 2020, respectively. The Company had cash, cash equivalents, restricted cash, and marketable securities of $ 368.8 million and $ 286.0 million as of September 30, 2021 and December 31, 2020, respectively. Prior to selling common stock in its IPO and follow-on financings, the Company had historically financed its operations primarily through the sale of its convertible preferred stock. Management expects operating losses to continue for the foreseeable future. The Company believes that its existing capital resources will be sufficient to meet the projected operating requirements for at least 12 months from the date of issuance of its financial statements. The Company will be required to raise additional capital to fund future operations. However, no assurance can be given as to whether additional needed financing will be available on terms acceptable to the Company, if at all. If sufficient funds on acceptable terms are not available when needed, the Company may be required to curtail planned activities to significantly reduce its operating expenses. Failure to manage discretionary spending or raise additional financing, as needed, may adversely impact the Company’s ability to achieve its intended business objectives and have an adverse effect on its results of operations and future prospects. Coronavirus Outbreak In March 2020, the World Health Organization declared a pandemic related to the global novel coronavirus disease 2019 (COVID-19) outbreak. As of November 4, 2021, the Company’s operations have not been significantly impacted by the COVID-19 pandemic. The Company is monitoring the impact COVID-19 may have on the clinical development of its product candidates, including potential delays or modifications to its ongoing and planned trials. However, the Company cannot at this time predict the specific extent, duration, or full impact that the COVID-19 outbreak will have on its financial condition and operations, including ongoing and planned clinical trials. 2. Summary of Significant Accounting Policies Basis of Presentation The Company’s condensed financial statements have been prepared in accordance with United States generally accepted accounting principles (U.S. GAAP). Use of Estimates The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the condensed financial statements and accompanying notes. On an ongoing basis, management evaluates such estimates and assumptions for continued reasonableness. In particular, management makes estimates with respect to accruals for research and development activities, fair value of common stock and convertible preferred stock (prior to the IPO completed in January 2020), stock-based compensation expense, and income taxes. Appropriate adjustments, if any, to the estimates used are made prospectively based upon such periodic evaluation. Actual results could differ from those estimates. Segments To date, the Company has viewed its financial information on an aggregate basis for the purposes of evaluating financial performance and allocating the Company’s resources. Accordingly, the Company has determined that it operates in one segment. Unaudited Interim Condensed Financial Statements The interim condensed balance sheet as of September 30, 2021, the interim condensed statements of operations and comprehensive loss, and the condensed changes in convertible preferred stock and stockholders’ equity (deficit) and cash flows for the three and nine months ended September 30, 2021 and 2020 are unaudited. These unaudited interim condensed financial statements have been prepared on the same basis as the Company’s audited annual financial statements and, in the opinion of management, reflect all adjustments (consisting only of normal recurring adjustments) that are necessary for a fair statement of the Company’s financial information. The financial data and the other financial information disclosed in these notes to the condensed financial statements related to the three- and nine-month periods are also unaudited. The condensed results of operations for the three 7 Table of Contents ARCUTIS BIOTHERAPEUTICS, INC. Notes to Condensed Financial Statements (unaudited) and nine months ended September 30, 2021 are not necessarily indicative of the results to be expected for the year ending December 31, 2021 or for any other future annual or interim period. The condensed balance sheet as of December 31, 2020 included herein was derived from the audited financial statements as of that date. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with U.S. GAAP have been condensed or omitted. Therefore, these unaudited interim condensed financial statements should be read in conjunction with the Company’s audited financial statements included in its Annual Report on Form 10-K for the year ended December 31, 2020. Cash and Cash Equivalents The Company considers all highly liquid investments purchased with original maturities of three months or less from the purchase date to be cash equivalents. Cash equivalents consist primarily of money market funds, commercial paper, and U.S. Treasury securities. Restricted Cash As of September 30, 2021 and December 31, 2020, the Company held $ 1.5 million of restricted cash as collateral for a letter of credit related to our amended office space lease. See Note 7. Marketable Securities Marketable securities consist of investment grade short to intermediate-term fixed income investments that have been classified as available-for-sale and are carried at estimated fair value as determined based upon quoted market prices or pricing models for similar securities. Management determines the appropriate classification of its investments in fixed income securities at the time of purchase. Available-for-sale securities with original maturities beyond three months at the date of purchase, including those that have maturity dates beyond one year from the balance sheet date, are classified as current assets on the condensed balance sheets due to their highly liquid nature and availability for use in current operations. Unrealized gains and losses are excluded from earnings and are reported as a component of other comprehensive income (loss). Realized gains and losses as well as credit losses, if any, on marketable securities are included in other income, net. The Company evaluated the underlying credit quality and credit ratings of the issuers during the period. To date, no such credit losses have occurred or have been recorded. The cost of investments sold is based on the specific-identification method. Unrealized gains and losses on marketable securities are reported as a component of accumulated other comprehensive income (loss) on the condensed balance sheets. Interest on marketable securities is included in other income, net. Concentration of Credit Risk and Other Risks and Uncertainties Financial instruments that potentially subject the Company to significant concentrations of credit risk consist primarily of cash, cash equivalents, and marketable securities. The Company maintains deposits in federally insured financial institutions in excess of federally insured limits. The Company is exposed to credit risk in the event of a default by the financial institutions holding its cash to the extent recorded on the condensed balance sheets. Management believes the Company is not exposed to significant credit risk due to the financial position of the depository institutions in which those deposits are held. 8 Table of Contents ARCUTIS BIOTHERAPEUTICS, INC. Notes to Condensed Financial Statements (unaudited) Fair Value Measurement The Company’s financial instruments, in addition to those presented in Note 3, include cash equivalents, accounts payable, and accrued liabilities. The carrying amount of cash equivalents, accounts payable, and accrued liabilities approximate their fair values due to their short maturities. Assets and liabilities recorded at fair value on a recurring basis on the condensed 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. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. The authoritative guidance on fair value measurements establishes a three-tier fair value hierarchy for disclosure of fair value measurements as follows: Level 1—Observable inputs such as unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date; Level 2—Inputs (other than quoted prices included in Level 1) are either directly or indirectly observable for the asset or liability. These include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active; 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. Property and Equipment Property and equipment are stated at cost less accumulated depreciation. Depreciation on property and equipment is calculated using the straight-line method over the estimated useful lives of the assets which range from three to five years . Leasehold improvements are depreciated on a straight-line basis over the shorter of their estimated useful lives or lease terms. Maintenance and repairs are expensed as incurred. The Company reviews the carrying values of its property and equipment for possible impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. There were no impairments recognized during the three and nine months ended September 30, 2021 and 2020. Leases The Company determines if an arrangement is or contains a lease at inception. Right-of-use (ROU) assets represent the Company’s right to use an underlying asset for the lease term and lease liabilities represent the Company’s obligation to make lease payments arising from the lease. The classification of the Company’s leases as operating or finance leases, along with the initial measurement and recognition of the associated ROU assets and lease liabilities, is performed at the lease commencement date. The measurement of lease liabilities is based on the present value of lease payments over the lease term. The Company uses its incremental borrowing rate, based on the information available at commencement date, to determine the present value of lease payments when its leases do not provide an implicit rate. The Company uses the implicit rate when readily determinable. The ROU asset is based on the measurement of the lease liability, includes any lease payments made prior to or on lease commencement and is adjusted for lease incentives and initial direct costs incurred, as applicable. Lease expense for the Company’s operating leases is recognized on a straight-line basis over the lease term. The Company considers a lease term to be the non-cancelable period that it has the right to use the underlying asset, including any periods where it is reasonably assured the Company will exercise the option to extend the contract. Periods covered by an option to extend are included in the lease term if the lessor controls the exercise of that option. The Company’s lease agreements includes lease and non-lease components and the Company has elected to not separate such components for all classes of assets. Further, the Company elected the short-term lease exception policy, permitting it to not apply the recognition requirements of this standard to leases with terms of 12 months or less (short-term leases) for all classes of assets. 9 Table of Contents ARCUTIS BIOTHERAPEUTICS, INC. Notes to Condensed Financial Statements (unaudited) Preclinical and Clinical Accruals and Costs The Company records accrued liabilities for estimated costs of research and development activities conducted by third-party service providers, which include the conduct of preclinical studies, clinical trials, and contract manufacturing activities. These costs are a significant component of the Company’s research and development expenses. The Company accrues for these costs based on factors such as estimates of the work completed and in accordance with agreements established with its third-party service providers under the service agreements. The Company makes significant judgments and estimates in determining the accrued liabilities balance in each reporting period. As actual costs become known, the Company adjusts its accrued liabilities. For the three and nine months ended September 30, 2021 and 2020, the Company has not experienced any material differences between accrued costs and actual costs incurred. Convertible Preferred Stock Prior to its IPO, the Company classified its outstanding convertible preferred stock outside of stockholders’ equity (deficit) on its condensed balance sheets as the requirements of triggering a deemed liquidation event, as defined within its amended and restated certificate of incorporation, were not entirely within the Company’s control. In the event of such a deemed liquidation event, the proceeds from the event were to be distributed in accordance with the liquidation preferences, provided that the holders of convertible preferred stock had not converted their shares into common stock. The Company recorded the issuance of convertible preferred stock at the issuance price less related issuance costs. The Company did not adjust the carrying values of the convertible preferred stock to the liquidation preferences of such shares because of the uncertainty as to whether or when a deemed liquidation event may have occurred. In connection with the IPO in February 2020, the Company’s outstanding shares of convertible preferred stock were automatically converted into 24,385,388 shares of common stock. Research and Development Research and development expenses include costs directly attributable to the conduct of research and development programs, including the cost of salaries, payroll taxes, employee benefits, license fees, stock-based compensation expense, materials, supplies, and the cost of services provided by outside contractors. All costs associated with research and development are expensed as incurred. Payments made prior to the receipt of goods or services to be used in research and development are capitalized until the goods are received or services are rendered. Such payments are evaluated for current or long-term classification based on when they will be realized. The Company has entered into, and may continue to enter into, license agreements to access and utilize certain technology. In each case, the Company evaluates if the license agreement results in the acquisition of an asset or a business. To date, none of the Company’s license agreements have been considered an acquisition of a business. For asset acquisitions, the upfront payments to acquire such licenses, as well as any future milestone payments made before product approval that do not meet the definition of a derivative, are immediately recognized as research and development expense when paid or become payable, provided there is no alternative future use of the rights in other research and development projects. Stock-Based Compensation The Company accounts for share-based payments at fair value. The fair value of stock options is measured using the Black-Scholes option-pricing model. For share-based awards that vest subject to the satisfaction of a service requirement, the fair value measurement date for such awards is the date of grant and the expense is recognized on a straight-line basis, over the expected vesting period. For share-based awards that vest subject to a performance condition, the Company will recognize compensation cost for awards if and when the Company concludes that it is probable that the awards with a performance condition will be achieved on an accelerated attribution method. The Company accounts for forfeitures as they occur. 10 Table of Contents ARCUTIS BIOTHERAPEUTICS, INC. Notes to Condensed Financial Statements (unaudited) Income Taxes Income taxes are accounted for using the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period of enactment. The Company records a valuation allowance to reduce deferred tax assets to an amount for which realization is more likely than not. Due to the Company’s historical operating performance and the recorded cumulative net losses in prior fiscal periods, the net deferred tax assets have been fully offset by a valuation allowance. The Company recognizes the tax benefit from an uncertain tax position if it is more likely than not that the tax position will be sustained upon examination by the tax authorities, based on the merits of the position. The Company’s policy is to recognize interest and penalties related to the underpayment of income taxes as a component of income tax expense or benefit. To date, there have been no interest or penalties incurred in relation to the unrecognized tax benefits. The United States Congress enacted the American Rescue Plan Act on March 10, 2021, Families First Coronavirus Response Act (FFCR Act) on March 18, 2020, and the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) on March 27, 2020. The American Rescue Plan Act is a follow-up to the CARES Act, which continue the emergency economic stimulus package and includes spending and tax breaks to strengthen the U.S. economy and fund a nationwide effort to curtail the effect of COVID-19. The American Rescue Plan Act, FFCR Act, and CARES Act include numerous tax-related provisions, including modifications to the limitations on business interest expense and net operating losses (NOLs), certain refundable employee retention credits, as well as a payment delay of employer payroll taxes in 2020 after the date of enactment. On June 29, 2020, the California State Assembly Bill 85 (Trailer Bill) was enacted which suspends the use of California NOL deductions and certain tax credits, including research and development credits, for the 2020, 2021, and 2022 tax years. The Company does not expect the American Rescue Plan Act, FFCR Act, CARES Act, or Trailer Bill to have a material impact on the Company’s financial statements. Variable Interest Entities The Company reviews agreements it enters into with third-party entities, pursuant to which the Company may have a variable interest in the entity, in order to determine if the entity is a variable interest entity (VIE). If the entity is a VIE, the Company assesses whether or not it is the primary beneficiary of that entity. In determining whether the Company is the primary beneficiary of an entity, the Company applies a qualitative approach that determines whether it has both (i) the power to direct the economically significant activities of the entity and (ii) the obligation to absorb losses of, or the right to receive benefits from, the entity that could potentially be significant to that entity. If the Company determines it is the primary beneficiary of a VIE, it consolidates that VIE into the Company’s financial statements. The Company’s determination about whether it should consolidate such VIEs is made continuously as changes to existing relationships or future transactions may result in a consolidation or deconsolidation event. The Company currently does not consolidate any VIEs. Net Loss Per Share Basic net loss per share is calculated by dividing the net loss by the weighted-average number of shares of common stock outstanding for the period, without consideration for potential dilutive shares of common stock. Diluted net loss per share is computed by dividing the net loss by the weighted-average number of common share equivalents outstanding for the period determined using the treasury-stock method. Since the Company was in a loss position for all periods presented, basic net loss per share is the same as diluted net loss per share since the effects of potentially dilutive securities are antidilutive. Shares of common stock subject to repurchase are excluded from the weighted-average shares. 11 Table of Contents ARCUTIS BIOTHERAPEUTICS, INC. Notes to Condensed Financial Statements (unaudited) Emerging Growth Company Status The Company is an emerging growth company, as defined in the Jumpstart Our Business Startups Act of 2012, or the JOBS Act. Under the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards issued subsequent to the enactment of the JOBS Act until such time as those standards apply to private companies. The Company has elected to use this extended transition period for complying with new or revised accounting standards that have different effective dates for public and private companies until the earlier of the date that it is (i) no longer an emerging growth company or (ii) affirmatively and irrevocably opt out of the extended transition period provided in the JOBS Act. As a result, these financial statements may not be comparable to companies that comply with the new or revised accounting pronouncements as of public company effective dates. Recently Adopted Accounting Pronouncements There have been no new accounting pronouncements issued or effective that are expected to have a material impact on the Company's condensed financial statements . 3. Fair Value Measurements The following table sets forth the Company’s financial instruments that were measured at fair value on a recurring basis by level within the fair value hierarchy (in thousands): September 30, 2021 Level 1 Level 2 Level 3 Total Assets: Money market funds (1) $ 51,778 $ — $ — $ 51,778 Commercial paper — 111,384 — 111,384 Corporate debt securities — 109,723 — 109,723 U.S. Treasury securities 94,385 — — 94,385 Total assets $ 146,163 $ 221,107 $ — $ 367,270 ______________ (1) This balance includes cash requirements settled on a nightly basis. December 31, 2020 Level 1 Level 2 Level 3 Total Assets: Money market funds (1) $ 65,082 $ — $ — $ 65,082 Commercial paper — 45,518 — 45,518 U.S. Treasury securities 173,841 — — 173,841 Total assets $ 238,923 $ 45,518 $ — $ 284,441 ______________ (1) This balance includes cash requirements settled on a nightly basis. Commercial paper, corporate debt securities, money market funds, and U.S. Treasury securities are valued taking into consideration valuations obtained from third-party pricing services. The pricing services utilize industry standard valuation models, including both income and market-based approaches, for which all significant inputs are observable, either directly or indirectly, to estimate fair value. These inputs include reported trades of and broker/dealer quotes on the same or similar securities; issuer credit spreads; benchmark securities; prepayment/default projections based on historical data; and other observable inputs. 12 Table of Contents ARCUTIS BIOTHERAPEUTICS, INC. Notes to Condensed Financial Statements (unaudited) The following table summarizes the estimated value of the Company’s cash, cash equivalents and marketable securities, and the gross unrealized holding gains and losses (in thousands): September 30, 2021 Amortized cost Unrealized gains Unrealized losses Estimated fair value Cash and cash equivalents: Money market funds (1) $ 51,778 $ — $ — $ 51,778 Total cash and cash equivalents $ 51,778 $ — $ — $ 51,778 Marketable securities: Commercial paper $ 111,384 $ — $ — $ 111,384 Corporate debt securities 109,750 — ( 27 ) 109,723 U.S. Treasury securities 94,376 9 — 94,385 Total marketable securities $ 315,510 $ 9 $ ( 27 ) $ 315,492 ______________ (1) This balance includes cash requirements settled on a nightly basis. December 31, 2020 Amortized cost Unrealized gains Unrealized losses Estimated fair value Cash and cash equivalents: Money market funds (1) $ 65,082 $ — $ — $ 65,082 Total cash and cash equivalents $ 65,082 $ — $ — $ 65,082 Marketable securities: Commercial paper $ 45,518 $ — $ — $ 45,518 U.S. Treasury securities 173,843 7 ( 9 ) 173,841 Total marketable securities $ 219,361 $ 7 $ ( 9 ) $ 219,359 ______________ (1) This balance includes cash requirements settled on a nightly basis. Realized gains or losses on investments for the three and nine months ended September 30, 2021 were no t material. There were no realized gains or losses on investments for the three and nine months ended September 30, 2020. As of September 30, 2021 and December 31, 2020, unrealized losses on marketable securities were no t material, and accordingly, no allowance for credit losses were recorded. As of September 30, 2021 and December 31, 2020, all securities have a maturity of 18 months or less and all securities with gross unrealized losses have been in a continuous loss position for less than one year. 13 Table of Contents ARCUTIS BIOTHERAPEUTICS, INC. Notes to Condensed Financial Statements (unaudited) 4. Balance Sheet Components Prepaid Expenses and Other Current Assets Prepaid expenses and other current assets consist of the following (in thousands): September 30, 2021 December 31, 2020 Prepaid clinical trial costs $ 4,356 $ 4,865 Prepaid insurance 1,211 249 Tax credits 362 510 Other prepaid expenses and current assets 7,029 1,219 Total prepaid expenses and other current assets $ 12,958 $ 6,843 Accrued Liabilities Accrued liabilities consist of the following (in thousands): September 30, 2021 December 31, 2020 Accrued compensation $ 6,771 $ 4,434 Clinical trial accruals 4,076 9,754 Early exercise liability, current 79 176 Accrued expenses and other current liabilities 2,955 1,098 Total accrued liabilities $ 13,881 $ 15,462 5. Property and Equipment, net Property and equipment, net consists of the following (in thousands): Useful life (in years) September 30, 2021 December 31, 2020 Computer hardware 3 $ 555 $ 286 Furniture and fixtures 5 248 230 Software 3 70 — Construction in process — 298 Leasehold improvements 1,568 1,280 Property and equipment, gross 2,441 2,094 Less accumulated depreciation ( 396 ) ( 78 ) Property and equipment, net $ 2,045 $ 2,016 Leasehold improvements are depreciated over the term of the lease. Depreciation expense was $ 116,000 and $ 318,000 for the three and nine months ended September 30, 2021, respectively, and $ 30,000 and $ 87,000 for the three and nine months ended September 30, 2020, respectively. 14 Table of Contents ARCUTIS BIOTHERAPEUTICS, INC. Notes to Condensed Financial Statements (unaudited) 6. License Agreements AstraZeneca License Agreement In July 2018, the Company entered into an exclusive license agreement, or the AstraZeneca License Agreement, with AstraZeneca AB (AstraZeneca), granting the Company a worldwide exclusive license, with the right to sublicense through multiple tiers, under certain AstraZeneca-controlled patent rights, know-how and regulatory documentation, to research, develop, manufacture, commercialize, and otherwise exploit products containing roflumilast in topical forms, as well as delivery systems sold with or for the administration of roflumilast, or collectively, the AZ-Licensed Products, for all diagnostic, prophylactic, and therapeutic uses for human dermatological indications, or the Dermatology Field. Under this agreement, the Company has sole responsibility for development, regulatory, and commercialization activities for the AZ-Licensed Products in the Dermatology Field, at its expense, and it shall use commercially reasonable efforts to develop, obtain, and maintain regulatory approvals for, and commercialize the AZ-Licensed Products in the Dermatology Field in each of the United States, Italy, Spain, Germany, the United Kingdom, France, China, and Japan. The Company paid AstraZeneca an upfront non-refundable cash payment of $ 1.0 million and issued 484,388 shares of Series B convertible preferred stock, valued at $ 3.0 million on the date of the AstraZeneca License Agreement. The Company subsequently paid AstraZeneca the first milestone cash payment of $ 2.0 million upon the completion of a Phase 2b study of roflumilast cream in plaque psoriasis in August 2019 for the achievement of positive Phase 2 data for an AZ-Licensed Product, which was recorded in research and development expense. The Company has agreed to make additional cash payments to AstraZeneca of up to an aggregate of $ 12.5 million upon the achievement of specified regulatory approval milestones with respect to the AZ-Licensed Products, which includes $ 7.5 million upon U.S. Food and Drug Administration (FDA) approval of the Company's first product, and payments up to an additional aggregate amount of $ 15.0 million upon the achievement of certain aggregate worldwide net sales milestones. With respect to any AZ-Licensed Products the Company commercializes under the AstraZeneca License Agreement, it will pay AstraZeneca a low to high single-digit percentage royalty rate on the Company’s, its affiliates’ and its sublicensees’ net sales of such AZ-Licensed Products, subject to specified reductions, until, as determined on an AZ-Licensed Product-by-AZ-Licensed Product and country-by-country basis, the later of the date of the expiration of the last-to-expire AstraZeneca-licensed patent right containing a valid claim in such country and ten years from the first commercial sale of such AZ-Licensed Product in such country. There were no payments made or due in connection with AZ-Licensed Products for the three and nine months ended September 30, 2021 and 2020. Hengrui Exclusive Option and License Agreement In January 2018, the Company entered into an exclusive option and license agreement, or the Hengrui License Agreement, with Jiangsu Hengrui Medicine Co., Ltd. (Hengrui), whereby Hengrui granted the Company an exclusive option to obtain certain exclusive rights to research, develop, and commercialize products containing the compound designated by Hengrui as SHR0302, a Janus kinase type 1 inhibitor, in topical formulations for the treatment of skin diseases, disorders, and conditions in the United States, Japan, Canada, and the European Union (including for clarity the United Kingdom). The Company made a $ 0.4 million upfront non-refundable cash payment to Hengrui upon execution of the Hengrui Option and License Agreement, which was recorded as research and development expense. In December 2019, the Company exercised its exclusive option under the agreement, for which it made a $ 1.5 million cash payment, which was recorded in research and development expense, and also contemporaneously amended the agreement to expand the territory to additionally include Canada. In addition, the Company has agreed to make cash payments of up to an aggregate of $ 20.5 million upon achievement of specified clinical development and regulatory approval milestones with respect to the licensed products and cash payments of up to an additional aggregate of $ 200.0 million in sales-based milestones based on certain aggregate annual net sales volumes with respect to a licensed product. 15 Table of Contents ARCUTIS BIOTHERAPEUTICS, INC. Notes to Condensed Financial Statements (unaudited) With respect to any products the Company commercializes under the Hengrui License Agreement, it will pay tiered royalties to Hengrui on net sales of each licensed product by the Company, or its affiliates, or its sublicensees, ranging from mid single-digit to sub-teen percentage rates based on tiered annual net sales bands subject to specified reductions. The Company is obligated to pay royalties until the later of (1) expiration of the last valid claim of the licensed patent rights covering such licensed product in such country and (2) expiration of regulatory exclusivity for the relevant licensed product in the relevant country, on a licensed product-by-licensed product and country-by-country basis. Additionally, the Company is obligated to pay Hengrui a specified percentage, ranging from the low-thirties to the sub-teens, of certain non-royalty sublicensing income it receives from sublicensees of its rights to the licensed products, such percentage decreasing as the development stage of the licensed products advance. There were no payments made or due in connection with Hengrui for the three and nine months ended September 30, 2021 and 2020. Hawkeye Collaboration Agreement In June 2019, the Company entered into a collaboration agreement, or Hawkeye Agreement, with Hawkeye Therapeutics, Inc. (Hawkeye), a related party with common ownership, for the development of one or more new applications of roflumilast. The Hawkeye Agreement grants Hawkeye an exclusive license to certain intellectual property developed under the agreement as it relates to the applications. Contemporaneously with the execution of the Hawkeye Agreement, the Company entered into a stock purchase agreement, purchasing 995,000 shares of Hawkeye’s common stock at $ 0.0001 per share, representing 19.9 % of the outstanding common stock of Hawkeye. In the event that Hawkeye issues shares of Series A preferred stock with proceeds over $ 5.0 million, Hawkeye is required to issue to the Company a number of fully-paid fully-vested shares of common stock determined by dividing (i) $ 2,000,000 by (ii) an amount equal to the cash price per share for Series A preferred stock. Other than the potential issuance of this common stock, there are no upfront payments, milestones, or royalties pursuant to the Hawkeye Agreement. The Company determined that Hawkeye is a VIE for which consolidation is not required as it is not the primary beneficiary. 7. Commitments and Contingencies Operating Lease The Company leases a facility in Westlake Village, California under an operating lease that commenced in February 2019. This lease was amended in April 2020 in order to relocate to a new expanded space comprising 22,643 square feet. At the time of the amendment, the Company reassessed the lease term of the original space in accordance with the option to terminate if leasing additional space in the same property. In connection with the reduction of the lease term for the original space, the Company reduced the ROU asset and lease liability balance by $ 123,000 . The Company recognized the ROU asset and lease liability for the new space on May 1, 2020, which was determined to be the lease commencement date, or the date on which the new space was made available to the Company for purposes of planning and constructing the leasehold improvements. The lease payment term for the new space began on December 30, 2020, which was 15 days after the leasehold improvements were substantially complete. The lease payments terminate 91 months thereafter, with a renewal option for a term of five years . The Company will have a one-time option to cancel the lease after month 67 . The renewal and one-time cancellation options have not been considered in the determination of the ROU asset or lease liability as the Company did not consider it reasonably certain it would exercise these options. 16 Table of Contents ARCUTIS BIOTHERAPEUTICS, INC. Notes to Condensed Financial Statements (unaudited) The lease is subject to fixed rate escalation increases with an initial base rent of $ 76,000 per month and includes rent free periods aggregating approximately one year . As a result, the Company recognizes rent expense on a straight-line basis for the full amount of the commitment including the minimum rent increases over the life of the lease and the free rent period. The amended lease agreement provided for a leasehold improvement allowance up to $ 1.25 million. It also required the Company to have an available letter of credit of $ 1.5 million upon occupying the space, which is allowed to be reduced throughout the lease period as rent obligations are met. Accordingly, in November 2020, the Company entered into a letter of credit for $ 1.5 million, which it secured with a restricted cash account in the same amount. The letter of credit and corresponding restricted cash will be reduced by $ 308,000 on the first, second, third, and fourth anniversary, and by $ 45,000 on the fifth anniversary from when the lease payment term began on December 30, 2020, with no further reductions thereafter. In association with commencement of this new lease, the Company recorded lease liabilities and ROU assets of $ 3.6 million on its condensed balance sheet as of June 30, 2020. Since the Company was reasonably certain to incur costs equal to or exceeding the leasehold improvement allowance of $ 1.25 million, the allowance was treated as a lease incentive that was payable to the Company at the lease commencement date. Accordingly, the leasehold improvement allowance was included in the measurement of the consideration in the contract at commencement, and was recognized as a reduction in the ROU asset and lease liability. Upon completion of the leasehold improvements in December 2020, the $ 1.25 million allowance was reclassified from the lease liability to property and equipment on the condensed balance sheet as of December 31, 2020. The Company capitalized $ 320,000 of additional leasehold improvements, in excess of the $ 1.25 million allowance, which were also reflected in property and equipment as of December 31, 2020. All leasehold improvements will be depreciated over the remaining term of the lease. The minimum annual rental payments of the Company’s operating lease liability as of September 30, 2021 are as follows (in thousands): Amounts 2021 (October through December) $ 114 2022 781 2023 965 2024 995 2025 1,024 Thereafter 2,794 Total minimum lease payments $ 6,673 Less: Amounts representing interest ( 1,443 ) Present value of future minimum lease payments $ 5,230 Current portion operating lease liability 306 Operating lease liability, noncurrent 4,924 Total operating lease liability $ 5,230 Straight-line rent expense recognized for operating leases was $ 171,000 and $ 516,000 for the three and nine months ended September 30, 2021, respectively, and $ 202,000 and $ 395,000 for the three and nine months ended September 30, 2020, respectively. There were no significant variable lease payments, including non-lease components such as common area maintenance fees, recognized as rent expense for operating leases for the three and nine months ended September 30, 2021 and 2020. 17 Table of Contents ARCUTIS BIOTHERAPEUTICS, INC. Notes to Condensed Financial Statements (unaudited) The following information represents supplemental disclosure for the condensed statements of cash flows related to the Company’s operating lease (in thousands): Nine Months Ended September 30, 2021 2020 Cash flows from operating activities Cash paid for amounts included in the measurement of lease liabilities $ — $ 144 The following summarizes additional information related to the operating lease: September 30, 2021 Weighted-average remaining lease term (in years) 6.8 Weighted-average discount rate 7.0 % Manufacturing Agreements The Company has entered into manufacturing supply agreements for the commercial supply of topical roflumilast cream which include certain minimum purchase commitments. Firm future purchase commitments under these agreements are approximately $ 5.4 million within the next 3 months and then approximately $ 0.6 million per year for the following 4 years. This amount does not represent all of the Company’s anticipated purchases, but instead represents only the contractually obligated minimum purchases or firm commitments of non-cancelable minimum amounts. Indemnification In the ordinary course of business, the Company enters into agreements that may include indemnification provisions. Pursuant to such agreements, the Company may indemnify, hold harmless, and defend an indemnified party for losses suffered or incurred by the indemnified party. Some of the provisions will limit losses to those arising from third party actions. In some cases, the indemnification will continue after the termination of the agreement. The maximum potential amount of future payments the Company could be required to make under these provisions is not determinable. The Company has never incurred material costs to defend lawsuits or settle claims related to these indemnification provisions. The Company has also entered into indemnification agreements with its directors and officers that may require the Company to indemnify its directors and officers against liabilities that may arise by reason of their status or service as directors or officers to the fullest extent permitted by the provisions of the Company’s Bylaws and the Delaware General Corporation Law. The Company currently has directors’ and officers’ insurance coverage that reduces its exposure and enables the Company to recover a portion of any future amounts paid. The Company believes any potential loss exposure under these indemnification agreements in excess of applicable insurance coverage is minimal. 18 Table of Contents ARCUTIS BIOTHERAPEUTICS, INC. Notes to Condensed Financial Statements (unaudited) 8. Convertible Preferred Stock and Stockholders’ Equity Convertible Preferred Stock In connection with the Company's IPO in February 2020, all of the Company’s outstanding shares of convertible preferred stock were automatically converted into 24,385,388 shares of common stock. Common Stock The holders of the Company’s common stock have one vote for each share of common stock. Common stockholders are entitled to dividends when, as, and if declared by the board of directors. The holders have no preemptive or other subscription rights and there are no redemption or sinking fund provisions with respect to such shares. As of September 30, 2021, no dividends had been declared by the board of directors. The Company reserved the following shares of common stock for issuance as follows: September 30, 2021 December 31, 2020 Options issued and outstanding 5,715,147 3,655,945 Common stock awards available for grant under employee benefit plans 2,187,166 2,501,329 Restricted stock units outstanding 337,868 162,930 Total common stock reserved 8,240,181 6,320,204 Authorized Share Capital On February 4, 2020, the Company’s certificate of incorporation was amended and restated to provide for 300,000,000 authorized shares of common stock with a par value of $ 0.0001 per share and 10,000,000 authorized shares of preferred stock with a par value of $ 0.0001 per share. There were no shares of preferred stock outstanding as of September 30, 2021 and December 31, 2020. 9. Stock-Based Compensation In January 2020, the Company’s board of directors approved the 2020 Equity Incentive Plan (2020 Plan), which became effective January 30, 2020 in connection with the IPO. The 2020 Plan serves as the successor incentive award plan to the Company’s 2017 Equity Incentive Plan (2017 Plan) and has 2,134,000 shares of common stock available for issuance pursuant to a variety of stock-based compensation awards, including stock options, stock appreciation rights, restricted stock awards, restricted stock unit awards, and other stock-based awards, plus 1,550,150 shares of common stock that were reserved for issuance pursuant to future awards under the 2017 Plan at the time the 2020 Plan became effective, plus shares represented by awards outstanding under the 2017 Plan that are forfeited or lapsed unexercised and which following the effective date of the 2020 Plan are not issued under the 2017 Plan. In addition, the 2020 Plan reserve will increase on January 1 of each year through 2030, by an amount equal to the lesser of (a) four percent of the shares of stock outstanding (on an as converted basis) on the day immediately prior to the date of increase and (b) such smaller number of shares of stock as determined by our board of directors; provided, however, that no more than 11,000,000 shares of stock may be issued upon the exercise of incentive stock options. Accordingly, on January 1, 2021, the plan reserve increased by 1,747,112 shares. As of September 30, 2021, the Company had 1,456,234 shares available for future grant under the 2020 Plan. The 2020 Plan provides for the Company to sell or issue common stock or restricted common stock, or to grant incentive stock options or nonqualified stock options for the purchase of common stock, to employees, members of the board of directors, and consultants of the Company under terms and provisions established by the board of directors. Under the terms of the 2020 Plan, options may be granted at an exercise price not less than fair market value. The Company generally grants stock-based awards with service conditions. Options granted typically vest over a four-year period but may be granted with different vesting terms. Following the Company’s IPO and in connection with the effectiveness of the Company’s 2020 Plan, the 2017 Plan terminated and no further awards will be granted under that plan. However, all outstanding awards under the 2017 Plan will continue to be governed by their existing terms. 19 Table of Contents ARCUTIS BIOTHERAPEUTICS, INC. Notes to Condensed Financial Statements (unaudited) Stock Option Activity The following summarizes option activity (in thousands, except share amounts): Number of Options Weighted- Average Exercise Price Remaining Contractual Term (Years) Aggregate Intrinsic Value Balance—December 31, 2020 3,655,945 $ 12.09 8.78 $ 59,274 Granted 2,490,171 $ 28.04 Exercised ( 203,893 ) $ 5.33 Forfeited ( 199,416 ) $ 22.32 Expired ( 27,660 ) $ 28.42 Balance—September 30, 2021 5,715,147 $ 18.84 8.57 $ 44,093 Exercisable—September 30, 2021 (1) 2,363,828 $ 10.28 7.66 $ 34,790 ______________ (1) Options exercisable includes early exercisable options. The aggregate intrinsic value is calculated as the difference between the exercise price of the options and the fair value of the Company’s common stock as of September 30, 2021. Prior to the Company's IPO in January 2020, the estimated fair value of the Company's common stock was determined by the board of directors. The intrinsic value of options exercised for the nine months ended September 30, 2021 was $ 4.8 million. The total grant-date fair value of the options vested during the nine months ended September 30, 2021 was $ 11.7 million. The weighted-average grant-date fair value of employee options granted during the nine months ended September 30, 2021 was $ 19.48 . Restricted Stock Unit Activity The following table summarizes information regarding our RSUs: Number of Units Weighted-Average Grant Date Fair Value Balance—December 31, 2020 162,930 $ 27.26 Granted 225,900 $ 30.51 Vested ( 37,362 ) $ 27.19 Forfeited ( 13,600 ) $ 31.37 Unvested Balance—September 30, 2021 337,868 $ 29.27 The grant date fair value of an RSU equals the closing price of our common stock on the grant date. RSUs generally vest equally over four years . 20 Table of Contents ARCUTIS BIOTHERAPEUTICS, INC. Notes to Condensed Financial Statements (unaudited) Stock-Based Compensation Expense Stock-based compensation expense included in the condensed statements of operations and comprehensive loss was as follows (in thousands): Three Months Ended September 30, Nine Months Ended September 30, 2021 2020 2021 2020 Research and development $ 2,266 $ 1,067 $ 5,898 $ 2,209 General and administrative 3,097 1,194 12,308 3,091 Total stock-based compensation expense $ 5,363 $ 2,261 $ 18,206 $ 5,300 As of September 30, 2021, there was $ 56.7 million of total unrecognized compensation cost related to unvested options that are expected to vest, which is expected to be recognized over a weighted-average period of 3.2 years. As of September 30, 2021, there was $ 7.9 million of total unrecognized compensation cost related to RSUs that is expected to vest, which is expected to be recognized over a weighted-average period of 3.2 years. In March 2021, in connection with the retirement of the former Chief Financial Officer, the Company modified the terms of this individual’s historical stock awards. As a result of the modifications, the Company recognized approximately $ 5.3 million of incremental stock compensation expense during the period, which is included in general and administrative expenses. In determining the fair value of the stock options granted, the Company uses the Black-Scholes option-pricing model and assumptions discussed below. Each of these inputs is subjective and generally requires significant judgment. Fair value of common stock— For options granted prior to IPO in the year ended December 31, 2019, given the absence of a public trading market, the Company’s board of directors with input from management considered numerous objective and subjective factors to determine the fair value of common stock. The factors included, but were not limited to: (i) third-party valuations of the Company’s common stock; (ii) the Company’s stage of development; (iii) the status of research and development efforts; (iv) the rights, preferences, and privileges of the Company’s convertible preferred stock relative to those of the Company’s common stock; (v) the Company’s operating results and financial condition, including the Company’s levels of available capital resources; (vi) equity market conditions affecting comparable public companies; (vii) general U.S. market conditions; and (viii) the lack of marketability of the Company’s common stock. For options granted after IPO, the Company uses its closing stock price as reported on Nasdaq on the grant date for the fair value of its stock. Expected Term —The Company’s expected term represents the period that the Company’s stock-based awards are expected to be outstanding. The Company used the simplified method (based on the mid-point between the vesting date and the end of the contractual term) to determine the expected term. Expected Volatility —The Company does not yet have sufficient trading history for its common stock to solely use its own historical volatility. Therefore, the expected volatility was estimated based on a combination of its own historical common stock volatility as well as the average historical volatilities for comparable publicly traded pharmaceutical companies over a period equal to the expected term of the stock option grants. The comparable companies were chosen based on their similar size, stage in the life cycle, and area of specialty. The Company will continue to apply this process until a sufficient amount of historical information regarding the volatility of its own stock price becomes available. Risk-Free Interest Rate —The risk-free interest rate is based on the U.S. Treasury zero coupon issues in effect at the time of grant for periods corresponding with the expected term of option. Dividend Yield —The Company has never paid dividends on its common stock and has no plans to pay dividends on its common stock. Therefore, the Company used an expected dividend yield of zero . 21 Table of Contents ARCUTIS BIOTHERAPEUTICS, INC. Notes to Condensed Financial Statements (unaudited) The fair value of stock option awards granted was estimated at the date of grant using a Black-Scholes option-pricing model with the following assumptions: Nine Months Ended September 30, 2021 Year Ended December 31, 2020 Expected term (in years) 5.5 – 6.2 5.5 – 6.8 Expected volatility 80.6 – 85.2 % 78.4 – 80.8 % Risk-free interest rate 0.6 – 1.1 % 0.3 – 1.4 % Dividend yield — % — % Early Exercise of Employee Options The terms of the 2017 and 2020 Plans permit certain option holders to exercise options before their options are vested, subject to certain limitations. Upon early exercise, the awards become subject to a restricted stock agreement. The shares of restricted stock granted upon early exercise of the options are subject to the same vesting provisions in the original stock option awards. Shares issued as a result of early exercise that have not vested are subject to repurchase by the Company upon termination of the purchaser’s employment, at the price paid by the purchaser. While such shares have been issued, they are not considered outstanding for accounting purposes until they vest and are therefore excluded from shares used in determining loss per share until the repurchase right lapses and the shares are no longer subject to the repurchase feature. The liability is reclassified into common stock and additional paid-in capital as the shares vest and the repurchase right lapses. Accordingly, the Company has recorded the unvested portion of the exercise proceeds of $ 110,000 and $ 258,000 as a liability from the early exercise in the accompanying condensed balance sheets as of September 30, 2021 and December 31, 2020, respectively. As of September 30, 2021 and December 31, 2020, there were $ 79,000 and $ 176,000 recorded in accrued liabilities, respectively, and $ 31,000 and $ 82,000 recorded in other long-term liabilities, respectively related to shares that were subject to repurchase. Founder Awards In August 2016, the Company issued 1,187,738 shares of restricted common stock to founders, of which 1,102,903 shares would vest under a service condition, and 84,835 shares would vest under a performance condition. The shares were issued under the terms of the respective restricted stock purchase agreements, or the Stock Purchase Agreement, and unvested shares were subject to repurchase by the Company at the original purchase price per share upon the holder’s termination of his relationship with the Company. The restricted shares were not considered outstanding for accounting purposes until they vested and are therefore excluded from shares used in determining loss per share until the repurchase right lapses and the shares are no longer subject to the repurchase feature. One-fourth of the 1,102,903 shares of restricted common stock were vested on the first-anniversary date and the remaining 827,177 shares vested on a monthly basis thereafter. All shares of restricted stock subject to the award were vested as of June 30, 2020. 2020 Employee Stock Purchase Plan The Company adopted the 2020 Employee Stock Purchase Plan, or the ESPP, which became effective on January 30, 2020 in connection with the IPO. The ESPP is designed to allow the Company’s eligible employees to purchase shares of the Company’s common stock, at semi-annual intervals, with their accumulated payroll deductions. Under the ESPP, participants are offered the option to purchase shares of the Company’s common stock at a discount during a series of successive offering periods. The option purchase price will be the lower of 85 % of the closing trading price per share of the Company’s common stock on the first trading date of an offering period in which a participant is enrolled or 85 % of the closing trading price per share on the purchase date, which will occur on the last trading day of each offering period. 22 Table of Contents ARCUTIS BIOTHERAPEUTICS, INC. Notes to Condensed Financial Statements (unaudited) The ESPP is intended to qualify under Section 423 of the U.S. Internal Revenue Service Code of 1986, as amended. The maximum number of the Company’s common stock which will be authorized for sale under the ESPP is equal to the sum of (a) 351,000 shares of common stock and (b) an annual increase on the first day of each year beginning in 2021 and ending in 2030, equal to the lesser of (i) 1 % of the shares of common stock outstanding (on an as converted basis) on the last day of the immediately preceding fiscal year and (ii) such number of shares of common stock as determined by the Company’s board of directors; provided, however, no more than 5,265,000 shares of the Company’s common stock may be issued under the ESPP. Accordingly, on January 1, 2021, the ESPP reserve increased by 436,778 shares. The Company commenced an offering period on January 31, 2020, which ended on May 31, 2020, and resulted in 19,862 shares of stock being issued under the ESPP. The Company also commenced an offering period on June 1, 2020, which ended on November 30, 2020, and resulted in 14,326 shares of stock being issued under the ESPP. In addition, the Company commenced an offering period on December 1, 2020, which ended on May 31, 2021, and resulted in 22,658 shares of stock being issued under the ESPP. Stock-based compensation expense related to the ESPP was $ 88,000 and $ 304,000 for the three and nine months ended September 30, 2021, respectively, and $ 88,000 and $ 249,000 for the three and nine months ended September 30, 2020, respectively. 10. Net Loss Per Share The following outstanding potentially dilutive shares have been excluded from the calculation of diluted net loss per share for the periods presented due to their anti-dilutive effect: As of September 30, 2021 2020 Stock options to purchase common stock 5,715,147 3,604,363 Early exercised options subject to future vesting 131,923 419,312 RSU's subject to future vesting 337,868 163,560 ESPP shares subject to future issuance 22,634 14,817 Total 6,207,572 4,202,052 23 Table of Contents