Arcutis Biotherapeutics, Inc. 10-Q

Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis of our financial condition and results of operations should be read together with our unaudited condensed financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q, and the audited financial statements and notes thereto as of and for the year ended December 31, 2021 and the related Management's Discussion and Analysis of Financial Condition and Results of Operations, both of which are contained in our Annual Report on Form 10-K for the year ended December 31, 2021, which has been filed with the Securities and Exchange Commission (SEC). Some of the information contained in this discussion and analysis or set forth elsewhere in this Quarterly Report on Form 10-Q, including information with respect to our plans, objectives, expectations, projections, and strategy for our business, includes forward-looking statements that involve risks and uncertainties. These statements are often identified by the use of words such as “may,” “will,” “expect,” “believe,” “anticipate,” “intend,” “could,” “should,” “estimate,” or “continue,” and similar expressions or variations. Such forward-looking statements are subject to risks, uncertainties, and other factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. As a result of many factors, including those factors identified below and those set forth in the “Risk Factors” section of our Annual Report on Form 10-K, our actual results and the timing of selected events could differ materially from the forward-looking statements contained in the following discussion and analysis. Overview We are a late-stage biopharmaceutical company focused on developing and commercializing treatments for dermatological diseases with high unmet medical needs. Our current portfolio is comprised of highly differentiated topical treatments with significant potential to treat immune-mediated dermatological diseases and conditions. We believe we have built the industry's leading platform for dermatologic product development. Our strategy is to focus on validated biological targets, and to use our drug development platform and deep dermatology expertise to develop differentiated products that have the potential to address the major shortcomings of existing therapies in our targeted indications. We believe this strategy uniquely positions us to rapidly progress towards our goal of bridging the treatment innovation gap in dermatology, while maximizing our probability of technical success and financial resources. Our lead product candidate, roflumilast cream, has successfully completed pivotal Phase 3 clinical trials in plaque psoriasis, demonstrating symptomatic improvement and favorable tolerability in this population. We have submitted a New Drug Application (NDA) to the FDA, and the FDA has set a Prescription Drug User Fee Act (PDUFA) action date of July 29, 2022. Roflumilast cream is a once-daily topical formulation of roflumilast, a highly potent and selective phosphodiesterase-4 (PDE4) inhibitor. PDE4 is an established biological target in dermatology, with multiple PDE4 inhibitors approved by the FDA for the systematic treatment of dermatological conditions. We are developing roflumilast cream for the treatment of plaque psoriasis, including psoriasis in intertriginous regions such as the groin, axillae, and inframammary areas, as well as atopic dermatitis. We have also successfully completed a long-term safety study of roflumilast cream in plaque psoriasis subjects showing continued symptomatic improvement and favorable tolerability over a treatment period of 52 to 64 weeks. In atopic dermatitis, we have initiated three pivotal Phase 3 clinical studies: INTEGUMENT-1 and -2 are enrolling subjects six years of age or older and INTEGUMENT-PED is enrolling subjects between the ages of two and five years. We expect to provide topline data from each of INTEGUMENT-1 and -2 by the end of 2022. We intend to submit a supplemental New Drug Application (sNDA) for topical roflumilast cream for the treatment of atopic dermatitis patients aged six years or older in 2023 based on the results of INTEGUMENT-1 and -2. We expect to provide topline data from INTEGUMENT-PED in 2023 and submit a subsequent sNDA for the younger age cohort following the potential initial atopic dermatitis approval in patients aged six years or older. We are also developing a topical foam formulation of roflumilast, and have completed enrollment in single pivotal Phase 3 clinical trials in both seborrheic dermatitis and scalp and body psoriasis. In seborrheic dermatitis, we anticipate topline data in mid-year 2022. If positive, we expect the data to be a sufficient basis for an NDA submission in the first half of 2023. In our Phase 3 scalp and body psoriasis trial, we anticipate topline data late in the third quarter or early in the fourth quarter of 2022. If positive, we expect the data to be a sufficient basis for a sNDA submission. 24 Table of Contents Beyond topical roflumilast, we are developing ARQ-252, a potent and highly selective topical JAK1 inhibitor. In May 2021, we announced that the Phase 2 study of ARQ-252 in chronic hand eczema did not meet its primary endpoint with further analyses of the study pointing to inadequate local drug delivery to the skin. Given these analyses, we also elected to terminate the Phase 2a clinical trial evaluating ARQ-252 as a potential treatment in vitiligo, as we began reformulation efforts to develop an enhanced formulation of ARQ-252 that delivers more active drug to targets in the skin. Additionally, we have Investigational New Drug application (IND)-enabling efforts continuing for ARQ-255, an alternative deep-penetrating topical formulation of ARQ-252 designed to reach deeper into the skin and hair follicle in order to potentially treat alopecia areata. The ARQ-255 formulation is separate and distinct from ARQ-252, and thus there are no implications to ARQ-255 from ARQ-252. We expect to initiate a clinical trial of ARQ-255 in alopecia areata in 2022. Since our inception in 2016, we have invested a significant portion of our efforts and financial resources in clinical development activities. We have not generated any revenue from product sales and have funded our operations primarily with the net proceeds from equity and debt offerings. Prior to our IPO, we received $162.5 million in net cash proceeds from private placements of our convertible preferred stock. On February 4, 2020, we received $167.2 million in net proceeds in connection with our IPO. On October 6, 2020, we closed a public offering and a concurrent private placement of our common stock and received an aggregate of $128.4 million in net proceeds. On February 5, 2021, we closed a public offering of our common stock and received an aggregate of $207.5 million in net proceeds. In December 2021, we received $72.4 million in net proceeds under the Loan Agreement. In March 2022, we received $14.5 million in net proceeds related to shares issued under our ATM. See Note 1 to the financial statements for additional information. We have incurred net losses in each year since inception, including net losses of $64.3 million and $36.0 million for the three months ended March 31, 2022 and 2021, respectively. As of March 31, 2022, we had an accumulated deficit of $472.6 million and cash, cash equivalents, restricted cash, and marketable securities of $344.8 million. As of March 31, 2022, we had $75.0 million outstanding under the Loan Agreement and an aggregate of up to $150.0 million in additional funding may become available subject to the satisfaction of specified conditions. We expect to continue to incur losses for the foreseeable future and expect to incur increased expenses as we advance our product candidates through clinical trials, regulatory submissions, and commercialization. We do not expect to generate revenue from product sales unless, and until, we obtain regulatory approval or clearance from the FDA or other foreign regulatory authorities for our product candidates. If we obtain regulatory approval or clearance for our product candidates, we expect to incur significant commercialization expenses related to product sales, marketing, manufacturing, and distribution. As a result, we will need substantial additional funding to support our operating activities. Adequate funding may not be available to us on acceptable terms, or at all. We currently anticipate that we will seek to fund our operations through equity or debt financings or other sources, such as future potential collaboration agreements. Our failure to obtain sufficient funds on acceptable terms as and when needed could have a material adverse effect on our business, results of operations, and financial condition. See “Liquidity, Capital Resources, and Requirements” below and Note 1 to the financial statements for additional information. Based on our current planned operations, we expect that our current cash, cash equivalents, and marketable securities, combined with committed funding under the Loan Agreement, will be sufficient to fund our operations into 2024. We rely on third parties in the conduct of our nonclinical studies and clinical trials and for manufacturing and supply of our product candidates. We have no internal manufacturing capabilities, and we will continue to rely on third parties, many of whom are single source suppliers, for our nonclinical and clinical trial materials, as well as the commercial supply of our products. In addition, we have not yet completed the build out of our entire sales organization. Accordingly, we expect to incur significant expenses to fully develop a sales organization or commercial infrastructure in advance of generating any product sales. 25 Table of Contents COVID-19 Update In March 2020, the World Health Organization declared a pandemic related to the COVID-19 outbreak. COVID-19 has placed strains on the providers of healthcare services, including the sites where we conduct our clinical trials. These strains have resulted in some clinical sites slowing or halting enrollment in clinical trials and restricting the on-site monitoring of clinical trials. We follow FDA guidance on clinical trial conduct during the COVID-19 pandemic, including the remote monitoring of clinical data. We are monitoring the impact COVID-19 may have on the clinical development of our product candidates, including potential delays or modifications to ongoing and planned trials. We believe that the rapid spread of the Omicron variant in late 2021 and early 2022 has likely had a minor impact on the enrollment of our clinical trials. Because of this likely impact, along with the inherent challenges of enrolling young children in clinical trials, we have updated our expectation for providing topline data for the INTEGUMENT-PED trial, in atopic dermatitis subjects between two and five years of age, to 2023. We cannot, at this time, predict the specific extent, duration, or full impact that the COVID-19 outbreak will have on our ongoing and planned clinical trials and other business operations, including our commercialization activities. There have been no disruptions in our supply chain of drug manufacturers necessary to conduct our clinical trials and, given our drug inventories, we believe that we will be able to supply the drug needs of our ongoing clinical studies. In alignment with public health guidance designed to slow the spread of COVID-19, we implemented a remote work plan for all employees as of mid-March 2020. With COVID-19 moving to an endemic phase, we have formally returned to our previously existing hybrid work environment consisting of both local and remote employees. We may need to undertake additional actions that could impact our operations as required by applicable laws or regulations, or which we determine to be in the best interests of our employees. License Agreements AstraZeneca License Agreement In July 2018, we entered into the AstraZeneca License Agreement with AstraZeneca, granting us 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, we have sole responsibility for development, regulatory, and commercialization activities for the AZ-Licensed Products in the Dermatology Field, at our expense, and we 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. We paid AstraZeneca an upfront non-refundable cash payment of $1.0 million and issued 484,388 shares of our Series B convertible preferred stock, valued at $3.0 million on the date of the AstraZeneca License Agreement. We 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. We have agreed to make additional cash payments to AstraZeneca of up to an aggregate of $12.5 million upon the achievement of specific regulatory approval milestones with respect to the AZ-Licensed Products, which includes $7.5 million upon FDA Approval of our 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 we commercialize under the AstraZeneca License Agreement, we will pay AstraZeneca a low to high single-digit percentage royalty rate on our, our affiliates’ and our sublicensees’ net sales of such AZ-Licensed Products, 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. See Note 6 to the financial statements for additional information. 26 Table of Contents Hengrui Exclusive Option and License Agreement In January 2018, we entered into the Hengrui License Agreement, with Hengrui, whereby Hengrui granted us an exclusive option to obtain certain exclusive rights to research, develop, and commercialize products containing the compound designated by Hengrui as SHR0302, a JAK 1 inhibitor, in topical formulations for the treatment of skin diseases, disorders, and conditions in the United States, Canada, Japan, and the European Union (including for clarity the United Kingdom). We made a $0.4 million upfront non-refundable cash payment to Hengrui upon execution of the Hengrui Option and License Agreement. In December 2019, we exercised our exclusive option under the agreement, for which we made a $1.5 million cash payment, and also contemporaneously amended the agreement to expand the territory to additionally include Canada. In addition, we have agreed to make cash payments of up to an aggregate of $20.5 million upon our 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 achieving certain aggregate annual net sales volumes with respect to a licensed product. With respect to any products we commercialize under the Hengrui License Agreement, we will pay tiered royalties to Hengrui on net sales of each licensed product by us, or our affiliates, or our sublicensees, ranging from mid single-digit to sub-teen percentage rates based on tiered annual net sales bands subject to specified reductions. We are 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) the 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, we are obligated to pay Hengrui a specified percentage, ranging from the low-thirties to the sub-teens, of certain non-royalty sublicensing income we receive from sublicensees of our rights to the licensed products, such percentage decreasing as the development stage of the licensed products advance. The agreement continues in effect until the expiration of our obligation to pay royalties as described above, unless earlier terminated in accordance with the following: (1) by either party upon written notice for the other party’s material breach or insolvency event if such party fails to cure such breach or the insolvency event is not dismissed within specified time periods; and (2) by us for convenience upon 90 days prior written notice to Hengrui and having discussed and consulted any potential cause or concern with Hengrui in good faith. See Note 6 to the financial statements for additional information. Components of Our Results of Operations Operating Expenses Research and Development Expenses Since our inception, we have focused significant resources on our research and development activities, including conducting nonclinical studies and clinical trials, manufacturing development efforts, and activities related to regulatory filings for our product candidates. Research and development costs are expensed as incurred. These costs include direct program expenses, which are payments made to third parties that specifically relate to our research and development, such as payments to clinical research organizations, clinical investigators, manufacturing of clinical material, nonclinical testing, and consultants. In addition, employee costs, including salaries, payroll taxes, benefits, stock-based compensation, and travel for employees contributing to research and development activities are classified as research and development costs. We allocate direct external costs on a program specific basis (topical roflumilast program, topical JAK inhibitor program, and early stage programs). Our internal costs are primarily related to personnel or professional services and apply across programs, and thus are not allocable on a program specific basis. We expect to continue to incur substantial research and development expenses in the future as we develop our product candidates. In particular, we expect to incur substantial research and development expenses for the Phase 3 trials of roflumilast cream for atopic dermatitis, the Phase 3 trials of roflumilast foam for seborrheic dermatitis and scalp and body psoriasis, ARQ-252 for chronic hand eczema and vitiligo, and ARQ-255 for alopecia areata. 27 Table of Contents We have entered, and may continue to enter, into license agreements to access and utilize certain molecules for the treatment of dermatological diseases and disorders. We evaluate if the license agreement is an acquisition of an asset or a business. To date, none of our license agreements have been considered to be 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, are immediately recognized as research and development expense when due, provided there is no alternative future use of the rights in other research and development projects. The successful development of our product candidates is highly uncertain. At this time, we cannot reasonably estimate the nature, timing, or costs required to complete the remaining development of roflumilast cream, roflumilast foam, ARQ-252, and ARQ-255, or any future product candidates. This is due to the numerous risks and uncertainties associated with the development of product candidates. See “Risk Factors” for a discussion of the risks and uncertainties associated with the development of our product candidates. General and Administrative Expenses Our general and administrative expenses consist primarily of salaries and related costs, including payroll taxes, benefits, stock-based compensation, and travel. Other general and administrative expenses include costs related to sales support as we prepare for commercialization, legal costs of pursuing patent protection of our intellectual property, insurance, and professional services fees for marketing, auditing, tax, and general legal services. We expect our general and administrative expenses to continue to increase in the future as we expand our operating activities and prepare for potential commercialization of our product candidates, increase our headcount, and support our operations as a public company; including increased expenses related to legal, accounting, insurance, regulatory, and tax-related services associated with maintaining compliance with exchange listing and SEC requirements, directors and officers liability insurance premiums, and investor relations activities. Other Income, Net Other income, net primarily consists of interest income earned on our cash, cash equivalents, and marketable securities. Interest Expense Interest expense is related to our long term debt. 28 Table of Contents Results of Operations Comparison of the Three Months Ended March 31, 2022 and 2021 The following table sets forth our results of operations for the periods indicated: Three Months Ended March 31, Change 2022 2021 $ % (unaudited) (in thousands) Operating expenses: Research and development $ 40,622 $ 21,631 $ 18,991 88 % General and administrative 22,006 14,454 7,552 52 % Total operating expenses 62,628 36,085 26,543 74 % Loss from operations (62,628) (36,085) (26,543) 74 % Other income (expense): Other income, net 142 43 99 230 % Interest expense (1,838) — (1,838) * Total other income (expense) (1,696) 43 (1,739) (4044) % Net loss $ (64,324) $ (36,042) $ (28,282) 78 % ______________ *Not applicable Research and Development Expenses Three Months Ended March 31, Change 2022 2021 $ % (unaudited) (in thousands) Direct external costs: Topical roflumilast program $ 25,222 $ 9,787 $ 15,435 158 % Topical JAK inhibitor program 963 3,651 (2,688) (74) % Other early stage programs 295 177 118 67 % Indirect costs: Compensation and personnel-related 9,439 5,109 4,330 85 % Other 4,703 2,907 1,796 62 % Total research and development expense $ 40,622 $ 21,631 $ 18,991 88 % Research and development expenses increased by $19.0 million, or 88%, for the three months ended March 31, 2022 compared to the three months ended March 31, 2021. The increase was primarily due to an increase in direct costs related to the topical roflumilast program of $15.4 million, an increase in compensation and personnel-related costs of $4.3 million, and an increase in other costs of $1.8 million. These increases were partially offset by a decrease in direct costs related to the topical JAK inhibitor program (ARQ-252 and ARQ-255) of $2.7 million. The increase in topical roflumilast program costs was primarily due to increased clinical trial costs and increased manufacturing. Clinical trial costs increased due to the ongoing Phase 3 studies of roflumilast cream in atopic dermatitis and Phase 3 studies of roflumilast foam in seborrheic dermatitis and scalp psoriasis partially offset by the completion of Phase 3 studies of roflumilast cream in plaque psoriasis. Manufacturing costs increased due to the timing of purchases of roflumilast active pharmaceutical ingredient (API). The increase in compensation and personnel-related expenses, which includes stock-based compensation, was primarily due to an increase in headcount to manage our growing clinical programs. The increase in other costs was primarily due to an increase in 29 Table of Contents consulting activity and medical affairs spending. The decrease in topical JAK inhibitor program costs was primarily due to the completion of our Phase 2 study of ARQ-252 in chronic hand eczema. General and Administrative Expenses General and administrative expenses increased by $7.6 million, or 52%, for the three months ended March 31, 2022 compared to the three months ended March 31, 2021. The increase was primarily due to higher professional services of $5.3 million and higher compensation and personnel-related expenses of $1.3 million. The increase in professional services was due to an increase in consulting activity and marketing expenses primarily related to roflumilast. The increase in compensation and personnel-related expenses, which includes stock-based compensation, was primarily due to an increase in headcount as we prepare for commercialization. Other Income, Net Other income, net increased by $0.1 million for the three months ended March 31, 2022 compared to the three months ended March 31, 2021, primarily due to a larger marketable securities balance for the three months ended March 31, 2022. Interest Expense Interest expense increased by $1.8 million for the three months ended March 31, 2022 compared to the three months ended March 31, 2021, due to interest expense of $1.8 million related to our long-term debt. See Note 8. Liquidity, Capital Resources, and Requirements Sources of Liquidity We have incurred operating losses since our inception and have an accumulated deficit as a result of ongoing efforts to develop our product candidates, including conducting nonclinical and clinical trials and providing general and administrative support for these operations. As of March 31, 2022, we had cash, cash equivalents, restricted cash, and marketable securities of $344.8 million, and an accumulated deficit of $472.6 million. As of March 31, 2022, we had $75.0 million outstanding under our Loan Agreement. We have historically financed our operations primarily through private placements of preferred stock, our IPO completed in January 2020, our follow-on financings in October 2020 and February 2021, our Loan Agreement, and our ATM. We will continue to be dependent upon equity, debt financing, collaborations, or other forms of capital at least until we are able to generate positive cash flows from our operations. Cash Flows The following table sets forth our cash flows for the periods indicated: Three Months Ended March 31, 2022 2021 (unaudited) (in thousands) Cash used in operating activities $ (56,975) $ (46,203) Cash provided by investing activities 15,297 61,996 Cash provided by financing activities 14,716 207,815 Net increase (decrease) in cash, cash equivalents, and restricted cash $ (26,962) $ 223,608 30 Table of Contents Net Cash Used in Operating Activities During the three months ended March 31, 2022, net cash used in operating activities was $57.0 million, which consisted of a net loss of $64.3 million and a change in net operating assets and liabilities of $0.4 million, partially offset by net non-cash charges of $7.8 million. The net non-cash charges were primarily related to stock-based compensation expense of $6.5 million. During the three months ended March 31, 2021, net cash used in operating activities was $46.2 million, which consisted of a net loss of $36.0 million and a change in net operating assets and liabilities of $19.5 million offset by net non-cash charges of $9.3 million. The change in net operating assets and liabilities was primarily due to an increase of $12.7 million in prepaid expenses and other current assets due to an increase in prepaid clinical trials and a decrease of $6.9 million in accounts payable and accrued liabilities due to the timing of payments to contract research organizations and payment of employee bonuses accrued for at December 31, 2020. The net non-cash charges were primarily related to stock-based compensation expense of $8.5 million. Net Cash Provided by Investing Activities During the three months ended March 31, 2022, net cash provided by investing activities was $15.3 million, which was comprised primarily of proceeds from the maturities of marketable securities of $70.9 million, partially offset by purchases of marketable securities of $55.5 million. During the three months ended March 31, 2021, net cash provided by investing activities was $62.0 million, which was comprised primarily of proceeds from the maturities of marketable securities of $62.6 million, partially offset by the purchases of property and equipment of $0.6 million. Net Cash Provided by Financing Activities During the three months ended March 31, 2022, net cash provided by financing activities was $14.7 million, which was comprised primarily of the net cash proceeds received from shares sold under our ATM of $14.5 million. During the three months ended March 31, 2021, net cash provided by financing activities was $207.8 million, which was comprised primarily of the net cash proceeds received from the follow-on financing in February 2021 of $207.5 million. Funding Requirements We have historically incurred significant losses and negative cash flows from operations since our inception and had an accumulated deficit of $472.6 million as of March 31, 2022. We had cash, cash equivalents, and marketable securities of $343.6 million as of March 31, 2022. As of March 31, 2022, we had $75.0 million outstanding under the Loan Agreement and an aggregate of up to $150.0 million in additional funding may become available subject to the satisfaction of specified conditions. Based on our current planned operations, we expect that our current cash, cash equivalents, and marketable securities, combined with committed funding under the Loan Agreement, will be sufficient to fund our operations into 2024. Our ability to continue as a going concern is dependent upon our ability to successfully secure sources of financing and ultimately achieve profitable operations. We will need to raise substantial additional capital to fund our operations through the sale of our equity securities, accessing or incurring additional debt, entering into licensing or collaboration agreements with partners, grants, or other sources of financing. There can be no assurance that sufficient funds will be available to us at all or on attractive terms when needed from these sources. If we are unable to obtain additional funding from these or other sources when needed it may be necessary to significantly reduce our current rate of spending through reductions in staff and delaying, scaling back, or stopping certain research and development programs. Insufficient liquidity may also require us to relinquish rights to product candidates at an earlier stage of development or on less favorable terms than we would otherwise choose. 31 Table of Contents We have based our projections of operating capital requirements on assumptions that may prove to be incorrect and we may use all our available capital resources sooner than we expect. Because of the numerous risks and uncertainties associated with research, development, and commercialization of pharmaceutical products, we are unable to estimate the exact amount of our operating capital requirements. Our future funding requirements will depend on many factors, including, but not limited to: • the scope, progress, results, and costs of researching and developing our lead product candidates or any future product candidates, and conducting nonclinical studies and clinical trials, in particular our planned or ongoing clinical studies of roflumilast cream in atopic dermatitis, roflumilast foam in seborrheic dermatitis and scalp and body psoriasis, ARQ-252 in chronic hand eczema and vitiligo, and our IND-enabling efforts for ARQ-255 in alopecia areata; • suspensions or delays in the enrollment or changes to the number of subjects we decide to enroll in our ongoing clinical trials as a result of the COVID-19 pandemic; • the timing of, and the costs involved in, obtaining regulatory approvals for our lead product candidate or our other product candidates; • the number and characteristics of any additional product candidates we develop or acquire; • the cost of manufacturing our lead product candidates or any future product candidates and any products we successfully commercialize, including costs associated with building out our supply chain; • the cost of commercialization activities if our lead product candidates or any future product candidates are approved for sale, including marketing, sales, and distribution costs; • the cost of building a sales force in anticipation of product commercialization; • our ability to establish and maintain strategic collaborations, licensing or other arrangements, and the financial terms of any such agreements that we may enter into; • the costs related to milestone payments to AstraZeneca or Hengrui, upon the achievement of predetermined milestones; • any product liability or other lawsuits related to our products; • the expenses needed to attract and retain skilled personnel; • the costs associated with being a public company; • the costs involved in preparing, filing, prosecuting, maintaining, defending, and enforcing patent claims, and the outcome of this and any other future patent litigation we may be involved in; and • the timing, receipt, and amount of sales of any future approved products, if any. Indebtedness On December 22, 2021 we entered into a Loan Agreement with SLR and the lenders party thereto. Pursuant to the Loan Agreement, the lenders agreed to extend term loans to the us in an aggregate principal amount of up to $225.0 million, comprised of: (i) a tranche A term loan of $75.0 million, (ii) a tranche B-1 term loan of $50.0 million, (iii) a tranche B-2 term loan of up to $75.0 million, available in minimum increments of $15.0 million, and (iv) a tranche C term loan of up to $25.0 million. We refer to the tranche A, tranche B, and tranche C term loans together as our Term Loans. As security for the obligations under the Loan Agreement, we granted SLR, for the benefit of the lenders, a continuing security interest in substantially all of our assets, including our intellectual property, subject to certain exceptions. The tranche A term loan was funded on December 22, 2021. Each tranche B term loan is available following delivery to SLR of satisfactory evidence that we have received FDA Approval of roflumilast cream for an indication relating to the treatment of patients with plaque psoriasis, which we refer to as the FDA Approval. The tranche B-1 term loan will remain available for funding until the earlier of (i) 15 days after we have received FDA Approval and (ii) June 30, 2023. The tranche B-2 term loan will remain available for funding until June 30, 2023. The tranche C term loan is available following the achievement of a net product revenue milestone of $110.0 million, calculated on a trailing six month basis. The tranche C term loan will remain available for funding until September 30, 2024. 32 Table of Contents Principal amounts outstanding under the Term Loans will accrue interest at a floating rate equal to the applicable rate in effect from time to time, as determined by SLR on the third business day prior to the funding date of the applicable Term Loan and on the first business day of the month prior to each payment date of each Term Loan. The applicable rate is a per annum interest rate equal to 7.45% plus the greater of (a) 0.10% and (b) the per annum rate published by the Intercontinental Exchange Benchmark Administration Ltd. (or on any successor or substitute published rate) for a term of one month, subject to a replacement with an alternate benchmark rate and spread in certain circumstances. On March 31, 2022, the rate was 7.68%. Commencing on February 1, 2022, interest payments are payable monthly following the funding of any Term Loan. Any principal amounts outstanding under the Term Loans, if not repaid sooner, are due and payable on January 1, 2027, or the Maturity Date. We may voluntarily prepay principal amounts outstanding under the Term Loans in minimum increments of $5.0 million, subject to a prepayment premium of (i) 3.0% of the principal amount of such Term Loan so prepaid prior to December 22, 2022, (ii) 2.0% of the principal amount of such Term Loan so prepaid after December 22, 2022 and prior to December 22, 2023, or (iii) 1.0% of the principal amount of such Term Loan so prepaid after December 22, 2023 and prior to December 22, 2025. If the Term Loans are accelerated due to, among others, the occurrence of a bankruptcy or insolvency event, we are required to make mandatory prepayments of (i) all principal amounts outstanding under the Term Loans, plus accrued and unpaid interest thereon through the prepayment date, (ii) any fees applicable by reason of such prepayment, (iii) the prepayment premiums set forth in the paragraph above, plus (iv) all other obligations that are due and payable, including expenses and interest at the Default Rate (as defined below) with respect to any past due amounts. The Loan Agreement contains customary representations and warranties and customary affirmative and negative covenants, including, among others, requirements as to financial reporting and insurance and restrictions on our ability to dispose of our business or property, to change our line of business, to liquidate or dissolve, to enter into any change in control transaction, to merge or consolidate with any other entity or to acquire all or substantially all the capital stock or property of another entity, to incur additional indebtedness, to incur liens on its property, to pay any dividends or other distributions on capital stock other than dividends payable solely in capital stock or to redeem capital stock. We have also agreed to a financial covenant whereby, beginning with the month ending December 31, 2023, we must generate net product revenue in excess of specified amounts for applicable measuring periods; provided, however, that such financial covenant shall not apply if our average market capitalization over the trailing five day period prior to the last day of any measurement month is equal to or in excess of $400.0 million. We were in compliance with all covenants under the Loan Agreement as of March 31, 2022. In addition, the Loan Agreement contains customary events of default that entitle the lenders to cause any indebtedness under the Loan Agreement to become immediately due and payable, and to exercise remedies against us and the collateral securing the Term Loans. Under the Loan Agreement, an event of default will occur if, among other things, we fail to make payments under the Loan Agreement, we breach any of our covenants under the Loan Agreement, subject to specified cure periods with respect to certain breaches, the lenders determine that a material adverse change has occurred, or we or our assets become subject to certain legal proceedings, such as bankruptcy proceedings. Upon the occurrence and for the duration of an event of default, an additional default interest rate, or the Default Rate, equal to 4.0% per annum will apply to all obligations owed under the Loan Agreement. In connection with the Loan Agreement, we paid a closing fee of $1.0 million on December 22, 2021, and we are further obligated to pay (i) a final fee equal to 6.95% of the aggregate original principal amount of the Term Loans funded upon the earliest to occur of the Maturity Date, the acceleration of any Term Loan and the prepayment, refinancing, substitution or replacement of any Term Loan and (ii) a certain amount of lenders’ expenses incurred in connection with the execution of the Loan Agreement. Additionally, in connection with the Loan Agreement, we entered into an Exit Fee Agreement, whereby we agreed to pay an exit fee in the amount 3.0% of each Term Loan funded upon (i) any change of control transaction or (ii) a revenue milestone, calculated on a trailing six month basis. Notwithstanding the prepayment or termination of the Term Loan, the exit fee will expire 10 years from the date of the Loan Agreement. 33 Table of Contents Contractual Obligations and Contingent Liabilities The following summarizes our significant contractual obligations as of March 31, 2022. Facility Operating Lease In April 2020, we amended our lease agreement for our facility in Westlake Village, California to relocate to a new expanded space including 22,643 square feet. The lease payment term for the new space began on December 30, 2020 and will terminate 91 months thereafter, with a renewal option term of five years. We have a one-time option to cancel the lease after month 67. 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. The amended lease agreement required that we deliver a letter of credit to the landlord of $1.5 million upon occupying the space, which is allowed to be reduced throughout the lease period as rent obligations are met. Accordingly, as of March 31, 2022, we have a letter of credit and related restricted cash account of $1.2 million. The total commitment under the operating lease agreement is $6.4 million, including $0.6 million for the remaining nine months of 2022, $1.0 million for each of the years 2023 through 2027, and $0.6 million for the year 2028. See Note 7 to the unaudited condensed financial statements for additional information. Long-Term Debt Obligations As of March 31, 2022, we had $75.0 million outstanding under our Loan Agreement and an aggregate of up to $150.0 million in additional funding under the Loan Agreement that may become available subject to the satisfaction of specified conditions. The total commitment under the Loan Agreement is $108.7 million, including $4.5 million for 2022, $6.0 million for each of the years 2023 through 2026, and $80.2 million for 2027. These amounts do not represent or include any future draw downs, but instead represent only the contractually obligated minimum payments of interest, principal, and loan fees related to the funding of the $75.0 million tranche A term loan on December 22, 2021. License Agreements The terms of certain of our license agreements require us to pay potential future milestone payments based on product development and commercial success. The amount and timing of such obligations are unknown or uncertain. These potential obligations are further described in Note 6 to the financial statements. Manufacturing Agreements We have 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 $9.3 million within the next nine months and then approximately $0.6 million per year for the following three years. This amount does not represent all of the our anticipated purchases, but instead represents only the contractually obligated minimum purchases or firm commitments of non-cancelable minimum amounts. Indemnification In the normal course of business, we enter into contracts and agreements that contain a variety of representations and warranties and provide for general indemnifications. Our exposure under these agreements is unknown because it involves claims that may be made against us in the future, but have not yet been made. To date, we have not paid any claims or been required to defend any action related to our indemnification obligations. However, we may record charges in the future as a result of these indemnification obligations. In accordance with our certificate of incorporation and bylaws, we have indemnification obligations to our officers and directors for specified events or occurrences, subject to some limits, while they are serving at our request in such capacities. There have been no claims to date, and we have director and officer insurance that may enable us to recover a portion of any amounts paid for future potential claims. 34 Table of Contents Off-Balance Sheet Arrangements We did not have during the periods presented, and we do not currently have, any off-balance sheet arrangements, as defined under SEC rules. Critical Accounting Policies and Use of Estimates The preparation of our condensed financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the notes to the financial statements. Some of those judgments can be subjective and complex, and therefore, actual results could differ materially from those estimates under different assumptions or conditions. A summary of our critical accounting policies is presented in Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, of our Annual Report on Form 10-K for the year ended December 31, 2021. There were no material changes to our critical accounting policies during the three months ended March 31, 2022. Recent Accounting Pronouncements See Note 2 to our unaudited condensed financial statements.