What changed in this filing

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Item 7. Management’s Discussion and Analysis

2021-03-01 compared with 2020-03-10 · 130 added, 695 removed, 127 unchanged (87% of the section changed)

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Discussions of 2018 items and year-to-year comparisons between 2019 and 2018 that are not included in this Form 10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2020.

We are a clinical stage gene therapy company dedicated to developing and commercializing novel treatments for patients suffering from skin diseases.

We have developed a proprietary gene therapy platform, which we refer to as the Skin TARgeted Delivery platform, or STAR-D platform, that consists of a patented engineered viral vector based on herpes simplex virus 1, or HSV-1, and skin-optimized gene transfer technology, to develop off-the-shelf treatments for dermatological diseases for which we believe there are no known effective treatments.

We are initially using the STAR-D platform to develop treatments for rare or orphan dermatological indications caused by the absence of or a mutation in a single gene, and plan to leverage our platform in the future to expand our pipeline to include other indications and skin conditions.

Our lead clinical product candidate, B-VEC (beremagene geperpavec, previously “KB103”) is our proprietary gene therapy candidate therapy for the treatment of dystrophic epidermolysis bullosa, or DEB, a rare and severe genetic disease, for which there is currently no approved treatment.

In October 2019, we announced positive results from our Phase 1/2 clinical trial of B-VEC at Stanford University.

Safety data from all patients showed that B-VEC was well tolerated with no serious adverse events (SAEs) reported.

For more information on the B-VEC Phase 1/2 clinical trial, visit:

http://ir.krystalbio.com/news-releases/news-release-details/krystal-biotech-announces-final-update-phase-12-clinical-trial.

We anticipate commencing pivotal Phase 3 FDA trials in the first half of 2020.

The FDA and the European Medicines Agency, or EMA, have each granted B-VEC orphan drug designation for the treatment of DEB.

In addition, the FDA granted Regenerative Medicine Advanced Therapy, or RMAT to B-VEC.

The designation includes all the benefits of the FDA's Fast Track and Breakthrough Therapy designations and enables the ability to work more closely and frequently with the FDA to discuss surrogate or intermediate endpoints to support the potential acceleration of approval and satisfy post-approval requirements.

The EMA granted PRIority MEdicines, or PRIME, eligibility for B-VEC to treat DEB.

Through PRIME, the EMA offers enhanced support to medicine developers including early interaction and dialogue, and a pathway for accelerated evaluation by the agency.

B-VEC is also eligible during the FDA marketing process to apply for a Rare Pediatric Disease Priority Review Voucher that can be redeemed to receive a priority review of a subsequent marketing application for a different product.

Our second pipelin e candidate, KB105, is currently in a Phase 1/2 clinical trial for treatment of patients with deficient autosomal recessive congenital ichthyosis, or ARCI, which is associated with transglutaminase 1, or TGM-1.

There are currently no treatments for this di sease that affects approximately 20,000 patients worldwide.

The FDA has granted KB105 orphan drug designation and rare pediatric designation for the treatment of ARCI.

KB105 is also eligible during the FDA marketing process to apply for a Rare Pediatric Pr iority Review Voucher.

We anticipate announcing interim clinical results from the on-going trial in 1H 2020.

We are a clinical stage biotechnology company leading the field of redosable gene therapy for the treatment serious rare diseases.

Using our patented platform that is based on engineered HSV-1, we create vectors that efficiently deliver therapeutic transgenes to cells of interest in multiple organ systems.

The cell’s own machinery then transcribes and translates the encoded effector to treat or prevent disease.

We formulate our vectors for non-invasive or minimally invasive routes of administration at a doctor’s office or potentially in the patient’s home.

Our goal is to develop easy to use, redosable gene therapies to dramatically improve the lives of patients living with rare diseases.

Our innovative technology platform is supported by in-house, commercial scale cGMP manufacturing capabilities.

Refer to Part I, Item 1 - Business for more information about our clinical development pipeline and research programs and the status of our product candidates.

Pipeline Highlights:

• B-VEC is a topical gel containing our novel vector designed to deliver two copies of the COL7A1 transgene for the treatment of DEB, a serious rare skin disease caused by missing or mutated COL7.

The randomized, double-blind, placebo-controlled GEM-3 pivotal study is ongoing, with top line data anticipated in 4Q21.

Details of the pivotal study can be found at www.clinicaltrails.gov under NCT identifier NCT04491604.

Nothing included on these websites shall be deemed incorporated by reference into this Annual Report on Form 10-K.

• KB105 is a topical gel containing our novel vector designed to deliver two copies of the TGM1 transgene for the treatment of TGM1-ARCI, a serious rare skin disorder caused by missing or mutated TGM1 protein.

A randomized, placebo-controlled Phase 1/2 study is ongoing.

Details of the Phase 1/2 study can be found at www.clinicaltrials.gov under NCT identifier NCT04047732.

Nothing included on these websites shall be deemed incorporated by reference into this Annual Report on Form 10-K.

• KB407 is an inhaled (nebulized) formulation of our novel vector designed to deliver two copies of the full-length CFTR transgene for the treatment of cystic fibrosis, a serious rare lung disease caused by missing or mutated CFTR protein.

We expect to initiate clinical testing in 1H21.

• KB104 is a topical gel formulation of our novel vector designed to deliver two copies of the SPINK5 transgene for the treatment of Netherton Syndrome, a debilitating autosomal recessive skin disorder caused by missing or mutated SPINK5 protein.

We expect to file an IND in 2H21.

We have several other product candidates in various stages of preclinical development.

We commenced operations in April 2016.

In March 2017, we converted from a California limited liability company to a Delaware C-corporation, and changed our name from Krystal Biotech, LLC to Krystal Biotech, Inc.

On June 19, 2018, we incorporated Krystal Australia Pty Ltd, an Australian proprietary limited company, for the purposes of undertaking preclinical and clinical studies in Australia.

On April 24, 2019, the Company incorporated Jeune, Inc.

in Delaware, a wholly-owned subsidiary, for the purposes of undertaking preclinical studies for aesthetic skin conditions.

On September 22, 2017, the Company completed its initial public offering, or IPO, of 4,554,000 shares of its common stock at a price to the public of $10.00 per share.

Proceeds to the Company were $40.7 million, net of underwriting discounts, commissions and offering expenses.

On November 1, 2017, the Company entered into a stock purchase agreement with Epidermolysis Bullosa Medical Research Foundation, a California not-for-profit corporation (“EBMRF”), and EB Research Partnership, Inc., a New York not-for-profit corporation (“EBRP” and together with EBMRF, the “Purchasers”), pursuant to which the Company agreed to issue and sell, and the Purchasers agreed to purchase, an aggregate of 70,000 shares of the Company’s common stock, par value $0.00001 per share, for a purchase price of $11.00 per share, resulting in aggregate gross proceeds to the Company of $770 thousand.

On January 16, 2018, the United States Patent and Trademark Office or USPTO granted US patent No.

9,877,990 to the Company which covers compositions comprising herpes simplex viral or HSV vectors and methods of using the same for providing prophylactic, palliative or therapeutic relief of a wound, disorder or disease of the skin in a subject.

On August 16, 2018, the Company entered into a stock purchase agreement with Frazier Life Sciences for the private placement of 625,000 shares of the Company’s common stock at $16.00 per share.

The private placement yielded gross proceeds of $10 million and closed on August 17, 2018.

On October 23, 2018, the Company completed a public offering of 3,450,000 shares of its common stock at a price to the public of $20.00 per share, which includes the sale of 450,000 shares of the Company’s common stock pursuant to the underwriters’ full exercise of their option to purchase additional shares.

Net proceeds were approximately $64.3 million from the public offering after underwriter discounts, commissions and other offering expenses payable by the Company.

In January 2019, we completed the construction of our own commercial scale current good manufacturing practice or cGMP-compliant manufacturing facility, ANCORIS, to enhance supply chain control, increase supply capacity for clinical trials and ensure commercial demand is met in the event that B-VEC receives marketing approval.

We intend to use our cGMP manufacturing process for all clinical and commercial production of B-VEC.

On June 27, 2019, the Company completed a public offering of 2,500,000 shares of its common stock to the public at $40.00 per share.

We are also leveraging the ability of our platform to deliver proteins of interest to cells in the skin in the context of aesthetic medicine via our wholly-owned subsidiary Jeune, Inc.

A Summary description of Jeune’s key product candidate and its status is as follows:

• KB301 is a solution for intradermal injection designed to deliver two copies of the COL3A1 transgene to address signs of aging or damaged skin caused by declining levels of, or damaged proteins within the extracellular matrix, including type III collagen.

A Phase 1 safety study is currently ongoing.

Details of the Phase 1 study can be found at www.clinicaltrials.gov under NCT identifier NCT04540900.

Nothing included on these websites shall be deemed incorporated by reference into this Annual Report on Form 10-K

Jeune has several other aesthetic medicine product candidates in various stages of preclinical development.

Business Highlights:

• On May 21, 2020, the Company completed a public offering of 2,275,000 shares of its common stock to the public at $55.00 per share.

Net proceeds to the Company from the offering were $117.2 million after deducting underwriting discounts and commissions of approximately $7.5 million, and other offering expenses payable by the Company of approximately $463 thousand.

On July 3, 2019, the underwriters exercised their option to purchase an additional 353,946 shares of common stock at $40.00 per share for additional net proceeds of $13.3 million after deducting underwriting discounts and commissions of approximately $849 thousand.

On September 27, 2019, the Company announced the granting of a new patent for its lead product candidate, B-VEC, after receiving a Notice of Acceptance from IP Australia for patent application number 2016401692.

This represents the company’s first foreign patent and a Notice of Acceptance appeared in the Australian Official Journal of Patents on October 3, 2019.

This patent covers pharmaceutical compositions comprising B-VEC, as well as to medical uses thereof, e.g.

, in the treatment of wounds, disorders, or diseases of the skin, particularly those found in epidermolysis bullosa patients.

In addition, the United States Patent and Trademark Office (USPTO) announced a new US patent for B-VEC that covers the STAR-D, for skin-targeted therapeutics, as well as methods of its use for delivering any effector of interest to the skin.

On January 21, 2020, the Company announ ced the appointment of Jennifer Chien to the newly created position of chief commercial officer, effective January 20, 2020.

Chien has more than 20 years of commercial leadership experience in the biopharmaceutical industry, most recently having served as vice president, head of genetic diseases at Sanofi Genzyme.

On January 24, 2020, we announced the ground breaking of the second commercial gene therapy facility in Findlay Township, Pennsylvania.

The Findlay-based GMP facility, named ASTRA, will have the capacity to produce commercial gene therapy medicines to treat patients suffering from debilitating rare diseases.

The ASTRA facility will initially be used as a commercial back up facility for B-VEC, which is being developed for the treatment of dystrophic epidermolysis bullosa, a rare and devastating skin disorder, and expand to produce investigational and commercial material for our pipeline products.

The 100,000 square foot facility will be built-out and validated with an expected completion date by early 2021.

At December 31, 2019, our cash, cash equivalents and short-term investments balance was approximately $193.7 million.

Since operations began, we have incurred operating losses.

Our net losses were $19.1 million and $10.9 million for the years ended December 31, 2019 and 2018, respectively.

At December 31, 2019, we had an accumulated deficit of $39.0 million.

We expect to incur significant expenses and increasing operating losses for the foreseeable future.

Our net losses may fluctuate significantly from quarter to quarter and year to year.

We will need to generate significant revenue to achieve profitability, and we may never generate revenue or enough revenue to achieve profitability.

Costs related to clinical trials can be unpredictable and therefore there can be no guarantee that we will have sufficient capital to fund our continued clinical studies of B-VEC, KB105 and planned preclinical studies for our other product candidates, or our operations.

Our funds may not be sufficient to enable us to conduct pivotal clinical trials for, seek marketing approval for or commercially launch B-VEC, KB105 or any other product candidate.

Accordingly, to obtain marketing approval for and to commercialize this or any other product candidates, we may be required to obtain further funding through public or private equity offerings, debt financings, collaboration and licensing arrangements or other sources.

Adequate additional financing may not be available to us on acceptable terms, if at all.

Our failure to raise capital when needed could have a negative effect on our financial condition and our ability to pursue our business strategy.

Substantially all our net losses resulted from costs incurred in connection with our research and development programs and from general and administrative costs associated with our operations.

We expect to continue to incur significant expenses and increasing operating losses for at least the next several years.

We expect our expenses will increase substantially in connection with our ongoing and planned activities, as we:

conduct clinical studies for our B-VEC and KB105 product candidates;

increase research and development-related activities for the discovery and development of our pipeline product candidates;

continue our research and development efforts internally;

manufacture clinical study materials and establish the infrastructure necessary to support and develop large-scale manufacturing capabilities;

seek regulatory approval for our product candidates;

add personnel to support our product development and commercialization efforts;

increase activities leading up to the potential commercial launch of our B-VEC, KB105 and other product candidates.

We do not expect to generate any product revenues until 2022, at the earliest, assuming we receive marketing approval for B-VEC on the schedule we currently contemplate.

While we are in the process of building out our internal vector manufacturing capacity, currently all of our manufacturing activities are contracted out to third parties.

Additionally, we currently utilize third-party contract research organizations, or CROs, to carry out our clinical development activities.

As we seek to obtain regulatory approval for any of our product candidates, we expect to incur significant commercialization expenses as we prepare for product sales, marketing, manufacturing, and distribution.

Accordingly, we will seek to fund our operations through public or private equity or debt financings, strategic collaborations, or other sources.

However, we may be unable to raise additional funds or enter into such other arrangements when needed on favorable terms or at all.

Our failure to raise capital or enter into such other arrangements as and when needed would have a negative impact on our financial condition and our ability to develop our products.

Because of the numerous risks and uncertainties associated with product development, we are unable to predict the timing or amount of increased expenses or when or if we will be able to achieve or maintain profitability.

Even if we are able to generate rev enues from the sale of our products, we may not become profitable.

If we fail to become profitable or are unable to sustain profitability on a continuing basis, then we may be unable to continue our operations at planned levels and be forced to reduce our operations.

• On December 31, 2020, the Company entered into a sales agreement (the "Sales Agreement") with Cowen and Company, LLC ("Cowen") with respect to an at-the-market equity offering program ("ATM Program"), under which Cowen will act as the Company's agent and/or principal and may issue and sell from time to time, during the term of the Sales Agreement, shares of its common stock, par value $0.0001 per share, having an aggregate offering price up to $150.0 million ("Placement Shares").

In 2021, 262,500 shares of common stock have been issued pursuant to the ATM Program for net proceeds of $16.9 million, resulting in a remaining $132.5 million available for issuance under the ATM Program.

• On January 29, 2021, the Company entered into a Purchase and Sale Agreement ("PSA") for ASTRA with Northfield related to the purchase option exercised by the Company on October 15, 2020 for a purchase price of $9.4 million.

The transaction is expected to close in early March 2021 subject to customary closing conditions.

• On February 1, 2021, the Company completed a public offering of 2,211,538 shares of its common stock, including 288,461 shares purchased by the underwriters, at $65.00 per share.

Net proceeds to the Company from the offering were $135.0 million after deducting underwriting discounts and commissions of approximately $8.6 million, and other estimated offering expenses payable by the Company of approximately $193 thousand.

In December 2019, COVID-19 was first reported in Wuhan, China and in March 2020, a global pandemic was declared by the World Health Organization.

In an effort to slow the spread of the virus, certain governments, including the Commonwealth of Pennsylvania where the Company’s primary offices, laboratory and manufacturing spaces are located, enacted stay-at-home orders, and sweeping restrictions to travel were initiated by corporations and governments.

Although these restrictions have been lifted in some areas, it is not known at this time whether they will be reestablished or the extent to which the Company will be impacted.

The degree of COVID-19’s effect on the Company’s clinical, operational and financial performance will depend on future developments, including additional protective measures that may be implemented by governmental authorities or the Company to protect its employees, or by investigators, caregivers or patients to minimize exposure, all of which are uncertain and difficult to predict.

While to date the impact of COVID-19 on our business and clinical trials has been minimal, we will continue to assess the potential impact of the COVID-19 pandemic on our business and operations, including our supply chain and preclinical and clinical trial activities.

For additional information regarding the impact of the coronavirus pandemic, please see "Risk Factor - Business interruptions resulting from the COVID-19 outbreak or similar public health crises could cause a disruption of the development efforts.of our product candidates and adversely impact our business."

Financial Overview

We currently have no approved products for commercial marketing or sale and have not generated any revenue from the sale of products or other sources to date.

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Research and Development Expenses

Research and development expenses consist primarily of costs incurred to advance our preclinical candidates, which include:

Research and development expenses consist primarily of costs incurred to advance our preclinical and clinical candidates, which include:

• expenses incurred under agreements with contract manufacturing organizations, consultants and other vendors that conduct our preclinical activities;

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• facility costs, depreciation and other expenses, which include direct expenses for rent and maintenance of facilities and other supplies;

• payroll related expenses, including stock-based compensation expense.

We expense internal research and development costs to operations as incurred.

We expense third party costs for research and development activities, such as the manufacturing of preclinical and clinical materials, based on an evaluation of the progress to completion of specific tasks such as manufacturing of drug substance, fill/finish and stability testing, which is provided to us by our vendors.

We expect our research and development expenses will increase as we continue the manufacture of preclinical and clinical materials and manage the clinical trials of, and seek regulatory approval for, our product candidates and expand our product portfolio.

In the near term, we expect that our research and development expenses will increase as we begin our planned pivotal Phase 3 clinical trial for B-VEC, conduct our ongoing Phase 1/2 clinical trial for KB105, and incur pre-clinical expenses for our other product candidates.

We expect our research and development expenses will increase as we continue the manufacturing of preclinical and clinical materials and manage the clinical trials of, and seek regulatory approval for, our product candidates and expand our product portfolio.

In the near term, we expect that our research and development expenses will increase as we continue our ongoing GEM-3 pivotal study for B-VEC, our Phase 1/2 clinical trial for KB105, our Phase 1 safety study for KB301, and incur preclinical expenses for our other product candidates.

Due to the numerous risks and uncertainties associated with product development, we cannot determine with certainty the duration, costs and timing of this clinical trial, and, as a result, the actual costs to complete this planned clinical trial may exceed the expected costs.

General and Administrative Expenses

General and administrative expenses consist principally of professional fees associated with corporate and intellectual property legal expenses, consulting and accounting services and facility-related costs.

Other general and administrative costs include stock-based compensation and travel expenses.

General and administrative expenses consist primarily of salaries and other related costs, including stock-based compensation, for personnel in our executive, commercial, business development and other administrative functions.

General and administrative expenses also include legal fees relating to intellectual property and corporate matters, professional fees for accounting, auditing, tax and consulting services, insurance costs, travel, facility related expenses and other operating costs.

We anticipate that our general and administrative expenses will increase in the future to support the continued research and development of our product candidates and to operate as a public company.

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Additionally, if and when we believe a regulatory approval of our first product candidate appears likely, we anticipate that we will increase our salary and personnel costs and other expenses as a result of our preparation for commercial operations

Interest and Other Income (Expense), Net

Interest and other income (expense), net for year ended December 31, 2019 consisted primarily of interest earned on our cash, cash equivalents and short-term investments.

Interest Income

Interest income consists primarily of income earned from our cash, cash equivalents and investments.

Critical Accounting Policies and Significant Judgments and Estimates

Our management’s discussion and analysis of our financial position and results of operations is based on our financial statements, which have been prepared in accordance with US generally accepted accounting principles, or GAAP.

Our management’s discussion and analysis of our financial position and results of operations is based on our financial statements, which have been prepared in accordance with U.S.

generally accepted accounting principles, or GAAP.

The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes.

On an ongoing basis, we evaluate estimates which include, but are not limited to, estimates related to clinical trial and contract manufacturing prepayments and accruals, stock-based compensation expense, and reported amounts of related expenses during the period.

On an ongoing basis, we evaluate estimates which include, but are not limited to, estimates related to clinical trial and contract manufacturing prepayments and accruals, stock-based compensation expense, construction-in-progress, and reported amounts of related expenses during the period.

We base our estimates on historical experience and other market-specific or other relevant assumptions that we believe to be reasonable under the circumstances.

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The majority of our service providers invoice us monthly in arrears for services performed or when contractual milestones are met.

We make estimates of our accrued research and development expenses, current assets and other current liabilities as of each balance sheet date in our financial statements based on facts and circumstances known to us at that time.

Examples of estimated accrued research and development expenses, prepaid assets and other current liabilities include fees paid to contract manufacturers made in connection with the manufacturing of pre-clinical and clinical trials materials.

We base our expenses related to clinical manufacturing on our estimates of the services performed pursuant to contracts with the entities producing clinical materials on our behalf.

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Stock-Based Compensation

We have applied the fair value recognition provisions of Financial Accounting Standards Board Accounting Standards Codification, or ASC, Topic 718, Compensation—Stock Compensation , or ASC 718, to account for stock-based compensation for employees and ASC 718 and ASC 505, Equity , or ASC 505, for non-employees for 2018.

We have applied the fair value recognition provisions of Financial Accounting Standards Board Accounting Standards Codification, or ASC, Topic 718, Compensation—Stock Compensation (" ASC 718"), to account for stock-based compensation for employees and ASC 718 and ASC 505, Equity (" ASC 505"), for non-employees for 2018.

We recognize compensation costs related to stock options granted to employees based on the estimated fair value of the awards on the date of grant.

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We utilize a dividend yield of zero based on the fact that we have never paid cash dividends and have no current intention of paying cash dividends.

The risk-free interest rate used for each grant is based on the US Treasury yield curve in effect at the time of grant for instruments with a similar expected life.

Under ASC 718, we elected to estimate the level of forfeitures expected to occu r and record stock-based compensation expense only for those awards that we ultimately expect will vest .

The risk-free interest rate used for each grant is based on the U.S.

Treasury yield curve in effect at the time of grant for instruments with a similar expected life.

Under ASC 718, we elected to estimate the level of forfeitures expected to occur and record stock-based compensation expense only for those awards that we ultimately expect will vest.

During the years ended December 31, 2020 and 2019, our estimated annual forfeiture rate was 14.74 % and 10.00 %, respectively.

We adopted FASB ASC Topic 842, Lease ("ASC 842") on January 1, 2019, with no restatement of prior periods or cumulative adjustment to retained earnings.

Upon adoption, the Company took advantage of the transition package of practical expedients permitted within ASC 842, which allowed the Company not to reassess previous accounting conclusions around whether arrangements were, or contained leases, as well as to carry forward both the historical classification of leases and the treatment of initial direct costs for existing leases.

As the Company's lease agreements do not provide an implicit rate and as the Company does not have external borrowings, we use an estimated incremental borrowing rate based on the information available at lease commencement in determining the present value of lease payments.

The incremental borrowing rate is the rate of interest that the Company would expect to borrow on a collateralized and fully amortizing basis over a similar term an amount equal to the lease payments in a similar economic environment.

For lease arrangements where it has been determined that the Company has control over an asset that is under construction and is thus considered the accounting owner of the asset during the construction period, the Company records a construction-in-progress asset ("CIP") and corresponding financial obligation on the consolidated balance sheet.

Once the construction is complete, an assessment will be performed to determine whether the lease meets certain "sale-leaseback" criteria.

If the sale-leaseback criteria are determined to be met, the Company will remove the asset and related financial

obligation from the balance sheet and treat the building lease as either an operating or finance lease based on our assessment of the guidance.

If, upon completion of construction, the project does not meet the "sale-leaseback" criteria, the lease will be treated as a financing obligation and the Company will depreciate the asset over its estimated useful life for financial reporting purposes.

JOBS Act Accounting Election

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Years Ended December 31, 2020, 2019 and 2018

Years Ended December 31,

(in thousands)

Years Ended December 31, Change

(in thousands) 2020 2019 2018 2020 vs.

2019 2019 vs.

Research and development $ 17,936 $ 15,616 $ 7,761 $ 2,320 $ 7,855

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Total interest and other income, net 832 2,993 1,027 (2,161) 1,966

Net loss $ (32,167) $ (19,088) $ (10,889) $ (13,079) $ (8,199)

Research and Development Expenses

Research and development expenses increased $2.3 million for the year ended December 31, 2020 compared to the year ended December 31, 2019.

Higher research and development expenses were due to increases in professional services related to outsourced manufacturing, in-vivo and clinical studies of $2.3 million, payroll, employee benefits and stock-based compensation of $1.9 million due to an increase in headcount as we scaled up our research and development efforts for our 2 leading product candidates, B-VEC and KB105, lab supplies of $2.2 million, and other research and development expenses of $1.5 million.

Higher research and development expenses were due to increases in lab supplies of $142 thousand, payroll related expenses of approximately $2.0 million which is primarily driven by an increase in headcount to support overall growth and includes a $417 thousand increase in stock-based compensation, and other research and development expenses of $757 thousand, with a decrease in outsourcing research and development activities of $560 thousand.

Research and development expenses increased $7.9 million for the year ended December 31, 2019 compared to the year ended December 31, 2018.

Higher research and development expenses were due largely to increases in professional services related to outsourced manufacturing, in-vivo and clinical studies of $1.9 million, payroll, employee benefits and stock-based compensation of $1.5 million due to an increase in headcount as we scaled up our research and development efforts for our 2 leading product candidates, KB103 and KB105, lab supplies of $860 thousand, and other research and development expenses of $216 thousand.

General and Administrative Expenses

General and administrative expenses increased $8.6 million for the year ended December 31, 2020 compared to the year ended December 31, 2019.

Higher general and administrative spending was due largely to increases in legal and professional services of $184 thousand, payroll, employee benefits and stock-based compensation costs of $1.5 million, insurance expenses of $242 thousand, and other administrative costs of $434 thousand.

Higher general and administrative spending was due largely to increased payroll related expenses of approximately $4.0 million which is primarily driven by an increase in headcount to support overall growth and includes an approximate $1.6 million increase in stock-based compensation, market research related expenses of approximately $2.0 million, legal and professional fees of approximately $1.6 million, insurance expense of $693 thousand and other administrative expenses of $295 thousand.

General and administrative expenses increased $2.3 million for the year ended December 31, 2019 compared to the year ended December 31, 2018.

Higher general and administrative spending was due largely to increases in legal and professional services of $420 thousand, payroll, employee benefits and stock-based compensation costs of $1.6 million, insurance expenses of $270 thousand as a result of being a public company for the full year, tax and license expenses of $142 thousand as a result of increased authorized common shares for the full year, and other administrative costs of $196 thousand.

Interest and Other Income ( Expense ) , Net

Interest and other income for the year ended December 31, 2019 was $3.0 million and consisted of interest income earned from our cash, cash equivalents, short-term and long-term investments.

Interest and other income, net, for the year ended December 31, 2018 was $1.0 million and consisted of interest income earned from our cash, cash equivalents and short-term investments .

This increase was due to our increased cash position in 2019 as compared to 2018.

Interest and other income for the year ended December 31, 2018 was $1.0 million and consisted of interest income earned from our cash, cash equivalents and short-term investments.

Interest and other expense, net, for the year ended December 31, 2017 was $3.1 million and consisted primarily of interest expense incurred due to the beneficial conversion feature upon conversion of promissory notes to shares of preferred stock, and to a lesser degree due to interest expense on our convertible promissory notes before their conversion to shares of preferred stock, partially offset by interest earned on our cash and cash equivalents.

Interest and Other Income

Interest and other income for the year ended December 31, 2020 and 2019 was $832 thousand and $3.0 million, respectively, and consisted of interest and dividend income earned from our cash, cash equivalents and investments.

This decrease was driven by a decline in market interest rates.

Interest and other income for the year ended December 31, 2019 and 2018 was $3.0 million and $1.0 million, respectively, and consisted of interest and dividend income earned from our cash, cash equivalents and investments.

This increase was primarily driven by an increase in our cash position in 2019 as compared to 2018.

Liquidity and Capital Resources

At December 31, 2019 and 2018, we had accumulated deficits of $39.0 million and $20.0 million, respectively.

We believe that our cash, cash equivalents and short-term investments of approximately 193.7 million as of December 31, 2019 will be sufficient to allow the Company to fund its operations for at least 12 months from the filing date of this Form 10-K.

As the Company continues to incur losses, a transition to profitability is dependent upon the successful development, approval and commercialization of its product candidates and the achievement of a level of revenues adequate to support the Company’s cost structure.

At December 31, 2020, our cash, cash equivalents and short-term investments balance was approximately $271.3 million.

Since operations began, we have incurred operating losses.

Our net losses were $32.2 million and $19.1 million for the years ended December 31, 2020 and 2019, respectively.

At December 31, 2020, we had an accumulated deficit of $71.2 million.

With the net proceeds raised from our public and private securities offerings, including the public offering completed on May 21, 2020, the ATM Program and the public offering completed on February 1, 2021, the Company believes that its cash, cash equivalents and short-term investments will be sufficient to allow us to fund our operations for at least 12 months from the filing date of this Form 10-K.

As the Company continues to incur losses, a transition to profitability is dependent upon the successful development, approval and commercialization of our product candidates and the achievement of a level of revenues adequate to support the Company’s cost structure.

The Company may never achieve profitability, and unless and until it does, the Company will continue to need to raise additional capital.

Management intends to fund future operations through the sale of equity and debt financings and may also seek additional capital through arrangements with strategic partners.

There can be no assurances that additional funding will be available on terms acceptable to the Company, if at all.

We have funded our operations principally from the sale of common stock in public and private placement offerings as outlined below:

In June 2019, we received net proceeds of approximately $107.1 million from our public offering after deducting underwriting discounts and commissions and other offering expense payable by the Company.

In October 2018, we received net proceeds of approximately $64.3 million from our public offering after underwriter discounts, commissions and other offering expenses payable by the Company.

In August 2018, we closed the sale of common stock in a private placement to Frazier Life Sciences for gross proceeds of $10 million.

In November 2017, we closed the sale of common stock in a private placement for gross proceeds of $770 thousand.

On September 22, 2017, we received net proceeds of approximately $40.7 million from our initial public offering

In August 2017, we closed the sale of preferred stock to a single investor for aggregate proceeds of $7.0 million, and the sale of 130,590 shares of our common stock with a party related to a member of our board of directors for aggregate proceeds of $1.0 million.

Prior to August 2017, we had received $1.4 million in gross proceeds from the issuance of equity securities and $4.1 million in gross proceeds from debt financings.

Costs related to clinical trials can be unpredictable and therefore there can be no guarantee that we will have sufficient capital to fund our continued clinical studies of B-VEC, KB105, KB301 or our planned preclinical studies for our other product candidates, or our operations.

Further, we do not expect to generate any product revenues until 2022, at the earliest, assuming we receive marketing approval for B-VEC on the schedule we currently contemplate.

While we are in the process of building out our internal vector manufacturing capacity, some of our manufacturing activities will be contracted out to third parties.

Additionally, we currently utilize third-party contract research organizations to carry out our clinical development activities.

Our funds may not be sufficient to enable us to conduct pivotal clinical trials for, seek marketing approval for or commercially launch B-VEC, KB105, KB301 or any other product candidate.

Adequate additional financing may not be available to us on acceptable terms, if at all.

Our failure to raise capital when needed could have a negative effect on our financial condition and our ability to pursue our business strategy.

Operating Capital Requirements

Our primary uses of capital are, and we expect will continue to be for the near future, compensation and related expenses, manufacturing costs for preclinical and clinical materials, third party clinical trial research and development services, laboratory and related supplies, clinical costs, legal and other regulatory expenses and general overhead costs.

We expect that our existing cash, cash equivalents and short-term investments as of December 31, 2019 will be sufficient to fund our planned operations and to enable us to complete our planned pivotal Phase 3 clinical trial for B-VEC and our ongoing Phase 1/2 clinical trial for KB105.

In order to complete the process of obtaining regulatory approval for any of our product candidates and to build the sales, manufacturing, marketing and distribution infrastructure that we believe will be necessary to commercialize our product candidates, if approved, we will require substantial additional funding.

We have based our projections of operating capital requirements on assumptions that may prove to be inc orrect and we may use all of our available capital resources sooner than we expect.

We have based our projections of operating capital requirements on assumptions that may prove to be incorrect and we may use all of 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 progress, timing, results and costs of our ongoing Phase 1/2 clinical trial for KB105;

the progress, timing and costs of manufacturing of B-VEC for our planned pivotal Phase 3 clinical trials;

the continued development and the filing on an Investigational New Drug, or IND, application for future product candidates;

• the timeline and costs of our pivotal Phase 3 clinical trial for B-VEC;

• the progress, timing and costs of our ongoing Phase 1/2 clinical trials for KB105;

• the progress, results and costs of our Phase 1 clinical trials for KB301;

• the progress, timing, and costs of manufacturing of B-VEC for our pivotal Phase 3 clinical trials;

• the continued development and the filing on an IND application for future product candidates;

• the initiation, scope, progress, timing, costs and results of drug discovery, laboratory testing, manufacturing, preclinical studies and clinical trials for any other product candidates that we may pursue in the future, if any;

the costs of maintaining our own commercial-scale cGMP manufacturing facility;

• the costs of maintaining our own commercial-scale cGMP manufacturing facilities;

• the outcome, timing and costs of seeking regulatory approvals;

• the costs associated with the manufacturing process development and evaluation of third-party manufacturers;

the costs of future activities, including product sales, medical affairs, marketing, manufacturing and distribution, in the event we receive marketing approval for B-VEC, KB105 or any other product candidates we may develop;

• the costs of future activities, including product sales, medical affairs, marketing, manufacturing and distribution, in the event we receive marketing approval for our current and future product candidates;

• the extent to which the costs of our product candidates, if approved, will be paid by health maintenance, managed care, pharmacy benefit and similar healthcare management organizations, or will be reimbursed by government authorities, private health coverage insurers and other third-party payors;

the costs of commercialization activities for B-VEC, KB105 and other product candidates if we receive marketing approval for B-VEC, KB105 or any other product candidates we may develop, including the costs and timing of establishing product sales, medical affairs, marketing, distribution and manufacturing capabilities;

subject to receipt of marketing approval, if any, revenue received from commercial sale of B-VEC, KB105 or our other product candidates;

• the costs of commercialization activities for our current and future product candidates if we receive marketing approval for such product candidates we may develop, including the costs and timing of establishing product sales, medical affairs, marketing, distribution and manufacturing capabilities;

• subject to receipt of marketing approval, if any, revenue received from commercial sale of our current and future product candidates;

• the terms and timing of any future collaborations, licensing, consulting or other arrangements that we may establish;

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• the extent to which we acquire or in-license other product candidates and technologies.

We expect that we will need to obtain substantial additional funding in order to receive regulatory approval and to commercialize B-VEC or any other product candidates, including KB105.

We expect that we will need to obtain substantial additional funding in order to receive regulatory approval and to commercialize our product candidates.

To the extent that we raise additional capital through the sale of common stock, convertible securities or other equity securities, the ownership interests of our existing stockholders may be materially diluted and the terms of these securities could include liquidation or other preferences that could adversely affect the rights of our existing stockholders.

In addition, debt financing, if available, would result in increased fixed payment obligations and may involve agreements that include restrictive covenants that limit our ability to take specific actions, such as incurring additional debt, making capital expenditures or declaring dividends, that could adversely affect our ability to conduct our business.

If we are unable to raise capital when needed or on attractive terms, we could be forced to significantly delay, scale back or discontinue the development or commercialization of B-VEC, KB105 or our other product candidates, seek collaborators at an earlier stage than otherwise would be desirable or on terms that are less favorable than might otherwise be available, and relinquish or license, potentially on unfavorable terms, our rights to B-VEC or KB105 or our other product candidates that we otherwise would seek to develop or commercialize ourselves.

If we are unable to raise capital when needed or on attractive terms, we could be forced to significantly delay, scale back or discontinue the development or commercialization of our product candidates, seek collaborators at an earlier stage than otherwise would be desirable or on terms that are less favorable than might otherwise be available, and relinquish or license, potentially on unfavorable terms, our rights to our product candidates that we otherwise would seek to develop or commercialize ourselves.

The following table summarizes our sources and uses of cash (in thousands):

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Operating Activities

Net cash used in operating activities for the year December 31, 2019 was $18.7 million and consisted primarily of a net loss of $19.1 million adjusted for non-cash items of depreciation of $748 thousand, stock-based compensation expense of $1.2 million, loss on disposals of fixed assets of $67 thousand, amortization of right-of-use asset of $226 thousand, and cash used by net decreases in operating assets and liabilities of $1.9 million.

Net cash used in operating activities for the year ended December 31 , 2018 was $9.4 million and consisted primarily of a net loss of $10.9 million adjusted for non-cash items of depreciation and stock-based compensation expense of $933 thousand and a net decrease in operating assets and liabilities of approximately $511 thousand.

Net cash used in operating activities for the year December 31, 2020 was $26.1 million and consisted primarily of a net loss of $32.2 million adjusted for non-cash items of $5.2 million primarily made up of depreciation and amortization of $1.9 million and stock-based compensation expense of $3.3 million, and cash used by decreases in net operating liabilities of approximately $928 thousand.

Net cash used in operating activities for the year ended December 31, 2019 was $18.7 million and consisted primarily of a net loss of $19.1 million adjusted for non-cash items of depreciation of $748 thousand, stock-based compensation expense of $1.2 million, loss on disposals of fixed assets of $67 thousand, amortization of right-of-use assets of $226 thousand, and cash used by decreases in net operating assets and liabilities of $1.9 million.

Investing Activities

Net cash used in investing activities for the year ended December 31, 2020 was approximately $11.2 million and consisted primarily of purchases of $3.2 million of short-term available-for-sale investment securities, and expenditures of $14.8 million on the build-out of our ASTRA facility, leasehold improvement of new office space, and purchases of computer and laboratory equipment, partially offset by proceeds of $6.9 million from maturities of short-term investments.

Net cash used in investing activities for the year ended December 31, 2019 was $5.0 million and consisted primarily of purchases of $8.6 million of short-term available-for-sale investment securities, proceeds of $10.5 million from maturities of short-term investments, purchases of $497 thousand of long-term investments, expenditures of $6.4 million for the build-out of our GMP facility and purchases of computer and laboratory equipment.

Net cash used in investing activities for the year ended December 31, 2018 was $10.3 million and consisted primarily of purchases of $8.1 million of short-term available-for-sale investment securities, expenditures of $2.2 million for the build-out of our new GMP facility and purchases of computer and laboratory equipment .

Financing Activities

Net cash provided by financing activities for the year ended December 31, 2020 was $118.0 million and was primarily from proceeds from our public offering on May 21, 2020 of 2,275,000 shares of our common stock to the public at $55.00 per share.

Net proceeds to the Company from the offering were $117.2 million after deducting underwriting discounts and commissions of approximately $7.5 million and other offering expenses of approximately $463 thousand.

Net cash provided by financing activities for the year ended December 31, 2019 was $107.5 million and was primarily from net proceeds of $107.1 million after underwriter discounts and other offering expenses payable by the Company from a follow-on public offering of 2,853,946 shares of common stock at a price of $40.00 per share, which includes the sale of 353,946 shares of the Company’s common stock pursuant to the underwriters’ exercise of their option to purchase additional shares.

Net cash provided by financing activities for the year ended December 31 , 2018 was $73.8 million and was primarily form net proceeds of $64.3 million after underwriter discounts, commissions and other offering expenses payable by the Company from a follow-on public offering of 3,450,000 shares of common stock at a price of $20.00 per share, which includes the sale of 450,000 shares of the Company’s common stock pursuant to the underwriters’ full exercise of their option to purchase additional shares, and an August 2018 private placement of 625,000 shares of the Company’s common stock at $16.00 per share resulting in gross proceeds of $10.0 million, partially offset by transactions costs of $450 thousand.

Off-Balance Sheet Arrangements

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The following table summarizes our outstanding contractual obligations as of payment due date by period at December 31, 2020 (in thousands):

Total Less than

4-5 More Than

Future minimum operating lease payments (1)(2)(3)

Obligation to contract manufacturing organization

$ 23,525 $ 1,430 $ 2,956 $ 3,075 $ 16,064

Clinical supply and product manufacturing agreement obligations $ 3,631 $ 3,631 $ — $ — $ —

Other contractual obligations $ 2,736 $ 2,736 $ — $ — $ —

(1) We lease approximately 29,000 square feet of office and laboratory space at 2100 Wharton St., Suite 701, Pittsburgh, Pennsylvania.

The lease expires February 2027.

On December 26, 2019, we entered into a lease agreement for our second commercial gene therapy facility in the Pittsburgh, Pennsylvania area.

The 100,000 square foot facility is under construction and is expected to be completed by early 2021.

The lease will commence when the space is available for access, which is anticipated to be in the second half of 2020, and has an initial term that lasts until October 31, 2035.

A cash contribution in the amount of $2.4 million was paid to escrow on January 21, 2020.

The contribution was intended to reduce the amount of the building construction costs and had the effect of reducing the base rental rate of the lease.

(2) On December 26, 2019, we entered into a lease agreement for our second commercial gene therapy facility in the Pittsburgh, Pennsylvania area ("ASTRA lease").

The 150,000 square foot facility is under construction and is expected to be completed and validated in 2022.

The lease will commence when the space is delivered by Landlord as substantially complete and available for access, which is anticipated to be in 1H 2021, and has an initial term that expires on October 31, 2035.

The ASTRA lease contains an option ("Purchase Option") to purchase the building, related improvements and take corresponding assignment of the Landlord's rights under its existing Ground Lease (the "Ground Lease").

On October 15, 2020, the Company gave the Landlord notice

of its intent to purchase ASTRA subject to the parties entering into a commercially reasonable purchase and sale agreement.

(3) On October 5, 2020, the Company became the accounting owner of the Ground Lease due to obtaining control over ASTRA and recorded the applicable right-of-use asset and corresponding lease liability as of October 5, 2020.

The lease expires in April 2071.

Recent Accounting Pronouncements

In August 2018, the SEC issued a final rule to simplify certain disclosure requirements.

In addition, the amendments expanded the disclosure requirements on the analysis of stockholders’ equity for interim financial statements.

In August and September 2018, further amendments were issued to provide implementation guidance on adoption of the SEC rule and transition guidance for the new interim stockholders’ equity disclosure.

The amended guidance is effective for us commencing in the first quarter of 2019.

The adoption of this amended guidance resulted in us disclosing the Condensed Consolidated Statements of Stockholders’ Equity in the quarterly financial statements for the year ended December 31, 2019 and 2018.

In August 2018, the FASB issued ASU 2018-13 - Fair Value Measurement (Topic 820) (“ASU 2018-13”) which removes, modifies and adds disclosure requirements on fair value measurements.

ASU 2018-13 removes disclosure requirements for transfers between Level 1 and Level 2 measurements and valuation processes for Level 3 measurements but adds new disclosure requirements including changes in unrealized gains/losses in other comprehensive income related to recurring Level 3 measurements.

The amended guidance is effective for us beginning in the first quarter of 2020.

The amended guidance was effective for us commencing in the first quarter of 2020.

Certain aspects may be applied prospectively while other aspects may be applied retrospectively upon the effective date.

The Company does not anticipate a material impact to the consolidated financial statements as a result of the adoption of this guidance.

In June 2018, the FASB issued ASU 2018-07 - Compensation – Stock Compensation (Topic 718):

Improvements to Nonemployee Share-Based Payment Accounting which simplifies the accounting for share-based payments to nonemployees by aligning it with the accounting for share-based payments to employees, with certain exceptions.

The new guidance expands the scope of ASC 718 to include share-based payments granted to nonemployees in exchange for goods or services used or consumed in an entity’s own operations.

The amended guidance is effective for us beginning in the first quarter of 2019.

Early adoption is permitted.

The adoption of this amended guidance did not have a material effect on our consolidated financial statements .

In February 2016, the FASB issued ASC 842 - Leases (“ASC 842”), which replaces the existing lease accounting standards.

The new standard requires a dual approach for lessee accounting under which a lessee would account for leases as finance (also referred to as capital) leases or operating leases.

Both finance leases and operating leases with terms longer than 12 months will result in the lessee recognizing a right-of-use asset and a corresponding lease liability.

For finance leases the lessee would recognize interest expense and amortization of the right-of-use asset and for operating leases the lessee would recognize straight-line total lease expense.

In July 2018, further amendments were issued to clarify how to apply certain aspects of the amended lease guidance and to address certain implementation issues.

ASC 842 was effective for the Company beginning in the first quarter of 2019.

The Company generally does not finance purchases of equipment but does lease office and lab facilities.

The adoption of this amended guidance resulted in $1.1 million of right-of-use asset and $1.4 million of lease liability being recognized on the consolidated balance sheet as of January 1, 2019.

Qualitative and Quantitative D isclosures About Market Risk

We had cash, cash equivalents and short-term investments of approximately $193.7 million and long-term investment of $497 thousand at December 31, 2019, which consist primarily of money market funds, bank deposits, US Treasury bills and certificates of deposit.

The adoption of the guidance resulted in us disclosing the Company’s cash, cash equivalents and available-for-sale securities by significant investment category as of December 31, 2020 and 2019.

Qualitative and Quantitative Disclosures About Market Risk

We had cash, cash equivalents and short-term investments of approximately $271.3 million, which consist primarily of money market funds, bank deposits and certificates of deposit.

The investments in these financial instruments are made in accordance with an investment policy which specifies the categories, allocations and ratings of securities we may consider for investment.

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Our cash, cash equivalents and short-term investments are recorded at fair value.

Financial Statement s and Supplementary Data.

INDEX TO FINANCIAL STATEMENTS

Report of Independent Registered Public Accounting Firm

Consolidated Balance Sheets as of December 31, 2019 and December 31, 2018

Consolidated Statements of Operations and Comprehensive Loss for the Years Ended December 31, 2019 and December 31, 2018

Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2019 and December 31, 2018

Consolidated Statements of Cash Flows for the Years Ended December 31, 2019 and December 31, 2018

Notes to Consolidated Financial Statements

Report of Independent Regist ered Public Accounting Firm

To the Board of Directors and

Stockholders of Krystal Biotech, Inc.:

Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheets of Krystal Biotech, Inc.

(“Company”) as of December 31, 2019 and 2018, and the related consolidated statements of operations and comprehensive loss, stockholders’ equity and cash flows for each of the two years in the period ended December 31, 2019, and the related notes (collectively referred to as the “financial statements”).

In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2019, in conformity with accounting principles generally accepted in the United States of America.

Adoption of New Accounting Standard

As discussed in Note 2 to the financial statements, the Company changed its method of accounting for lease agreements as a result of the adoption of Accounting Standards Codification Topic 842, Leases, effective January 1, 2019, under the modified retrospective method.

Basis for Opinion

These financial statements are the responsibility of the Company’s management.

Our responsibility is to express an opinion on the Company’s financial statements based on our audits.

We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S.

federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB.

Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud.

The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting.

As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting.

Accordingly, we express no such opinion.

Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks.

Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements.

Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements.

We believe that our audits provide a reasonable basis for our opinion.

/s/ Mayer Hoffman McCann P.C.

We have served as the Company's auditor since 2017.

San Diego, California

March 10, 2020

Krystal Biotech, Inc.

Consolidated Balance Sheets

(In thousands, except shares and per share data)

Current assets

Cash and cash equivalents

Short-term investments

Prepaid and other current assets

Total current assets

Property and equipment, net

Long-term investments

Right-of-use asset

Other noncurrent assets

Liabilities and Stockholders' Equity

Current liabilities

Accounts payable

Accrued expenses and other current liabilities

Current portion of lease liabilities

Total current liabilities

Lease liabilities

Other noncurrent liabilities

Total liabilities

Commitments and contingencies (Note 6)

Stockholders' equity

Preferred stock;

$0.00001 par value;

20,000,000 shares authorized at

December 31, 2019 and 2018;

2,061,773 shares issued, and no

shares outstanding at December 31, 2019 and 2018

Common stock;

$0.00001 par value;

80,000,000 shares authorized at

December 31, 2019 and 2018;

17,354,310 and 14,428,916 shares

issued and outstanding at December 31, 2019 and 2018, respectively

Additional paid-in capital

Accumulated other comprehensive income

Accumulated deficit

Total stockholders' equity

Total liabilities and stockholders' equity

The accompanying notes are an integral part of these consolidated financial statements.

Krystal Biotech, Inc.

Consolidated Statements of Operations and Comprehensive Loss

(In thousands, except share and per share data)

Research and development

General and administrative

Total operating expenses

Loss from operations

Other Expense

Interest and other income, net

Unrealized gain on available-for-sale securities

Comprehensive loss

Net loss per common share:

Basic and diluted

Weighted-average common shares outstanding:

Basic and diluted

The accompanying notes are an integral part of these consolidated financial statements.

Krystal Biotech, Inc .

Consolidated Statements of Stockholders' Equity

(In thousands, except shares)

Comprehensive

Stockholders'

Balances at January 1, 2018

Issuance of common stock

Stock-based compensation expense

Unrealized gain on investments

Balances at December 31, 2018

Issuance of common stock

Stock-based compensation expense

Unrealized gain on investments

Balances at December 31, 2019

The accompanying notes are an integral part of these consolidated financial statements.

Krystal Biotech, Inc.

Consolidated Statements of Cash Flows

Year Ended December 31,

(In thousands)

Operating Activities

Adjustments to reconcile net loss to net cash and cash equivalents used in

operating activities

Stock-based compensation expense

Loss on disposals of fixed assets

Amortization of right-of-use asset, net

Increase (Decrease) in

Prepaids and other current assets

Accounts payable

Accrued expenses and other current liabilities

Other noncurrent liabilities

Net cash and cash equivalents used in operating activities

Investing Activities

Purchases of property and equipment

Purchases of short-term investments

Proceeds from maturities of short-term investments

Purchases of long-term investments

Net cash and cash equivalents used in investing activities

Financing Activities

Issuance of common stock, net

Net cash and cash equivalents provided by financing activities

Net increase in cash and cash equivalents

Cash and cash equivalents at beginning of year

Cash and cash equivalents at end of year

Supplemental Disclosures of Non-Cash Investing and Financing Activities

Unpaid purchases of property and equipment

The accompanying notes are an integral part of these consolidated financial statements.

Krystal Biotech, Inc.

Notes to Consolidated Financial Statements

Krystal Biotech, Inc.

and its consolidated subsidiaries (the “Company,” or “we” or other similar pronouns) commenced operations in April 2016.

In March 2017, the Company converted from a California limited liability company to a Delaware C-corporation, and changed its name from Krystal Biotech LLC to Krystal Biotech, Inc.

On June 19, 2018, the Company incorporated Krystal Australia Pty Ltd., an Australian proprietary limited company, for the purpose of undertaking preclinical and clinical studies in Australia.

On April 24, 2019, the Company incorporated Jeune, Inc.

in Delaware, a wholly-owned subsidiary, for the purpose of undertaking preclinical studies for aesthetic skin conditions.

We are a clinical-stage gene therapy company dedicated to developing and commercializing novel medicines for patients suffering from skin diseases.

We have developed a proprietary gene therapy platform to develop off-the-shelf treatments for skin diseases for which we believe there are no known effective treatments.

Our platform consists of a patented engineered viral vector based on the herpes simplex virus type 1 (“HSV-1”) containing skin-optimized gene transfer technology, which we refer to as the Skin TARgeted Delivery (“STAR-D”) platform.

We are initially using our STAR-D platform to develop treatments for rare or orphan monogenic dermatological indications caused by the absence of or a mutation in a single gene.

We plan to leverage our platform in the future to expand our pipeline to include non-monogenic dermatological indications and skin conditions.

Liquidity and Risks

As of December 31, 2019, the Company had an accumulated deficit of $39.0 million.

With the net proceeds raised upon the close of our initial public offering (“IPO”) in September 2017, and as described in Note 7 “Capitalization”, a private placement in August 2018, two follow-on public offerings in October 2018 and June 2019, the Company believes that its cash, cash equivalents and short-term investments of approximately $193.7 million as of December 31, 2019 will be sufficient to allow the Company to fund its operations for at least 12 months from the filing date of this Form 10-K.

The Company may never achieve profitability, and unless and until it does the Company will continue to need to raise additional capital or obtain financing from other sources.

Management intends to fund future operations through the sale of equity and debt financings and may also seek additional capital through arrangements with strategic partners or other sources.

There can be no assurance that additional funding will be available on terms acceptable to the Company, if at all.

The Company is subject to risks common to companies in the biotechnology industry, including but not limited to the development of technological innovations by its competitors, risks of failure in clinical studies, dependence on key personnel, protection of proprietary technology, compliance with government regulations and the ability to commercialize product candidates.

Summary of Significant Accounting Policies

Basis of Presentation

The accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America or (“GAAP”) as found in the Accounting Standards Codification (“ASC”), the Accounting Standards Update (“ASU”) of the Financial Accounting Standards Board (“FASB”) and the rules and regulations of the US Securities and Exchange Commission (the “SEC”).

All intercompany balances and transactions have been eliminated in consolidation.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts in the financial statements and accompanying notes.

Actual results could materially differ from those estimates.

Management considers many factors in selecting appropriate financial accounting policies and controls, and in developing the estimates and assumptions that are used in the preparation of these financial statements.

Management must apply significant judgment in this process.

In addition, other factors may affect estimates, including:

expected business and operational changes, sensitivity and volatility associated with the assumptions used in developing estimates, and whether historical trends are expected to be representative of future trends.

The estimation process

Krystal Biotech, Inc.

Notes to Consolidated Financial Statements — Continued

often may yield a range of potentially reasonable estimates of the ultimate future outcomes and management must select an amount that falls within that range of reasonable estimates.

This process may result in actual results differing materially from those estimated amounts used in the preparation of the financial statements.

Estimates are used in the following areas, among others:

stock-based compensation expense, accrued research and deve lopment expenses, the fair value of financial instruments, incremental borrowing rate for lease liability, and the valuation allowance included in deferred income taxes calculations.

Segment and Geographical Information

Operating segments are defined as components of an enterprise about which separate discrete information is available for evaluation by the chief operating decision maker, or decision-making group, in deciding how to allocate resources and in assessing performance.

The Company and the Company’s chief operating decision maker view the Company’s operations and manage its business in one operating segment, which is the business of developing and commercializing pharmaceuticals.

Concentrations of Credit Risk and Off-Balance Sheet Risk

Financial instruments that potentially subject the Company to credit risk consist of cash, cash equivalents and investments.

The Company’s policy is to invest its cash and cash equivalents in money market funds, certificate of deposits and various bank deposit accounts.

The counterparties to the agreements relating to the Company’s investments consist of financial institutions of high credit standing.

The Company is exposed to credit risk in the event of default by the financial institutions to the extent of amounts recorded on the balance sheets which may be in excess of insured limits.

The Company has not experienced any credit losses in such accounts and does not believe it is exposed to any significant credit risk on these funds.

The Company has no financial instruments with off-balance sheet risk of loss.

Cash, Cash Equivalents and Investments

Cash and cash equivalents consist of money market funds and bank deposits.

Cash equivalents are defined as short-term, highly liquid investments with original maturities of 90 days or less at the date of purchase.

Investments with maturities of greater than 90 days but less than one year are classified as short-term investments on the consolidated balance sheets and consist of US Treasury bills and certificates of deposit.

Investments with maturities of greater than one year are classified as long-term investments on the consolidated balance sheets and consist of certificates of deposit.

Accrued interest on US Treasury bills and certificates of deposit are also classified as short-term investments.

As our entire investment portfolio is considered available for use in current operations, we classify all investments as available-for-sale securities.

Available-for-sale securities are carried at fair value, with unrealized gains and losses reported in accumulated other comprehensive loss, which is a separate component of stockholders’ equity in the consolidated balance sheets.

Fair Value of Financial Instruments

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

There is a three-level hierarchy that prioritizes the inputs used in determining fair value by their reliability and preferred use, as follows:

Level 1 —Valuations based on unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.

Level 2 —Valuations based on quoted prices for similar assets or liabilities in markets that are not active or for which all significant inputs are observable, either directly or indirectly.

Level 3 —Valuations that require inputs that reflect the Company’s own assumptions that are both significant to the fair value measurement and are unobservable.

To the extent that a valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment.

Accordingly, the degree of judgment exercised by the Company in determining fair value is greatest for instruments categorized within Level 3.

A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.

Krystal Biotech, Inc.

Notes to Consolidated Financial Statements — Continued

There have been no significant changes to the valuation methods utilized by the Company during the periods presented.

There have been no transfers between Level 1, Level 2, and Level 3 in any periods presented.

The carrying amounts of financial instruments consisting of cash and cash equivalents, short-term investments, prepaid expenses, other current assets, accounts payable, accrued expenses and other current liabilities included in the Company’s financial statements, are reasonable estimates of fair value, primarily due to their short maturities.

Marketable securities are classified as long-term investments if the Company has the ability and intent to hold them and such holding period is longer than one year.

The Company classifies all its investments as available-for-sale.

Our available-for-sale short-term and long-term investments, which consist of US Treasury bills and certificates of deposit, are considered to be Level 2.

The fair value of Level 2 financial assets is determined using inputs that are observable in the market or can be derived principally from or corroborated by observable market data such as pricing for similar securities, recently executed transactions, cash flow models with yield curves, and benchmark securities.

In addition, Level 2 financial instruments are valued using comparisons to like-kind financial instruments and models that use readily observable market data as their basis.

Property and Equipment, net

Property and equipment is stated at cost, less accumulated depreciation.

Maintenance and repairs that do not improve or extend the lives of the respective assets are expensed to operations as incurred, while costs of major additions and betterments are capitalized.

Upon disposal, the related cost and accumulated depreciation is removed from the accounts and any resulting gain or loss is included in the results of operations.

Depreciation is recorded using the straight-line method over the estimated useful lives of the respective assets, which are as follows:

Computer equipment and software

Lab equipment

Furniture and fixtures

Leasehold improvements

shorter of 8 years and remaining life of lease

Construction-in-progress is not depreciated until the asset is placed in service.

Impairment of Long-Lived Assets

The Company evaluates long-lived assets for potential impairment when events or changes in circumstances indicate the carrying value may not be recoverable.

An impairment loss would be recognized when estimated when future cash flows expected to result from the use of the asset and its eventual disposition are less than the carrying amount of the asset.

The Company has not recognized any impairment losses for the years ended December 31, 2019 and 2018.

We have entered into a lease agreement for our laboratory and office space.

As described below under "Recent Accounting Standards,” we adopted ASC 842 – Leases as of January 1, 2019.

Pursuant to ASC 842, all of our leases outstanding on January 1, 2019 continued to be classified as operating leases.

With the adoption of ASC 842, we recorded an operating lease right-of-use asset and an operating lease liability on our balance sheet.

Right-of-use lease assets represent our right to use the underlying asset during the lease term and the lease obligation represents our commitment to make lease payments arising from the lease.

Right-of-use lease assets and obligations were recognized based on the present value of remaining lease payments over the lease term.

As the Company’s leases do not provide an implicit rate, we have used an estimated incremental borrowing rate based on the information available at our adoption date in determining the present value of lease payments.

Operating lease expense is recognized on a straight-line basis over the lease term.

The Company adopted the New Leasing Standards as of the effective date of January 1, 2019, with no restatement of prior periods or cumulative adjustment to retained earnings.

Comparative periods in the Company's financial statements will be presented in accordance with the previous guidance under ASC Topic 840, Leases.

Upon adoption, the Company took advantage of the transition package of practical expedients permitted within ASC 842, which allowed the Company not to reassess previous accounting conclusions around whether arrangements are, or contain, leases, as well as to carry forward both the historical classification of leases and the treatment of initial direct costs for existing leases.

In addition, the Company also has made an accounting policy election to exclude leases with an initial term of twelve months or less from its balance sheet.

Krystal Biotech, Inc.

Notes to Consolidated Financial Statements — Continued

Prior to our adoption of ASC 842 , when our lease agreements contained tenant improvement allowances and rent escalation clauses, we recorded a deferred rent asset or liability equal to the difference between the rent expense and the future minimum lease payments due.

The lease expense related to operating leases was recognized on a straight-line basis in the statements of operations over the term of each lease.

In cases where the lessor granted us leasehold improvement allowances that reduced our lease expense, we capitalized the improvements as incurred and recognized deferred rent, which was amortized over the shorter of the lease term or the ex pected useful life of the improvements.

Research and Development Expenses

Research and development costs are charged to expense as incurred in performing research and development activities.

The costs include employee compensation costs, facilities and overhead, preclinical activities and related clinical manufacturing costs, regulatory and other related costs.

The Company estimates contract research and clinical trials materials manufacturing expenses based on the services performed pursuant to contracts with research and manufacturing organizations that manufacture materials used in the Company’s ongoing preclinical studies.

Nonrefundable advanced payments for goods or services to be received in the future for use in research and development activities are deferred and capitalized.

The capitalized amounts are expensed as the related goods are delivered or the services are performed.

In accruing service fees, the Company estimates the time period over which services will be performed and the level of effort to be expended in each period.

These estimates are based on communications with the third party service providers and the Company’s estimates of accrued expenses using information available at each balance sheet date.

If the actual timing of the performance of services or the level of effort varies from the estimate, the Company will adjust the accrual accordingly.

Stock-Based Compensation Expense

The Company accounts for its stock-based compensation awards in accordance with FASB ASC Topic 718, Compensation-Stock Compensation (“ASC 718”).

ASC 718 requires all stock-based payments to employees, including grants of employee stock options and restricted stock, to be recognized in the statements of operations based on their grant-date fair values.

Compensation expense related to awards to employees is recognized on a straight-line basis based on the grant-date fair value over the associated service period of the award, which is generally the vesting term.

Beginning in the first quarter of 2019, the Company adopted ASU 2018-07 - Compensation – Stock Compensation (Topic 718):

Improvements to Nonemployee Share-Based Payment Accounting, which no longer required non-employee stock options to be periodically revalued.

The adoption of this amended guidance did not have a material effect on our consolidated financial statements.

The Company estimates the fair value of its stock options using the Black-Scholes option pricing model, which requires the input of subjective assumptions, including:

(i) the expected stock price volatility;

(ii) the expected term of the award;

(iii) the risk-free interest rate;

and (iv) expected dividends.

Due to the lack of sufficient history and trading volume of our Common Stock and a lack of Company-specific historical and implied volatility data, the Company has based its estimate of expected volatility on the historical volatility of a group of similar companies that are publicly traded.

When selecting these public companies on which it has based its expected stock price volatility, the Company selected companies with comparable characteristics to it, including enterprise value, risk profiles, position within the industry, and with historical share price information sufficient to meet the expected term of the stock-based awards.

The Company computes historical volatility data using the daily closing prices for the selected companies’ shares during the equivalent period of the calculated expected term of the stock-based awards.

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.

Due to the lack of Company-specific historical option activity, the Company has estimated the expected term of its employee stock options using the “simplified” method, whereby the expected term equals the arithmetic mean of the vesting term and the original contractual term of the option.

Beginning in the first quarter of 2019, the expected term of non-employee stock options also used the “simplified” method.

Prior to the first quarter of 2019, the expected term for non-employee awards was the remaining contractual term of the option.

The risk-free interest rates are based on the US Treasury securities with a maturity date commensurate with the expected term of the associated award.

The Company has never paid and does not expect to pay dividends in the foreseeable future.

The Company is also required to estimate forfeitures at the time of grant and to revise those estimates in subsequent periods if actual forfeitures differ from its estimates.

Beginning in the first quarter of 2019, the Company used historical data to estimate forfeitures and recorded stock-based compensation expense only for those awards that were expected to vest.

Prior to the first quarter of 2019, the forfeiture rate was estimated to be zero.

To the extent that actual forfeitures differ from the Company’s estimates, the differences are recorded as a cumulative adjustment in the period the estimates were revised.

Krystal Biotech, Inc.

Notes to Consolidated Financial Statements — Continued

Prior to the first quarter of 2019 , s hare-based payments issued to non-employees were recorded at their fair values, and were periodically revalued as the equity instruments vest ed and were recognized as expense over the related service period in accordance with the provisions of ASC 718 and ASC Topic 505, Equity, and were expensed ratably over the vesting term .

For the year ended December 31, 2019 income taxes are recorded in accordance with FASB ASC Topic 740, Income Taxes (“ASC 740”), which provides for deferred taxes using an asset and liability approach.

Under this method, we record deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the financial statement carrying amounts and the tax basis of assets and liabilities using enacted tax rates expected to be in effect when the differences are expected to reverse.

Valuation allowances are provided when necessary to reduce net deferred tax assets to the amount that is more likely than not to be realized.

Based on the available evidence, we are unable, at this time, to support the determination that it is more likely than not that our deferred tax assets will be utilized in the future.

Accordingly, we recorded a full valuation allowance as of December 31, 2019.

We intend to maintain valuation allowances until sufficient evidence exists to support its reversal.

The Company accounts for uncertain tax positions in accordance with the provisions of ASC 740.

When uncertain tax positions exist, the Company recognizes the tax benefit of tax positions to the extent that the benefit will more likely than not be realized.

The determination as to whether the tax benefit will more likely than not be realized is based upon the technical merits of the tax position as well as consideration of the available facts and circumstances.

As of December 31, 2019, the Company did not have any significant uncertain tax positions.

The Company may recognize interest and penalties related to uncertain tax positions in income tax expense.

As of December 31, 2019 and 2018, the Company had no accrued interest or penalties related to uncertain tax positions and no amounts have been recognized in the Company’s statements of operations.

Company’s consolidated statements of operations and comprehensive loss.

Comprehensive Loss

Comprehensive loss is defined as the change in equity during a period from transactions from non-owner sources.

Unrealized gains (losses) on available-for-sale securities is a component of other comprehensive gains (losses) and is presented net of taxes.

We have not recorded any reclassifications from other comprehensive gains (losses) to net loss during any period presented.

Recent Accounting Pronouncements

In August 2018, the SEC issued a final rule to simplify certain disclosure requirements.

In addition, the amendments expanded the disclosure requirements on the analysis of stockholders’ equity for interim financial statements.

The amended guidance is effective for us commencing in the first quarter of 2019.

In August 2018, the FASB issued ASU 2018-13 - Fair Value Measurement (Topic 820) (“ASU 2018-13”) which removes, modifies and adds disclosure requirements on fair value measurements.

The amended guidance is effective for us commencing in the first quarter of 2020.

Certain aspects may be applied prospectively while other aspects may be applied retrospectively upon the effective date.

The Company does not anticipate a material impact to the consolidated financial statements as a result of the adoption of this guidance.

Krystal Biotech, Inc.

Notes to Consolidated Financial Statements — Continued

In June 2018, the FASB issued ASU 2018-07 - Compensation – Stock Compensation (Topic 718):

The new guidance expands the scope of ASC 718 to include share-based payments granted to nonemployees in exchange for goods or serv ices used or consumed in an entity’s own operations.

The amended guidance is effective for us commencing in the first quarter of 2019.

The adoption of this amended guidance did not have a material effect on our consolidated financial statements.

In February 2016, the FASB issued ASC 842 - Leases (“ASC 842”), which replaces the existing lease accounting standards.

The new standard requires a dual approach for lessee accounting under which a lessee would account for leases as finance (also referred to as capital) leases or operating leases.

Both finance leases and operating leases with terms longer than 12 months will result in the lessee recognizing a right-of-use asset and a corresponding lease liability.

For finance leases the lessee would recognize interest expense and amortization of the right-of-use asset and for operating leases the lessee would recognize straight-line total lease expense.

In July 2018, further amendments were issued to clarify how to apply certain aspects of the amended lease guidance and to address certain implementation issues.

ASC 842 was effective for the Company beginning in the first quarter 2019.

The Company generally does not finance purchases of equipment but does lease office and lab facilities.

The adoption of this amended guidance resulted in a $1.1 million of right-of-use asset and $1.4 million of lease liability being recognized on the consolidated balance sheet as of January 1, 2019.

Net Loss Per Share Attributable to Common Stockholders

Basic net loss per share attributable to common stockholders is calculated by dividing net loss attributable to common stockholders by the weighted average shares outstanding during the period, without consideration for common stock equivalents.

Diluted net loss per share attributable to common stockholders is computed by dividing the net loss by the weighted-average number of shares of common stock and common share equivalents outstanding for the period.

Preferred stock and stock options are common share equivalents.

There were 420,766 and 399,515 common stock equivalents outstanding as of December 31, 2019 and 2018, respectively, in the form of stock options and unvested restricted stock awards, that have been excluded from the calculation of diluted net loss per share attributable to common stockholders as their effect would be anti-dilutive for all periods presented.

(In thousands, except share and per share data)

Year Ended December 31,

Net loss applicable to common stockholders

Weighted-average basic and diluted common

Basic and diluted net loss per common share

Krystal Biotech, Inc.

Notes to Consolidated Financial Statements — Continued

Fair Value Instruments

The following tables show the Company’s cash, cash equivalents and available-for-sale securities by significant investment category as of December 31, 2019 and 2018, respectively (in thousands):

December 31, 2019

Amortized Cost

Aggregate Fair

Cash and Cash

Securities (1)

Securities (2)

Money market instruments

government agency securities

Certificates of deposit

December 31, 2018

Amortized Cost

Aggregate Fair

Cash and Cash

Securities (1)

Securities (2)

Money market instruments

government agency securities

Certificates of deposit

(1) The Company’s short-term marketable securities mature in one year or less.

(2) The Company’s long-term marketable securities mature between one and two years.

See Note 2 to these consolidated financial statements for additional discussion regarding the Company’s fair value measurements.

Krystal Biotech, Inc.

Notes to Consolidated Financial Statements — Continued

Balance Sheet Components

Property and Equipment, Net

Property and equipment, net consist of the following (in thousands):

December 31, 2019

December 31, 2018

Construction-in-progress

Leasehold improvements

Furniture & fixtures

Computer equipment and software

Laboratory equipment

Total property and equipment

Accumulated depreciation and amortization

Property and equipment, net

Depreciation expense was $748 thousand and $141 thousand for the years ended December 31, 2019 and 2018, respectively.

Accrued Expenses and Other Current Liabilities

Accrued expenses and other current liabilities consisted of the following (in thousands):

December 31, 2019

December 31, 2018

Accrued preclinical and clinical expenses

Accrued professional fees

Accrued payroll and benefits

Accrued taxes

Accrued construction in progress and laboratory equipment

Other current liabilities

Krystal Biotech, Inc.

Notes to Consolidated Financial Statements — Continued

Commitments and Contingencies

Significant Contracts and Agreements

Lease Agreement

In May 2016, the Company signed an operating lease for laboratory and office space that commenced in June 2016 and expired on October 31, 2017 (the “2016 Lease”).

The 2016 Lease was amended to increase the area leased to approximately 31,000 square feet and to extend the expiration date to February 28, 2027, including 6,000 square feet relating to a month-to-month lease that we expect to utilize through the first quarter of 2020.

As mentioned above in “Recent Accounting Pronouncements” in Note 2, the adoption of ASC 842 on January 1, 2019 for the 2016 Lease, as amended, resulted in a $1.1 million of right-of-use asset and $1.4 million of lease liability being recognized on the consolidated balance sheet as of January 1, 2019.

On December 26, 2019, we entered into a lease agreement for our second commercial gene therapy facility in the Pittsburgh, Pennsylvania area.

The 100,000 square foot facility is under construction and is expected to be completed by early 2021.

The lease will commence when the space is available for access, which is anticipated to be in the second half of 2020, and has an initial term that expires on October 31, 2035.

A cash contribution in the amount of $2.4 million was paid to escrow on January 21, 2020.

The contribution was intended to reduce the amount of the building construction costs and had the effect of reducing the base rental rate of the lease.

As of December 31, 2019, future minimum commitments under the Company’s operating leases were as follows (in thousands):

Operating Leases

Total minimum lease payments, net

The Company recorded $669 thousand and $231 thousand in rent expense for the years ended December 31, 2019 and 2018, respectively.

Clinical Supply Agreements

The Company has entered into various product manufacturing and clinical supply agreements with Contract Manufacturing Organizations (“CMOs”).

The product manufacturing and clinical supply agreements provide the terms and conditions under which the CMOs will formulate, fill, inspect, package, label and test our product candidates, B-VEC and KB105 for clinic supply.

The Company is obligated to make milestone payments.

Additionally, certain raw materials, supplies, outsourced testing and other services for the purposes of batch production will be invoiced separately by the CMOs.

The estimated remaining commitment as of December 31, 2019 under these agreements for the manufacturing of our drug product is approximately $3.6 million.

The Company is also responsible for the payment of a monthly service fee for project management services for the duration of any arrangements.

The Company has incurred expenses under these agreements of $4.4 and $ 3.1 million for the years ended December 31, 2019 and 2018, respectively.

Capitalization

Sale of Common Stock

On November 1, 2017, the Company entered into a stock purchase agreement (the “Agreement”) with the Epidermolysis Bullosa Medical Research Foundation, a California not-for-profit corporation (“EBMRF”), and EB Research Partnership, Inc., a New York not-for-profit corporation (“EBRP” and together with EBMRF, the “Purchasers”), pursuant to which the Company issued and sold to the Purchasers an aggregate of 70,000 shares of the Company’s common stock, par value $0.00001 per share, for a purchase price of $11.00 per share, resulting in aggregate gross proceeds to the Company of $770 thousand (the “Transaction”).

The proceeds are to be used exclusively to complete the research plan pursuant to the

Krystal Biotech, Inc.

Notes to Consolidated Financial Statements — Continued

There are redemption features whereby the Company shall repurchase all or a portion of the shares at a purchase price of $11.00 per share or the closing trading price of the common stock on the redemption request date, whichever is higher, should the Company not commence work on or before September 1, 201 8 or cease commercially reasonable efforts.

The Company did commence work prior to September 1, 2018.

As the Company does not intend to cease commercially reasonable efforts, the remaining redemption feature is within the control of the Company and consequ ently the issued common stock is classified as permanent equity.

The offer, sale and issuance of the shares of the Company under the Agreement are exempt from registration pursuant to Rule 506 of Regulation D and Section 4(a)(2) of the Securities Act of 19 33, as amended.

The Transaction closed on November 2, 2017.

On August 16, 2018, the Company entered into a stock purchase agreement with Frazier Life Sciences for the private placement of 625,000 shares of the Company’s common stock at $16.00 per share.

The private placement yielded gross proceeds of $10.0 million and closed on August 17, 2018.

Pursuant to the terms of the purchase agreement, the Company filed a registration statement with the SEC which became effective on October 12, 2018.

Follow-on Public Offerings

On October 23, 2018, the Company completed it’s a public offering of 3,450,000 shares of its common stock at a price to the public of $20.00 per share, which includes the sale of 450,000 shares of the Company’s common stock pursuant to the underwriters’ full exercise of their option to purchase additional shares.

The Chief Executive Officer and Chief Operating Officer each purchased 25,000 shares of the Company’s common stock at $20.00 per share as part of the public offering.

Net proceeds to the Company from the offering were $64.3 million after deducting underwriting discounts and commissions of approximately $4.2 million, and other offering expenses of approximately $496 thousand payable by the Company.

On June 27, 2019, the Company completed a public offering of 2,500,000 shares of its common stock to the public at $40.00 per share.

Net proceeds to the Company from the offering were $93.8 million after deducting underwriting discounts and commissions of approximately $6.0 million, and other offering expenses payable by the Company of approximately $220 thousand.

In connection with the public offering, the Company suspended its “at-the-market” equity offering program (“ATM Facility”) that had previously been put in place in March 2019.

This program had allowed the Company to sell shares of its common stock for up to $50.0 million in gross proceeds.

Following the completion of the offering, $16.8 million remains suspended under this program .

Stock-Based Compensation

Options granted to employees vest ratably over a four-year period and options granted to directors of the company vest ratably over one and four-year periods.

Options have a life of ten years.

Commencing in the first quarter of 2019, the accounting treatment for stock options granted to non-employees was aligned with the accounting for employee stock options upon the adoption of ASU 2018-07 as described in Note 2 “Summary of Significant Accounting Policies”.

Prior to the first quarter of 2019, stock options granted to non-employees were accounted for using the fair value method of accounting, and were periodically revalued as the options vest, and recognized as expense over the related service period.

Krystal Biotech, Inc.

Notes to Consolidated Financial Statements — Continued

The following table summarizes the Company’s stock option activity:

(In thousands) (1)

Balance at January 1, 2018

Cancelled or forfeited

Balance at December 31, 2018

Cancelled or forfeited

Balance at December 31, 2019

Exercisable at December 31, 2019

Aggregate intrinsic value represents the difference between the closing stock price of our common stock on December 31, 2019 and the exercise price of outstanding in-the-money options.

Options for 72,073 shares of our common stock with an intrinsic value of $3,777 thousand were exercised during the year ended December 31, 2019.

The Company has recorded aggregate stock-based compensation expense related to the issuance of stock option awards and restricted stock awards to employees and non-employees in the consolidated statements of operations for the years ended December 31, 2019 and 2018 as follows (in thousands):

Year Ended December 31,

Research and development

General and administrative

Total stock-based compensation

Stock Options Granted to Employees.

The Company recorded stock-based compensation expense related to employees’ and board members’ stock options of $1,195 thousand and $739 thousand for the years ended December 31, 2019 and 2018, respectively.

The fair value of options granted to employees was estimated at the date of grant using the Black-Scholes valuation model with the following weighted-average assumptions for the years ended December 31, 2019 and 2018:

Year Ended December 31,

Expected stock price volatility

Expected term of the award (years)

Risk-free interest rate

Exercise price

Forfeiture Rate

Expected dividend yield

The weighted-average grant-date fair value per share of options granted to employees during the years ended December 31, 2019 and 2018 was $21.72 and $9.74, respectively.

There was $4.1 million of unrecognized stock-based compensation expense related to employees’ awards that is expected to be recognized over a weighted-average period of 2.22 years as of December 31, 2019.

Krystal Biotech, Inc.

Notes to Consolidated Financial Statements — Continued

Stock Options Granted to Non-Employees .

The Company recorded stoc k-based compensation expense related to non-employees’ stock options of $44 thousand and $53 thousand for the years ended December 31, 2019 and 2018, respectively.

There was $33 thousand of unrecognized stock-based compensation expense related to non-employees’ awards that is expected to be recognized over a weighted-average period of 0.91 years as of December 31, 2019.

There were no options granted to non-employees in the year ended December 31, 2019 or 2018.

Restricted Stock Awards.

The Company granted 26,213 and 16,213 restricted stock awards (“RSA”s) on June 1, 2018 to our Chief Executive Officer and Chief Operating Officer, respectively.

The RSAs vest ratably over a one-year period and had completely vested as of May 31, 2019.

No RSAs were outstanding as of December 31, 2019.

The fair value of each restricted stock was $10.30 reflecting the closing price of our common stock on the grant date.

The Company recorded stock-based compensation expense related to RSAs of $182 thousand and $255 thousand for the year ended December 31, 2019 and 2018, respectively, within general and administrative expenses in the accompanying consolidated statements of operations.

Stock options available to grant were 545,824 at December 31, 2019.

From inception through December 31, 2016, the Company was a Limited Liability Company treated as a “pass-through” for federal and state income tax purposes, and therefore, all items of income or loss through December 31, 2016 flowed through to the members of the LLC.

Effective January 1, 2017, the Company converted from an LLC to a C-corporation for federal and state income tax purposes.

Prior to the conversion to a C-corporation, the Company did not record deferred tax assets or liabilities or have any net operating loss (“NOL”) carryforwards for federal income tax purposes.

Effective upon the conversion to a C-corporation, the Company became subject to income tax at the federal and state levels.

We did not record a current or deferred income tax expense or benefit for the years ended December 31, 2019 and 2018 due to the Valuation Allowance position.

A reconciliation of income tax expense (benefit) computed at the statutory federal and state income tax rate for the year to income tax expense (benefit) as reflected in our financial statements for years ended December 31, 2019 and 2018 are as follows (in thousands):

Federal income tax expense (benefit) at statutory rate

Change in valuation allowance

State income tax expense net of federal benefit

Prior period adjustment

Other non-deductible expenses

Total tax expense (benefit)

Krystal Biotech, Inc.

Notes to Consolidated Financial Statements — Continued

The significant components of the Company’s deferred tax assets as of December 31, 2019 and 2018 are as follows (in thousands):

Deferred tax assets:

Net operating loss carryforwards

Stock compensation

Lease liability

Accrued expenses

Total deferred tax assets

Valuation allowance

Deferred tax assets

Deferred tax liabilities:

Right-of-use asset

Prepaid expenses

Unrealized loss on marketable securities

Total deferred tax liabilities

Net deferred tax assets

The Company has evaluated the positive and negative evidence bearing upon the realizability of its deferred tax assets.

Based on the Company’s history of operating losses, the Company has concluded that it is more likely than not that the benefit of its deferred tax assets will not be realized.

Accordingly, the Company has provided a full valuation allowance for deferred tax assets as of December 31, 2019.

As of December 31, 2019, the Company had cumulative US federal NOL carryforwards of approximately $34.3 million.

Of this amount, $5 million is available to offset future income tax liabilities and will expire in 2037, the remaining $29.3 million is available indefinitely to offset future income tax liabilities with no expiration period.

Under the provisions of the Internal Revenue Code, the NOL carryforwards are subject to review and possible adjustment by the Internal Revenue Service and state tax authorities.

NOL carryforwards may become subject to an annual limitation in the event of certain cumulative changes in the ownership interest of significant shareholders over a three-year period in excess of 50%, as defined under Internal Revenue Code Sections 382 and 383 of the Internal Revenue Code, respectively, as well as similar state provisions.

This could limit the amount of tax attributes that can be utilized annually to offset future taxable income or tax liabilities.

The amount of the annual limitation is determined based on the value of the Company immediately prior to the ownership change.

Subsequent ownership changes may further affect the limitation in future years.

The Company has completed several financings since its inception which may have resulted in a change in control as defined by Sections 382 and 383 of the Internal Revenue Code, or could result in a change in control in the future.

The Company files income tax returns in the United States at the federal level and in states in which the Company conducts business activities.

The federal and state income tax returns are generally subject to tax examinations for the tax year ended December 31, 2017 and 2018.

To the extent the Company has tax attribute carryforwards, the tax years in which the attribute was generated may still be adjusted upon examination by the Internal Revenue Service or state tax authorities to the extent utilized in a future period.

Related Party Transactions

O ur Chief Executive Officer and Chief Operating Officer of the Company each purchased 25,000 shares of common stock at the offering price of $20 per share in connection with our follow-on public offering in October 2018.

In December 2019 the Company advanced $420 thousand to a member of our management team to cover the personal payroll and income taxes on their taxable income from NSO exercises.

This employee repaid the Company in the full amount on January 6, 2020.

Changes in and Disagreements w ith Accou ntants on Accounting and Financial Disclosure.

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis