Krystal Biotech, Inc. 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis of our financial condition and results of operations should be read together with the unaudited condensed consolidated financial statements and related notes included in Item 1 of Part I of this Quarterly Report on Form 10-Q and with the audited financial statements and the related notes included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022, as filed with the SEC on February 27, 2023. SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. Forward-looking statements include all statements that are not historical facts and can be identified by terms such as “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,” “predict,” “project,” “seek,” “should,” “target,” “will,” “would,” or similar expressions and the negatives of those terms. These statements relate to future events or to our future operating or financial performance and involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performances or achievements expressed or implied by the forward-looking statements. Some of such factors include, but are not limited to: • the commercial success of VYJUVEK; • the initiation, timing, cost, progress and results of our research and development activities, preclinical studies and clinical trials for our product candidates; • the timing, scope or results of regulatory filings and approvals, including timing of final U.S. Food and Drug Administration (“FDA”) and other regulatory approval of our product candidates; • our ability to achieve certain accelerated or orphan drug designations from the FDA; • changes in our estimates regarding the potential market opportunity for our FDA-approved product, VYJUVEK (beremagene geperpavec-svdt) (also known as “B-VEC” where not approved), and our product candidates; • increases in costs associated with our research and development programs for our product candidates; • increases in our selling, general, and administrative expenses; • risks related to our ability to successfully develop and commercialize our product candidates; • our ability to identify new product candidates; • our ability to identify, recruit and retain key personnel; • risks related to our marketing and manufacturing capabilities and strategy; • our business model and strategic plans for our business, product candidates and technology; • the rate and degree of market acceptance and clinical utility of our product candidates and gene therapy, in general; • our competitive position and the success of competing therapies; • our intellectual property position and our ability to protect and enforce our intellectual property; • our ability to establish and maintain collaborations; • our financial performance and our estimates regarding expenses, future revenue, capital requirements and needs for additional financing, as well as our ability to raise capital; • our ability to successfully avoid or resolve any litigation, intellectual property or other claims, that may be brought against us; • global economic conditions, including the recent rise in inflation and interest rates and recent bank failures; and • the impact of changes in laws and regulations. 22 Forward-looking statements are subject to a number of risks, uncertainties and assumptions, including those described in (i) Item 1A of Part II of this Quarterly Report on Form 10-Q, (ii) “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022, and (iii) other filings we make with the SEC from time to time. Moreover, we operate in a very competitive and rapidly changing environment, and new risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this Quarterly Report on Form 10-Q may not occur and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements. Given these uncertainties, you should not place undue reliance on these forward-looking statements. Also, forward-looking statements represent our management’s beliefs and assumptions only as of the date of this Quarterly Report. You should read this Quarterly Report completely and with the understanding that our actual future results may be materially different from what we expect. Except as required by law, we assume no obligation to update these forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future. Throughout this Form 10-Q, unless the context requires otherwise, all references to “Krystal,” “the Company,” we,” “our,” “us” or similar terms refer to Krystal Biotech, Inc., together with its consolidated subsidiaries. Web links throughout this document are provided for convenience only and are not intended to be active hyperlinks to the referenced websites. No content on the referenced websites shall be deemed incorporated by reference into this Quarterly Report on Form 10-Q. Overview We are a commercial-stage biotechnology company focused on the discovery, development, and commercialization of genetic medicines to treat diseases with high unmet medical needs. Our approach leverages our patented platform that is based on an engineered Herpes Simplex Virus-1 (“HSV-1”) vector to deliver therapeutic transgenes to cells of interest in multiple organ systems. The cell’s own machinery then transcribes and translates the transgene to treat the disease. We formulate our vectors for non-invasive or minimally invasive routes of administration at a healthcare professional’s office or in the patient’s home by a healthcare professional. Our innovative technology platform is supported by two in-house, commercial scale CGMP manufacturing facilities. Our US FDA Approved Product VYJUVEK On May 19, 2023, the United States Food and Drug Administration (the “FDA”) approved VYJUVEK, the first ever re-dosable gene therapy for treating patients, six months of age or older, suffering from Dystrophic Epidermolysis Bullosa (“DEB”), a rare and severe monogenic disease that affects the skin and mucosal tissues and is caused by one or more mutations in a gene called COL7A1 . VYJUVEK is a redosable topical gel containing our novel vector designed to deliver two copies of the COL7A1 transgene to a patient’s skin cells to produce the COL7 protein. VYJUVEK is the first and only medicine approved by the FDA for the treatment of DEB, both recessive and dominant, that can be administered by a healthcare professional in either a healthcare professional setting or in the home. We possess exclusive rights to develop, manufacture, and commercialize VYJUVEK and all our pipeline candidates throughout the world. As of September 30, 2023, the Company received 284 Patient Start Forms, of which 20% were generated for patients with dominant DEB. In addition, the Company has received positive coverage determinations from all major commercial national health plans. Optional Medicaid fee-for service states initiated coverage in July, and the Company expects to receive positive coverage from most mandatory states in the fourth quarter of 2023 and the balance in the first quarter of 2024. Consequently, we plan on reporting the number of Patients on Therapy starting in the first quarter of 2024 as we believe that Patients on Therapy will be a better predictor of net revenue from VYJUVEK sales. In October 2023, we filed for a Marketing Authorization for B-VEC with the European Medicines Agency (the “EMA”) and anticipate approval in the EU in the second half of 2024. Previously, in July 2023, the Company received a positive opinion from the EMA Pediatric Committee on the Pediatric Investigation Plan for B-VEC for the treatment of DEB with no additional studies required. In July 2023, the Pharmaceuticals and Medical Devices Agency in Japan officially accepted our open label extension study of B-VEC. Following that acceptance, we initiated an open label extension study of B-VEC in 5 patients in Japan. Details of the study can be found at jrct.niph.go.jp under JRCT ID jRCT2053230075. We intend to file a Japanese New Drug Application for B-VEC for the treatment of DEB in the first half of 2024 following completion of the open label extension study. 23 Pipeline Highlights and Recent Developments Respiratory KB407 is an inhaled (nebulized) formulation of our novel vector designed to deliver two copies of the full-length cystic fibrosis transmembrane conductance regulator (“CFTR”) transgene for the treatment of Cystic Fibrosis (“CF”), a serious rare lung disease caused by missing or mutated CFTR protein. In July 2023, we announced that we dosed the first patient in a Phase 1 (CORAL-1) clinical trial of KB407 for the treatment of CF. Cohort 1 of the CORAL-1 study has been enrolled and completed. The Company is working to initiate Cohort 2 of the CORAL-1 study following safety review by the Data Monitoring Committee. The CORAL-1 study is a multi-center, dose-escalation trial of KB407 in patients with CF, regardless of their underlying genotype. The Company anticipates announcing data from the CORAL-1 study in 2024. Details of the Phase 1 study can be found at www.clinicaltrials.gov under NCT identifier NCT05504837. KB408 is an inhaled (nebulized) formulation of our novel vector designed to deliver two copies of the SERPINA1 transgene, that encodes for normal human alpha-1 antitrypsin protein, for the treatment of alpha-1 antitrypsin deficiency (“AATD”), a serious rare lung disease. In September 2023, the Company announced that the FDA had cleared the Company’s Investigational New Drug (“IND”) application for KB408. The Company plans to initiate a Phase 1 clinical trial (SERPINA-1) and dose the first patient with KB408 in the first quarter of 2024. Previously, the FDA granted Orphan Drug Designation for KB408 for the treatment of AATD. Oncology In July 2023, we announced expansion of our R&D pipeline to oncology, leveraging our prior experience in skin and lung tissue for local delivery of immune boosting cytokines to the tumor microenvironment. Our lead oncology product candidate, KB707, is a modified HSV-1 vector designed to deliver genes encoding both human IL-12 and IL-2 to the tumor microenvironment and promote systemic immune-mediated tumor clearance. KB707 targets solid tumors that are accessible via intratumoral injection or inhalation. In July 2023, the FDA accepted our IND application to evaluate intratumoral injection of KB707 in a clinical trial to treat patients with locally advanced or metastatic solid tumor malignancies. The FDA also granted KB707 fast track designation to delay disease progression in the treatment of patients with anti-PD-1 relapsed/refractory locally advanced or metastatic melanoma. In October 2023, we dosed the first patient in the KB707 Phase 1 (OPAL-1) study to evaluate intratumoral KB707 in patients with locally advanced or metastatic solid tumor malignancies. The OPAL-1 study is an open-label, multi-center, monotherapy, dose escalation and expansion study, enrolling patients with locally advanced or metastatic solid tumors, who relapsed or are refractory to standard of care, with at least one measurable and injectable tumor accessible by transcutaneous route. The primary objective of the study is to evaluate safety and tolerability of KB707. Efficacy will also be assessed by multiple measures including overall response rate, progression free survival, and overall survival, and the immune effects of KB707 monotherapy will be assessed in tumor tissue, lymph nodes, and blood. Details of the Phase 1 study can be found www.clinicaltrials.gov under NCT identifier NCT05970497. The Company presented preclinical data in multiple oncology models at the Society for Immunotherapy of Cancer’s annual meeting on November 3 and 4, 2023. Combinatorial IL-2 and IL-12 expressed from the Company’s platform technology was shown in one presentation, to provide a synergistic effect in a melanoma model, suppressing treated and non-treated tumor outgrowth, enhancing survival, and eliciting a durable memory response sufficient for recurrent tumor control. Similarly, the Company presented that non-invasive inhalation of vector-encoded IL-2 and IL-12 was found to be both safe and effective in treating lung tumors in a metastasis model, resulting in long-term survival after single or repeated cancer cell challenge, suggestive of prolonged adaptive immunity. The Company is on track to file an amendment to the existing KB707 IND in the fourth quarter of 2023 to allow the Company to evaluate inhaled KB707 in a clinical trial to treat tumors in a patient’s lungs. The Company expects to dose the first patient with inhaled KB707 in the first half of 2024. Dermatology 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 TMG1 protein. 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 intend to commence our Phase 2 trial of KB105 (JADE-1) for the treatment of TGM1-ARCI, in 2024, and we anticipate filing an IND application with the FDA and initiating a clinical trial of KB104 to treat patients with Netherton Syndrome in late 2024. 24 Aesthetics 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 Aesthetics, Inc. (“Jeune”). KB301 is a solution formulation of our novel vector 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. In April 2023, Jeune treated the first subject in the Phase 1, Cohort 3 study of KB301 for the improvement of lateral canthal lines (“LCL”) at rest. The Phase 1, Cohort 3 study is being conducted at a single center as an open label study to evaluate two different doses of KB301 in up to 20 subjects. Improvement of lateral canthal lines at rest was selected as a target indication for KB301 based upon the Phase 1 safety, efficacy and durability studies, which evaluated KB301 in the lower and upper cheek, including the lateral canthal region. Subjects will be followed for three months after KB301 treatment. Jeune has encountered delays in enrollment in the Cohort 3 study and plans to announce results from this study in the first half of 2024. Following completion of this study, Jeune plans to initiate a Phase 2 study of KB301 in LCL at rest. Details of the Phase 1 study can be found at www.clinicaltrials.gov under NCT identifier (NCT04540900). Business Highlights and Recent Developments On October 10, 2023, the United States Patent & Trademark Office issued U.S. Patent No. 11,779,660 entitled Viral Vectors for Cancer Therapy to Krystal Biotech, Inc. The issued patent covers the Company’s lead oncology product candidate, KB707. In August 2023, the Company sold its Rare Pediatric Disease Priority Review Voucher (“PRV”) for $100.0 million. The Company was awarded the PRV in connection with the FDA’s accelerated approval of VYJUVEK. Under the Rare Pediatric Disease Priority Review Voucher Program, the FDA awards priority review vouchers to sponsors of rare pediatric disease product applications that meet certain criteria. The program is intended to encourage development of new drugs and biologics for the prevention and treatment of rare pediatric diseases. A PRV can be redeemed to receive priority review of a subsequent marketing application for a different product, or alternatively, sold or transferred. In August 2023, we began research and development operations in our second CGMP biologics manufacturing facility, ASTRA. ASTRA is a 155,000 sq. ft. state-of-the-art CGMP facility with comprehensive end-to-end capabilities, which currently include or will include, process development, analytical testing, virus and cell banking, commercial scale drug product/substance manufacturing, fill/finish and packaging, labeling and distribution, waste handling, environmental monitoring, and warehousing with temperature controlled CGMP storage. ASTRA is equipped with multiple clean rooms with flexibility designed into its configuration for further scale-up and scale-out capabilities. Financial Overview Revenue In May 2023, we received FDA approval for VYJUVEK for the treatment of DEB in patients six months or older. After approval, we began commercial marketing and sales of the product throughout the United States and began recognizing revenue in 3Q 2023. Our future revenue will fluctuate from quarter to quarter for many reasons, including the uncertain timing and amount of any such sales. We sell VYJUVEK through agreements with a limited number of specialty pharmacies (“SPs”) that mix the medication and administer it to patients in the patient’s home by a healthcare professional and a specialty distributor (“SD”), that distributes VYJUVEK to hospitals and outpatient clinics where patients are administered the medication at a healthcare professional’s office. The transaction price that we recognized as revenue for products includes an estimate of variable consideration, which includes discounts, returns, and rebates that are offered within contracts with our customers. Refer to Note 2 of our condensed consolidated financial statements for additional information. Cost of Goods Sold We recognize cost of goods sold for direct and indirect costs related to the manufacturing of VYJUVEK. These costs consist of manufacturing costs, personnel costs including stock-based compensation, facility costs, and other indirect overhead costs. Cost of goods sold may also include period costs related to certain manufacturing services and inventory adjustment charges. Prior to receiving FDA approval for VYJUVEK in May 2023, costs associated with the manufacturing of VYJUVEK were expensed as research and development expense. As such, a portion of the cost of inventory sold during the period was expensed prior to FDA approval. We anticipate that the previously expensed inventory has and will continue to favorably impact the cost of goods sold and the Company’s gross margin until the remaining pre-approval inventory is sold. 25 Research and Development Expenses 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, contract research organizations, consultants and other vendors that conduct our preclinical activities; • costs of acquiring, developing and manufacturing clinical trial materials and lab supplies; • facility costs, depreciation and other expenses, which include direct expenses for rent and maintenance of facilities and other supplies; and • 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 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 resume dosing with KB105 Phase 1/2 clinical trial, continue the Phase 1, Cohort 3 study and initiate a Phase 2 trial for KB301, continue the Phase 1 trial for KB407, continue the Phase 1 trial for intratumoral KB707 and initiate a Phase 1 trial for inhaled KB707, initiate a Phase 1 trial for KB408, initiate a Phase 1 trial for KB104, 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 clinical trials, and, as a result, the actual costs to complete clinical trials may exceed the expected costs. Selling, General, and Administrative Expenses Selling, general, and administrative expenses consist principally of salaries and other related costs, including stock-based compensation for personnel in our executive, commercial, business development and other administrative functions. Selling, general, and administrative expenses also include professional fees associated with corporate and intellectual property-related legal expenses, consulting and accounting services, facility-related costs and expenses associated with obtaining and maintaining patents. Other selling, general, and administrative costs include travel expenses, patient access program fees, management service fees, and other selling expenses which include transportation, shipping and handling fees. We anticipate that our selling, general, and administrative expenses will increase in the future to support the continued research and development of our product candidates and our commercial and operational goals. These increases will likely include increased costs for insurance, costs related to the hiring of additional personnel and payments to outside consultants, lawyers and accountants, among other expenses. Additionally, we anticipate that we will continue to increase our salary and personnel costs and other expenses as a result of our commercial activities in the U.S. and preparation for commercial operations outside of the U.S. ASTRA Capital Expenditures In March 2021, we closed on the purchase of the building that was constructed to house our second CGMP facility, ASTRA, and we are currently in the process of completing and qualifying this facility. The Company placed a portion of ASTRA into service during the three and nine months ended September 30, 2023 as it was determined that certain assets were ready for their intended use. On March 27, 2023, the Company received the permanent occupancy permit for ASTRA which allowed the Company to begin utilizing certain portions of the building. As certain building improvements and certain qualification activities are still underway, the Company will continue to hold the remaining assets within construction in progress until validation has been completed and the assets are ready for their intended use. Validation of the facility is expected to be completed in 2023. 26 Gain from Sale of Priority Review Voucher Gain from sale of priority review voucher relates to proceeds from sale of the rare pediatric PRV we received in connection with the FDA’s approval of VYJUVEK. Interest and Other Income Interest and other 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 United States 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. Revenue Recognition After FDA approval of VYJUVEK in May 2023, we began commercial marketing and made our first product sales in 3Q 2023. ASC 606 Revenue from Contracts with Customers requires us to make estimates of variable consideration, included in contracts with customers, to be included in the transaction price. The transaction price that is recognized as revenue for products upon delivery and transfer of control to the customer includes an estimate of variable consideration for reserves, which result from discounts, rebates, and returns that are offered within contracts between us and our customers. – Prompt Pay Discounts: As an incentive for prompt payment, we offer a cash discount to customers. We estimate accrued prompt pay discounts using the most likely amount method. We record the discount as an allowance against accounts receivable, net and a reduction of revenue. – Government Rebates: We participate in certain government rebate programs including Medicaid. We estimate accrued government rebates using the expected value method. We accrue estimated rebates based on estimated percentages of VYJUVEK prescribed to qualified patients, estimated rebate percentages and estimated levels of inventory in the distribution channel that will be prescribed to qualified patients and record the rebates as a reduction of revenue. Accrued government rebates are included in other accrued liabilities on the condensed consolidated balance sheets. – Commercial Rebates: We participate in certain commercial rebate programs. Under these rebate programs, we pay a rebate to the commercial entity or third-party administrator of the program. Accrued commercial rebates are estimated using the expected value method. We accrue estimated rebates based on contract prices, estimated percentages of medicine that will be prescribed to qualified patients and estimated levels of inventory in the distribution channel and record the rebate as a reduction of revenue. Accrued commercial rebates are included in other accrued liabilities on the condensed consolidated balance sheets. – Copay Assistance: We reimburse pharmacies for this discount through third-party vendors. We estimate accrued copay assistance costs using the expected value method. The estimate is based on contract prices, estimated percentages of VYJUVEK that will be prescribed to qualified patients, average assistance paid based on reporting from the third-party vendors and estimated levels of inventory in the distribution channel. Copay assistance costs are recorded as reductions to revenue and are accrued in other accrued liabilities on the condensed consolidated balance sheets. – Returns: We offer SPs and SDs limited return rights relating to product damage or defect and based on these provisions, we believe that there will be minimal returns. Variable consideration is estimated and reduces the transaction price to reflect our best estimate of the amount of consideration to which we are entitled based on the terms of the contracts and are recorded in the same period the related product revenues is recognized. The amount of variable consideration that is included in the transaction price may be constrained and is included in the net sales price only to the extent that it is considered probable that a significant reversal in the amount of the cumulative revenue recognized will not occur in a future period. Actual amounts of consideration ultimately received may differ from our estimates. If actual results in the future vary from our estimates, we will adjust these estimates in the period these variances become known. Aside from revenue recognition as noted above, there have been no significant changes during the three and nine months ended September 30, 2023 to our critical accounting policies, significant judgments and estimates as disclosed in our 27 management’s discussion and analysis of financial condition and results of operations included in our Annual Report on Form 10-K for the year ended December 31, 2022. Results of Operations Three Months Ended September 30, 2023 and 2022 Three Months Ended September 30, 2023 2022 Change (In thousands) (unaudited) Product revenues, net $ 8,556 $ — 8,556 Expenses: Cost of goods sold 223 — 223 Research and development 10,629 11,516 (887) Selling, general, and administrative 23,697 19,935 3,762 Total operating expenses 34,549 31,451 3,098 Loss from operations (25,993) (31,451) 5,458 Other income Gain from sale of priority review voucher 100,000 — 100,000 Interest and other income, net 6,740 1,601 5,139 Net income (loss) $ 80,747 $ (29,850) $ 110,597 Product Revenues, net Product revenues, net was $8.6 million for the three months ended September 30, 2023 as compared to zero for the three months ended September 30, 2022 due to initial sales of VYJUVEK after FDA approval was obtained on May 19, 2023. As VYJUVEK was approved by the FDA in May 2023, there were no comparative period revenues. To date, all of our product revenue has been generated in the United States. Cost of Goods Sold Cost of goods sold was $223 thousand for the three months ended September 30, 2023 as compared to zero for the three months ended September 30, 2022 due to initial sales of VYJUVEK after FDA approval was obtained on May 19, 2023. Prior to receiving FDA approval for VYJUVEK in May 2023, costs associated with the manufacturing of VYJUVEK were expensed as research and development expense. As such, a portion of the cost of inventory sold during the period was expensed prior to FDA approval. Research and Development Expenses Research and development expenses decreased $887 thousand in the three months ended September 30, 2023 compared to the three months ended September 30, 2022. The decrease was primarily due to decreases in pre-commercial manufacturing expenses of approximately $1.1 million due to costs related to the manufacturing of VYJUVEK following FDA approval being recorded as inventory, a decrease in outsourced research and development of $581 thousand, and a decrease of $482 thousand from overhead allocations to inventory. These decreases were partially offset by increased payroll related expenses of $859 thousand, which were primarily driven by an increase in headcount to support overall growth, and includes a $152 thousand increase in stock-based compensation, and an increase in depreciation of $484 thousand. Research and development expenses consist primarily of costs relating to the preclinical and clinical development of our product candidates and preclinical programs. Direct research and development expenses associated with our product candidates or development programs consist of compensation related expenses for our internal resources conducting research and development activities, fees paid to external consultants, contract research organizations, or for costs to support our clinical trials. Indirect research and development expenses that are allocated to our product candidates or programs consist of lab supplies and software fees. A significant portion of our research and development expenses are not allocated to individual product candidates and preclinical programs, as certain expenses benefit multiple product candidates and pre-clinical programs. For example, we do not allocate costs associated with stock-based compensation, manufacturing of preclinical or clinical development products or costs relating to facilities and equipment to individual product candidates and preclinical programs. 28 The following table summarizes our research and development expenses by product candidate or program, and for unallocated expenses, by type, for the three months ended September 30, 2023 and 2022: Three Months Ended September 30, (in thousands) 2023 2022 Change KB103 (1) $ 1,749 $ 2,330 $ (581) KB105 7 7 — KB407 441 585 (144) KB301 150 549 (399) KB707 1,265 68 1,197 Other dermatology programs 1 437 (436) Other respiratory programs 340 128 212 Other aesthetics programs 9 42 (33) Other research programs 172 232 (60) Other development programs 160 175 (15) Stock-based compensation 2,336 2,184 152 Other unallocated manufacturing expenses (2) 2,682 3,639 (957) Other unallocated expenses (3) 1,317 1,140 177 Research and development expense $ 10,629 $ 11,516 $ (887) (1) For the three months ended September 30, 2023, KB103 expenses consist of post marketing study costs and overseas preclinical and clinical trial costs, licensing and regulatory costs. (2) Unallocated manufacturing expenses consist of shared pre-commercial manufacturing costs, primarily relating to raw materials, contract manufacturing, contract testing, process development, quality control and quality assurance activities and other manufacturing costs which support the development of multiple product candidates in our preclinical and clinical development programs. (3) Other unallocated expenses include rental, storage, depreciation, and other facility related costs that we do not allocate to our individual product candidates. As noted above, research and development expenses decreased $887 thousand in the three months ended September 30, 2023 compared to the three months ended September 30, 2022. Expenses for KB103 decreased $581 thousand following the U.S. commercial launch of VYJUVEK. Other unallocated manufacturing expenses decreased $957 thousand due to the costs related to the manufacturing of VYJUVEK following FDA approval being recorded as inventory and fewer receipts of raw materials period over period that were purchased for planned manufacturing runs of the Company’s products. Other Dermatology decreased $436 thousand due to a reduction in contract manufacturing expenses. These decreases were partially offset by an increase in expenses for KB707 of $1.2 million due primarily to increased internal resources and other payroll related costs to support continued research and increases in contract research expenses in preparation for the Phase 1 clinical trial. Selling, General, and Administrative Expenses Selling, general, and administrative expenses increased $3.8 million in the three months ended September 30, 2023 as compared to the three months ended September 30, 2022. Higher selling, general, and administrative spending was due largely to increases in payroll related expenses of approximately $2.2 million, which was primarily driven by an increase in headcount in our commercial and other administrative functions to support overall growth and preparation for commercialization, and includes an offsetting $900 thousand decrease in stock-based compensation due to the departure of certain employees, increased selling expenses related to the launch of VYJUVEK of $733 thousand, increased travel related costs of $452 thousand, increased information technology infrastructure costs of $423 thousand, increased software-related costs of $377 thousand, increased legal and professional costs of $327 thousand, and a $189 thousand increase in other selling, general, and administrative expenses. These increases were partially offset by a decrease in marketing costs of $921 thousand due to the timing of marketing activities ahead of the VYJUVEK launch. 29 Gain from sale of Priority Review Voucher (“PRV”) Gain from sale of priority review voucher for the three months ended September 30, 2023 was $100.0 million and is related to the sale of our rare pediatric disease PRV, which was awarded to the Company in connection with the FDA’s approval of VYJUVEK. Interest and Other Income Interest and other income for the three months ended September 30, 2023 and 2022 was $6.7 million and $1.6 million, respectively, and consisted of interest and dividend income earned from our cash, cash equivalents and investments. The increase in interest and dividend income is the result of increased investment activity and more favorable interest rates as compared to the prior period and an increase in our balance of cash, cash equivalents, and investments. Nine Months Ended September 30, 2023 and 2022 Nine Months Ended September 30, 2023 2022 Change (In thousands) (unaudited) Product revenues, net $ 8,556 $ — $ 8,556 Expenses: Cost of goods sold 223 — 223 Research and development 35,061 31,720 3,341 Selling, general, and administrative 73,637 53,705 19,932 Litigation settlement 12,500 25,000 (12,500) Total operating expenses 121,421 110,425 10,996 Loss from operations (112,865) (110,425) (2,440) Other income: Gain from sale of priority review voucher 100,000 — 100,000 Interest and other income, net 15,105 902 14,203 Net income (loss) $ 2,240 $ (109,523) $ 111,763 Products Revenues, net Product revenues, net was $8.6 million for the nine months ended September 30, 2023 as compared to zero for the nine months ended September 30, 2022 due to initial sales of VYJUVEK after FDA approval was obtained on May 19, 2023. As VYJUVEK was approved by the FDA in May 2023, there were no comparative period revenues. To date, all of our product revenue has been generated in the United States. Cost of Goods Sold Cost of goods sold was $223 thousand for the nine months ended September 30, 2023 as compared to zero for the nine months ended September 30, 2022 due to initial sales of VYJUVEK after FDA approval was obtained on May 19, 2023. Due to the timing of FDA approval and our manufacturing schedule, a majority of the costs associated with VYJUVEK inventory manufactured for the commercial launch were previously expensed as research and development. Prior to receiving FDA approval for VYJUVEK in May 2023, costs associated with the manufacturing of VYJUVEK were expensed as research and development expense. As such, a portion of the cost of inventory sold during the period was expensed prior to FDA approval. Research and Development Expenses Research and development expenses increased $3.3 million in the nine months ended September 30, 2023 compared to the nine months ended September 30, 2022. The increase was primarily due to increased payroll related expenses of $5.5 million, which were primarily driven by an increase in headcount to support overall growth and includes a $2.1 million increase in stock-based compensation, an increase in depreciation of $1.8 million, and increased other research and development expenses of $877 thousand primarily due to facilities costs and licenses and regulatory fees. These increases were partially offset by decreases in preclinical, clinical and pre-commercial manufacturing expenses of $4.0 million, due to the costs related to the manufacturing of VYJUVEK following FDA approval being recorded as inventory and due to fewer receipts of raw materials and lab supplies period over period that were purchased for planned manufacturing runs of our products, a decrease of 30 $635 thousand from overhead allocations to inventory, and a decrease in outsourced research and development of $338 thousand. The following table summarizes our research and development expenses by product candidate or program, and for unallocated expenses, by type, for the nine months ended September 30, 2023 and 2022: Nine Months Ended September 30, (in thousands) 2023 2022 Change KB103 (1) 6,311 5,672 $ 639 KB105 260 116 144 KB407 1,259 1,522 (263) KB301 480 923 (443) KB707 2,633 66 2,567 Other dermatology programs 15 491 (476) Other respiratory programs 749 531 218 Other aesthetics programs 23 109 (86) Other research programs 429 672 (243) Other development programs 689 461 228 Stock-based compensation 7,695 5,547 2,148 Other unallocated manufacturing expenses (2) 10,207 12,611 (2,404) Other unallocated expenses (3) 4,311 2,999 1,312 Research and development expense $ 35,061 $ 31,720 $ 3,341 (1) For the nine months ended September 30, 2023, KB103 expenses included costs related to post market study costs and overseas preclinical and clinical trial costs, licensing and regulatory costs. (2) Unallocated manufacturing expenses consist of shared pre-commercial manufacturing costs, primarily relating to raw materials, contract manufacturing, contract testing, process development, quality control and quality assurance activities and other manufacturing costs which support the development of multiple product candidates in our preclinical and clinical development programs. (3) Other unallocated expenses include rental, storage, depreciation, and other facility related costs that we do not allocate to our individual product candidates. As noted above, research and development expenses increased $3.3 million in the nine months ended September 30, 2023 compared to the nine months ended September 30, 2022. Expenses for KB103 increased $639 thousand, due to increased payroll related expenses to support VYJUVEK’s pre-approval activities, clinical trial costs, license and regulatory costs, costs associated with overseas clinical trials and regulatory agency filings, and increased allocated research and development expenses. Due to the expansion of our research and development pipeline to oncology, KB707 spending increased $2.6 million primarily due to increased payroll related costs and increased contract research costs in preparation for the Phase 1 clinical trial. Stock-based compensation increased $2.1 million due to an increase in internal resources to support overall research and development growth. Additionally, other unallocated expenses increased $1.3 million primarily related to increases in depreciation expense. These increases were offset by a decrease in other unallocated manufacturing expenses of $2.4 million due to the costs related to the manufacturing of VYJUVEK following FDA approval being recorded as inventory and due to fewer receipts of raw materials period over period that were purchased for planned manufacturing runs of our products and a $443 thousand decrease in KB301 due to the reduction of clinical research costs. Selling, General, and Administrative Expenses Selling, general, and administrative expenses increased $19.9 million in the nine months ended September 30, 2023 as compared to the nine months ended September 30, 2022. Higher selling, general, and administrative spending was due largely to increases in payroll related expenses of approximately $15.1 million, which was primarily driven by an increase in headcount in our commercial and other administrative functions to support overall growth and preparation for commercialization, and includes a $4.3 million increase in stock-based compensation, increased information technology infrastructure costs of $1.6 million, increased software-related costs of $1.0 million, increased travel related costs of $957 thousand, increased selling expenses related to the commercial launch of VYJUVEK of $733 thousand, increased legal and professional costs of $418 thousand, increased marketing costs of $401 thousand, and an increase in other selling, general, and administrative expenses of $769 thousand, which consisted primarily of increased conference costs and utilities costs. These increases were partially offset by decreases in business development costs of $531 thousand and medical affairs costs of $511 thousand. 31 Litigation Settlement Litigation settlement for the nine months ended September 30, 2023 and 2022 was $12.5 million and $25.0 million, respectively, and consisted of amounts related to the settlement of litigation with PeriphaGen. See "Legal Proceedings" in Note 7 of the notes to condensed consolidated financial statements included in this Form 10-Q for more information. Gain from sale of Priority Review Voucher Gain from sale of priority review voucher for the nine months ended September 30, 2023 was $100 million related to the sale of our rare pediatric PRV, which was awarded to the Company in connection with the FDA’s approval of VYJUVEK. Interest and Other Income Interest and other income for the nine months ended September 30, 2023 and 2022 was $15.1 million and $2.5 million, respectively, and consisted of interest and dividend income earned from our cash, cash equivalents and investments. The increase in interest and dividend income is the result of increased investment activity and more favorable interest rates as compared to the prior period and an increase in our balance of cash, cash equivalents, and investments. 32 Liquidity and Capital Resources Overview At September 30, 2023, our cash, cash equivalents and short-term investments balance was approximately $562.1 million. Since operations began, we have incurred operating losses. At September 30, 2023, we had an accumulated deficit of $278.5 million. We believe that our cash, cash equivalents and short-term investments as of September 30, 2023 will be sufficient to allow us to fund operations for at least 12 months from the filing date of this Quarterly Report on Form 10-Q. As we continue to incur operating losses, a transition to operating profitability is dependent upon the successful commercialization of VYJUVEK and the successful development, approval and commercialization of our product candidates and the achievement of a level of revenues adequate to support our cost structure. Furthermore, we expect to incur increasing costs associated with satisfying regulatory and quality standards, maintaining product and clinical trials, and furthering our efforts around our current and future product candidates. We may never achieve operating profitability, and unless and until we do, we will continue to need to raise additional capital or obtain financing from other sources. 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 KB105, KB407, KB301, KB707 or our planned clinical and preclinical studies for our other product candidates, or our operations. Further, we expect future revenue to fluctuate from quarter to quarter for many reasons, including the uncertain timing and amount of any product sales. 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 some of our clinical development activities. As we seek to obtain regulatory approval for our product candidates, we expect to continue to incur significant manufacturing and commercialization expenses as we prepare for product sales, marketing, commercial manufacturing, packaging, labeling and distribution. Furthermore, pursuant to our settlement agreement with PeriphaGen, we paid $12.5 million upon the approval of VYJUVEK by the FDA, and will be required to pay three additional $12.5 million contingent milestone payments upon reaching $100.0 million in total cumulative sales, $200.0 million in total cumulative sales and $300.0 million in total cumulative sales. Our funds may not be sufficient to enable us to conduct pivotal clinical trials for, seek marketing approval for or commercial launch of KB105, KB407, KB408, KB301, KB707 or any other product candidate. Accordingly, to obtain marketing approval for and to commercialize these 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. 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, regulatory expenses, third-party clinical trial research and development services, laboratory and related supplies, selling expenses, costs to manufacture our commercial product, legal expenses, payments of settlement amounts to PeriphaGen and general overhead costs. 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 may require substantial additional funding. 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 costs needed to commercialize and market our lead product, VYJUVEK; • the progress, timing and costs of clinical trials of our current product candidates; • the progress, timing and costs of manufacturing of VYJUVEK and revenue received from commercial sale of VYJUVEK; • the continued development and the filing of an IND application for current and future product candidates; • the initiation, scope, progress, timing, costs and results of drug discovery, laboratory testing, manufacturing, preclinical studies and clinical trials for any product candidates that we may pursue in the future, if any; • the costs of maintaining our own commercial-scale CGMP manufacturing facilities; • the outcome, timing and costs of seeking regulatory approvals; 33 • the costs associated with the manufacturing process development and evaluation of third-party manufacturers; • 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 our current and future product candidates if we receive marketing approval for such product candidates, 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; • the amount and timing of any payments we may be required to make, or that we may receive, in connection with the licensing, filing, prosecution, maintenance, defense and enforcement of any patents or other intellectual property rights, including milestone and royalty payments and patent prosecution fees that we are obligated to pay pursuant to our license agreements; • our current license agreements remaining in effect and our achievement of milestones under those agreements; • our ability to establish and maintain collaborations and licenses on favorable terms, if at all; and • the extent to which we acquire or in-license other product candidates and technologies. We may 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 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. Sources and Uses of Cash The following table summarizes our sources and uses of cash for the nine months ended September 30, 2023 and 2022 (in thousands): Nine Months Ended September 30, 2023 2022 (unaudited) Net cash used in operating activities (81,572) (78,240) Net cash provided by (used in) investing activities 92,798 (108,875) Net cash provided by financing activities 200,131 32,278 Effect of exchange rate changes on cash and cash equivalents (16) — Net increase (decrease) in cash $ 211,341 $ (154,837) Operating Activities Net cash used in operating activities for the nine months ended September 30, 2023 was $81.6 million and consisted primarily of net income of $2.2 million adjusted for non-cash items primarily comprised of a gain on sale of the rare pediatric PRV of $100.0 million, stock-based compensation expense of $30.1 million, depreciation and amortization of $2.6 million and other adjustments of $4.3 million, and cash used by increases in net working capital of approximately $12.2 million. Net cash used in operating activities for the nine months ended September 30, 2022 was $78.2 million and consisted primarily of a net loss of $107.9 million adjusted for non-cash items primarily comprised of depreciation and amortization and 34 stock-based compensation expense of $26.4 million, and including net changes in operating assets and liabilities of approximately $3.2 million. Investing Activities Net cash provided by investing activities for the nine months ended September 30, 2023 was $92.8 million and consisted primarily of proceeds of $100.0 million from the sale of the rare pediatric PRV and $428.6 million received from the maturities of short-term investments, partially offset by expenditures of $10.0 million on the build-out of our ASTRA facility, leasehold improvement of new office space, and purchases of computer and laboratory equipment, and $425.9 million on the purchase of short-term and long-term investments. Net cash used in investing activities for the nine months ended September 30, 2022 was $108.9 million and consisted primarily of expenditures of $47.8 million on the build-out of our ASTRA facility, leasehold improvement of new office space, and purchases of computer and laboratory equipment, $214.7 million on the purchase of short-term and long-term investments, partially offset by proceeds of $153.6 million received from the maturities of short-term investments. Financing Activities Net cash provided by financing activities for the nine months ended September 30, 2023 was $200.1 million and consisted primarily of proceeds of $160.0 million received from a private placement equity offering and proceeds of $40.9 million primarily from exercises of stock options, partially offset by $749 thousand used for the employee tax withholding payment for settlement of vested restricted stock awards. Net cash provided by financing activities for the nine months ended September 30, 2022 was $32.3 million and consisted primarily of proceeds of $32.9 million received from our ATM Program and exercises of stock options and offset by $649 thousand used for the employee tax withholding payment for settlement of vested restricted stock awards. 35