Item 7. Management’s Discussion and Analysis
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Management’s Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is intended to provide information to assist you in better understanding and evaluating our financial condition and results of operations. We encourage you to read this MD&A in conjunction with our consolidated financial statements and the notes thereto included in Part II, Item 8 of this Annual Report on Form 10-K. This discussion contains forward-looking statements that involve risks and uncertainties. Please refer to the information under the heading "Cautionary Note Regarding Forward-Looking Statements" elsewhere in this report. References to the words "we," "our," "us," and the "Company" in this report refer to NovoCure Limited, including its consolidated subsidiaries .
Overview
We are a global oncology company with a proprietary platform technology called Tumor Treating Fields ("TTFields"), which are electric fields tuned to specific frequencies that disrupt cancer cell division. Our key priorities are to drive commercial adoption of Optune and Optune Lua, our commercial TTFields delivery systems, and to advance clinical and product development programs intended to extend overall survival in some of the most aggressive forms of cancer.
Optune is approved by the U.S. Food and Drug Administration ("FDA") under the Premarket Approval ("PMA") pathway for the treatment of adult patients with newly diagnosed GBM in combination with temozolomide, a chemotherapy drug, and for adult patients with GBM following confirmed recurrence after chemotherapy as monotherapy treatment. We also have approval or a CE certificate to market Optune for the treatment of GBM in the European Union ("EU"), Japan and certain other countries. We market Optune in the U.S., Austria, Germany, Israel, Japan, Sweden and Switzerland, which we refer to as our "active markets." With respect to GBM, our sales and marketing efforts are principally focused on driving adoption with both neuro-oncologists and radiation oncologists. We are expanding our commercial operations into France with an initial focus on developing key opinion leader relationships in GBM and establishing a path to reimbursement for our Products.
Optune Lua is approved by the FDA under the Humanitarian Device Exemption ("HDE") pathway to treat MPM in combination with standard chemotherapies. We have received CE certification to market Optune Lua (under the name " NovoTTF-100L ") in the EU and Switzerland. We currently market Optune Lua in the U.S., and are evaluating plans to expand access to our therapy for MPM patients in other markets. With respect to MPM, our commercial efforts are principally focused on generating awareness and on establishing a dialogue with third-party payers around access to Optune Lua.
We believe the mechanism of action behind TTFields therapy may be broadly applicable to solid tumor cancers. Currently, we are conducting phase 3 pivotal trials evaluating the use of TTFields in brain metastases from non-small-cell lung cancer ("brain metastases"), non-small-cell lung cancer ("NSCLC"), ovarian cancer and pancreatic cancer. In 2020, we enrolled our first patient in our global phase 4 TRIDENT trial to test the potential survival benefit of initiating Optune concurrent with radiation therapy versus following radiation therapy in patients with newly diagnosed GBM. We are also conducting phase 2 pilot trials evaluating the use of TTFields in liver cancer and gastric cancer, as well as testing the potential incremental survival benefit of TTFields delivered using high-intensity arrays versus standard arrays. We anticipate expanding our clinical pipeline over time to study the safety and efficacy of TTFields for additional solid tumor indications and combinations with other cancer treatment modalities. In the second quarter of 2021, we plan to launch the KEYNOTE B36 phase 2 pilot trial to study TTFields with pembrolizumab in first-line NSCLC through our clinical trial collaboration with MSD (a tradename of Merck & Co., Inc.).
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The table below presents the current status of the ongoing clinical trials in our pipeline and anticipated timing of final data.
Our therapy is delivered through a medical device and we continue to advance our Products with the intention to extend survival and maintain quality of life for patients. We have several product development programs underway that prioritize impact on both TTFields' dose and patient ease of use. Our intellectual property portfolio contains over 185 issued patents and numerous patent applications pending worldwide. We believe we own global commercialization rights to our Products in oncology and are well-positioned to extend those rights into the future as we continue to find innovative ways to improve our Products.
In 2018, we granted Zai Lab (Shanghai) Co., Ltd. ("Zai") a license to commercialize Optune in China, Hong Kong, Macau and Taiwan ("Greater China") under a License and Collaboration Agreement (the "Zai Agreement"). The Zai Agreement also establishes a development partnership intended to accelerate the development of TTFields in multiple solid tumor cancer indications. For additional information, see Note 12 to the Consolidated Financial Statements.
Impact of COVID-19
In March 2020, the World Health Organization (“WHO”) declared COVID-19 a global pandemic. Since the pandemic began, we have been following the guidance of the WHO, the U.S. Centers for Disease Control and Prevention, and local health authorities in all of our active markets and we have adjusted the way we conduct business to adapt to the evolving situation. The COVID-19 pandemic did not have a material impact on our financial results throughout 2020. The pandemic has had and is having an impact on our day-to-day operations, which varies by region based on factors such as geographical spread, stage of containment and recurrence of the pandemic in each region. We believe the prolonged disruption caused by COVID-19 is resulting in increased volatility across global health care systems, such as fluctuations in patient volumes and changes in patterns of care in certain regions, which is currently impacting and might continue to impact our business and clinical trials in the future. For example, we continue to see fluctuations in the timing of surgeries and radiation therapy in certain regions, which has had some adverse influence on the eligible patient population for Optune. TTFields is an emerging modality in cancer care and requires significant educational effort to drive awareness and acceptance of our therapy. We have relied heavily on virtual engagement to manage these educational efforts for nearly a year, which poses challenges to our ability to effectively communicate and engage with our customers and partners around the world.
Given the aggressive nature of the cancers that we treat, we believe that the fundamental value proposition of the TTFields platform remains unchanged. We continue to evaluate and plan for the potential effects of COVID-19 on our business moving forward. The extent to which the COVID-19 pandemic may impact our business and clinical trials in the future will depend on further developments, which are highly uncertain and cannot be predicted with
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confidence. The COVID-19 pandemic may also heighten many of the other risks described in our risk factors disclosed in this Annual Report.
We view our operations and manage our business in one operating segment. Our net revenues were $494.4 million for the year ended December 31, 2020, $351.3 million for the year ended December 31, 2019 and $248.1 million for the year ended December 31, 2018. Our net income was $19.8 million for the year ended December 31, 2020 and net loss $7.2 million for the year ended December 31, 2019 and $63.6 million for the year ended December 31, 2018. As of December 31, 2020, we had an accumulated deficit of $631.1 million. Our net income resulted primarily from net revenue growth coupled with an ongoing commitment to disciplined management of expenses.
Commentary on Results of Operations
Net revenues
Our revenues are primarily derived from patients using our Products in our active markets. We charge for treatment with our Products on a monthly basis. Our potential net revenues per patient are determined by our ability to secure payment, the monthly fee we collect and the number of months that the patient remains on therapy.
We also receive revenues pursuant to the Zai Agreement. For additional information regarding the Zai Agreement, see Note 12 to the Consolidated Financial Statements.
Cost of revenues
We contract with third parties to manufacture our Products. Our cost of revenues is primarily comprised of the following:
• disposable arrays;
• depreciation expense for the field equipment, including the electric field generator used by patients; and
• personnel and overhead costs such as facilities, freight and depreciation of property, plant and equipment associated with managing our inventory, warehousing and order fulfillment functions.
Operating expenses
Our operating expenses consist of research, development and clinical trials, sales and marketing and general and administrative expenses. Personnel costs are a significant component for each category of operating expenses and consist of wages, benefits and bonuses. Personnel costs also include share-based compensation.
Research, development and clinical trials
Our research, development and clinical trials activity is focused on advancing TTFields through clinical trials across multiple solid tumor types and improving the efficacy and usability of our delivery systems. Research, development and clinical trials costs, including direct and allocated expenses, are expensed as incurred and consist primarily of the following:
• personnel costs for those employees involved in our preclinical and basic research, clinical development programs, medical affairs, product development and regulatory activities;
• costs to conduct research, product development and clinical trial activity through agreements with contract research organizations and other third parties;
• manufacturing expenses associated with our Products, including durable components and disposable arrays, utilized in clinical trials and other research;
• costs associated with medical grants, publications, presentations and investigator-sponsored trials;
• professional fees related to regulatory approvals and conformity assessment procedures; and
• facilities, depreciation and other allocated expenses, which include direct and allocated expenses for rent and maintenance of facilities, depreciation of leasehold improvements and equipment and laboratory and other supplies.
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The following table summarizes our research, development and clinical trial expenses by program for the years ended December 31, 2020, 2019 and 2018:
Year ended December 31,
U.S. dollars in thousands 2020 2019 2018
Preclinical and basic research $ 12,079 $ 6,874 $ 4,132
Clinical development programs:
METIS 5,147 4,699 3,640
LUNAR 8,261 7,243 4,326
PANOVA - 3 7,033 5,368 3,076
INNOVATE - 3 14,190 4,822 510
TRIDENT 3,709 424 —
Other clinical trials 2,764 1,726 1,941
Clinical administration 13,158 8,834 8,075
Product development 9,710 4,944 3,367
Medical affairs 21,058 15,531 7,714
Other research and development costs (1) 34,901 18,538 13,793
Research, development and clinical trials $ 132,010 $ 79,003 $ 50,574
(1) Other research, development and clinical trial costs include regulatory affairs, quality assurance, intellectual property, product safety, allocated facilities, other overhead costs and share-based compensation.
We are committed to investing strategically to maximize the growth potential of the TTFields platform. We expect growth in our research and development investments to continue into 2021 as we work to advance our pipeline programs and increase acceptance of Tumor Treating Fields across the global oncology community.
Sales and marketing
Sales and marketing expenses consist primarily of personnel costs, travel, marketing and promotional activities, commercial shipping and facilities costs. Over the next few years, we expect to continue to make significant expenditures associated with selling and marketing our Products, primarily in connection with continued commercialization in the United States, EU and Japan for the treatment of our approved indications.
General and administrative
General and administrative expenses consist primarily of personnel, professional fees and facilities costs. General and administrative personnel costs include our executive, finance, human resources, information technology and legal functions. These costs also include our contributions to support industry and patient groups. Our professional fees consist primarily of accounting, information technology, legal and other consulting costs. We expect that general and administrative expenses will increase to support our growth. In addition, we incur significant legal and accounting costs related to compliance with SEC rules and regulations, including the costs of achieving and maintaining compliance with Section 404 of the Sarbanes-Oxley Act of 2002 and compliance with rules of the NASDAQ Stock Market, as well as insurance, investor relations and other costs associated with being a public company.
Financial expenses, net
Financial expenses, net primarily consists of credit facility interest expense and related debt issuance costs, interest income from cash balances and short-term investments and gains (losses) from foreign currency transactions. Our reporting currency is the U.S. dollar. We have historically held substantially all of our cash balances in U.S. dollar denominated accounts to minimize the risk of translational currency exposure.
Critical accounting policies and estimates
In accordance with U.S. GAAP, in preparing our financial statements we must make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of net revenues and expenses during the reporting period. We develop and periodically change these estimates and assumptions based on historical experience and on various
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other factors that we believe are reasonable under the circumstances. Actual results may differ from these estimates.
The critical accounting policies requiring estimates, assumptions and judgments that we believe have the most significant impact on our consolidated financial statements are described below.
Revenue recognition
In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2014-09, Revenue from Contracts with Customers (Topic 606) (ASU 2014-09), an updated standard on revenue recognition and issued subsequent amendments to the initial guidance in March 2016, April 2016, May 2016 and December 2016 within ASU 2016-08, 2016-10, 2016-12 and 2016-20, respectively. The Company adopted the standard effective January 1, 2018 using the modified retrospective method for all contracts. The reported results for 2018 and thereafter reflect the application of Accounting Standards Codification ("ASC") 606 guidance while the reported results for 2017 were prepared under the guidance of ASC 605, Revenue Recognition (ASC 605). The amount of revenue recognized in 2018 and 2019 reflects the consideration to which the Company expects to be entitled to receive in exchange for our Products. The adoption of this standard did not have a material impact on our financial position, results of operations or cash flows. For additional information, see Note 2(m) to the Consolidated Financial Statements.
We also receive revenues pursuant to the Zai Agreement. For additional information regarding the Zai Agreement, see Note 12 to the Consolidated Financial Statements.
Share-based compensation
Under the FASB's ASC 718, Compensation-Stock Compensation, we measure and recognize compensation expense for share options granted to our employees and directors and for our ESPP based on the fair value of the awards on the date of grant. The fair value of share options is estimated at the date of grant using the Black-Scholes option pricing model and for market condition awards we also use the Monte-Carlo simulation model. Both models requires management to apply judgment and make estimates, including:
• the expected term of the stock option award, which we calculate using the simplified method, in accordance with ASC No.718-10-S99-1 (SAB No. 110) as we have insufficient historical information regarding our stock options to provide a basis for an estimate;
• the expected share price volatility of our underlying ordinary shares, which we estimate based on the historical volatility of a representative group of publicly traded biopharmaceutical and medical technology companies with similar characteristics to us for a period matching the expected term assumption when there is not sufficient historical information for our ordinary shares;
• the risk-free interest rate, which we base on the yield curve of U.S. Treasury securities with periods commensurate with the expected term of the options being valued; and
• the expected dividend yield, which we estimate to be zero based on the fact that we have never paid cash dividends and have no present intention to pay cash dividends.
For information about our ESPP, see Note 14(b) to the Consolidated Financial Statements.
We recognize share-based compensation costs only for those shares expected to vest over the requisite vesting period of the award, which is generally the option vesting term of four years, using the accelerated method.
The table below summarizes the assumptions that were used to estimate the fair value of the options granted to employees during the periods presented:
Year ended December 31,
2020 2019 2018
Expected term (years) 5.50-6.00 5.50-6.00 5.50-6.25
Expected volatility 54%-56% 55%-61% 52%-55%
Risk-free interest rate 0.30%-0.86% 1.73%-2.40% 2.70%-2.99%
Dividend yield 0.00% 0.00% 0.00%
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If any of the assumptions used in the Black-Scholes option pricing model change significantly, share-based compensation for future awards may differ materially from the awards granted previously.
So long as our ordinary shares are publicly traded in a liquid market, we will rely on the daily trading price of our ordinary shares when we estimate the fair value of options granted.
We incurred share-based compensation expense of $75.7 million, $52.4 million and $39.8 million during the years ended December 31, 2020, 2019 and 2018, respectively. As of December 31, 2020, we have unrecognized compensation expense of $96.3 million, which is expected to be recognized over a weighted average period of approximately 2.9 years. We expect to continue to grant equity awards in the future, and to the extent that we do, our recognized share-based compensation expense will likely increase. For additional information, see Note 14(b) to the Consolidated Financial Statements.
Long-lived assets
Property and equipment and field equipment are stated at cost, net of accumulated depreciation. Depreciation is calculated using the straight-line method over the estimated useful life of the relevant asset. We make estimates of the useful life of our property and equipment and field equipment, based on similar assets purchased in the past and our historical experience with such similar assets, in order to determine the depreciation expense to be recorded for each reporting period.
Our field equipment consists of equipment being utilized under rental agreements accounted for on a monthly basis as an operating lease, as well as service pool equipment. Service pool equipment is equipment owned and maintained by us that is swapped for equipment that needs repair or maintenance by us while being used by a patient. We record a provision for any excess, lost or damaged equipment when warranted based on an assessment of the equipment.
We assess impairment whenever events or changes in circumstances indicate that the carrying amount of the asset is impaired or the estimated useful life is no longer appropriate. Circumstances such as changes in technology or in the way an asset is being used may trigger an impairment review. For additional information, see Notes 2(i) and 2(j) to the Consolidated Financial Statements.
Inventories
Inventories are stated at the lower of cost or net realizable value. We regularly evaluate the ability to realize the value of inventory. If the inventories are deemed damaged, if actual demand for our delivery systems declines, or if market conditions are less favorable than those projected, inventory write-offs may be required. For additional information, see Note 2(h) to the Consolidated Financial Statements.
Income taxes
As part of the process of preparing our consolidated financial statements, we are required to calculate our income taxes based on taxable income by jurisdiction. We make certain estimates and judgments in determining our income taxes, including assessment of our uncertain tax positions, for financial statement purposes. Significant changes to these estimates may result in an increase or decrease to our tax provision in the subsequent period when such a change in estimate occurs.
Uncertain tax positions are based on estimates and assumptions that have been deemed reasonable by management. Our estimates of unrecognized tax benefits and potential tax benefits may not be representative of actual outcomes.
For additional information, see Note 13 to the Consolidated Financial Statements.
Recently issued accounting pronouncements
For a description of our recently issued accounting pronouncements, see Note 2(aa) to the Consolidated Financial Statements.
Results of operations
The following discussion provides an analysis of our results of operations and reasons for material changes therein for 2020 as compared to 2019. See "Results of Operations" in Part II, Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations in the Company's 2019 Annual Report on Form 10-K, filed with the SEC on February 27, 2020, for an analysis of the 2019 results as compared to 2018.
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The following table sets forth our consolidated statements of operations data:
Year ended December 31,
U.S. dollars in thousands, except share and per share data 2020 2019 2018
Net revenues $ 494,366 $ 351,318 $ 248,069
Cost of revenues 106,501 88,606 80,048
Gross profit 387,865 262,712 168,021
Operating costs and expenses:
Research, development and clinical trials 132,010 79,003 50,574
Sales and marketing 118,017 96,675 77,663
General and administrative 107,437 87,948 73,456
Total operating costs and expenses 357,464 263,626 201,693
Operating income (loss) 30,401 (914) (33,672)
Financial expenses (income), net 12,299 7,910 12,270
Income (loss) before income tax 18,102 (8,824) (45,942)
Income tax (1,706) (1,594) 17,617
Net income (loss) $ 19,808 $ (7,230) $ (63,559)
Basic net income (loss) per ordinary share $ 0.20 $ (0.07) $ (0.69)
Weighted average number of ordinary shares used in computing basic net income (loss) per share 100,930,866 97,237,549 91,828,043
Diluted net income (loss) per ordinary share $ 0.18 $ (0.07) $ (0.69)
Weighted average number of ordinary shares used in computing diluted net income (loss) per share 108,877,648 97,237,549 91,828,043
The following table details the share-based compensation expense included in costs and expenses:
Year ended December 31,
U.S. dollars in thousands 2020 2019 2018
Cost of revenues $ 2,221 $ 2,231 $ 1,261
Research, development and clinical trials 18,125 7,570 4,709
Sales and marketing 17,672 11,897 7,393
General and administrative 37,703 30,718 26,483
Total share-based compensation expense $ 75,721 $ 52,416 $ 39,846
Key performance indicators
We believe certain commercial operating statistics are useful to investors in evaluating our commercial business as they help investors evaluate and compare the adoption of our Products from period to period. The number of active patients on therapy is our principal revenue driver. An "active patient" is a patient who is receiving treatment under a commercial prescription order as of the measurement date, including patients who may be on a temporary break from treatment and who plan to resume treatment in less than 60 days. Prescriptions are a leading indicator of demand. A "prescription received" is a commercial order for Optune or Optune Lua that is received from a physician certified to treat patients with our Products for a patient not previously on Optune or Optune Lua. Orders to renew or extend treatment are not included in this total.
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The following table includes certain commercial operating statistics for and as of the end of the periods presented.
December 31,
Operating statistics 2020 2019 2018
Active patients at period end
United States 2,193 1,952 1,637
EMEA:
Germany 562 493 439
Other EMEA 391 272 215
Japan 265 192 92
Total 3,411 2,909 2,383
Year ended December 31,
2020 2019 2018
Prescriptions received in period
United States 3,871 3,833 3,741
EMEA:
Germany 910 872 858
Other EMEA 467 360 299
Japan 365 306 162
Total 5,613 5,371 5,060
In the U.S., there were 16 active MPM patients on therapy as of December 31, 2020 and 55 MPM prescriptions were received in the year ended December 31, 2020.
Year ended December 31, 2020 compared to year ended December 31, 2019
The following discussion provides an analysis of our results of operations and reasons for material changes therein for 2020 as compared to 2019. See "Results of Operations" in Part II, Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations in the Company's 2019 Annual Report on Form 10-K, filed with the SEC on February 27, 2019 (the "2019 Annual Report"), for analysis of the 2019 results as compared to 2018.
Year ended December 31,
2020 2019 Change % Change
Net revenues $ 494,366 $ 351,318 $ 143,048 41 %
Net revenues. Net revenues increased by $143.0 million, or 41%, to $494.4 million for the year ended December 31, 2020 from $351.3 million for the year ended December 31, 2019. This was primarily due to an increase of 502 active patients in our active markets, representing 17% growth, and an increase in the net revenues per active patient per month. The increase in net revenues per active patient per month was primarily driven by improving reimbursement approval rates in the U.S.
For the year ended December 31, 2020, we recorded $36 million in revenues from Medicare fee-for-service beneficiaries billed under the coverage policy compared to $6 million for the year ended December 31, 2019. We have gained a good understanding of how to ensure timely processing of Medicare claims and have sufficient experience to recognize approximately two-thirds of the expected contribution from Medicare beneficiaries.
We also recognized approximately $19 million in incremental net revenues in the second half of 2020 compared to the first half of 2020 resulting from the successful appeal of previously denied claims for Medicare fee-for-service beneficiaries billed prior to established coverage.
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Year ended December 31,
2020 2019 Change % Change
Cost of revenues $ 106,501 $ 88,606 $ 17,895 20 %
Cost of revenues. Our cost of revenues increased by $17.9 million, or 20%, to $106.5 million for the year ended December 31, 2020 from $88.6 million for the year ended December 31, 2019. The increase in cost of revenues was primarily due to the cost of shipping arrays to a higher volume of commercial patients. Excluding sales to Zai, cost of revenues per active patient per month decreased 3% to $2,602 for the year ended December 31, 2020 from $2,694 for the year ended December 31, 2019 due to on-going efficiency initiatives and scale.
Cost of revenues per active patient is calculated by dividing the cost of revenues for the year less product sales to Zai for the year by the average of the active patients at the end of the each quarter in the current year and the end of the year active patients from the prior year. This annual figure is then divided by twelve to estimate the monthly cost of revenues per active patient. Sales to Zai are deducted because they are made at cost and in anticipation of future royalties from Zai, and Zai patient counts are not included in our active patient population. Product sales to Zai totaled $6.3 million for the year ended December 31, 2020 compared to $2.0 million for the year ended December 31, 2019.
Gross margin was 78% for the year ended December 31, 2020 and 75% for the year ended December 31, 2019. Gross margin continues to benefit from ongoing efficiency initiatives and increasing scale. Gross margin is also improved with revenue resulting from the successful appeal of previously denied claims for Medicare fee-for-service beneficiaries and tempered by product sales to Zai.
Year ended December 31,
2020 2019 Change % Change
Operating expenses:
Research, development and clinical trials $ 132,010 $ 79,003 $ 53,007 67 %
Sales and marketing 118,017 96,675 21,342 22 %
General and administrative 107,437 87,948 19,489 22 %
Total operating expenses $ 357,464 $ 263,626 $ 93,838 36 %
Research, development and clinical trials expenses. Research, development and clinical trials expenses increased by $53.0 million, or 67%, to $132.0 million for the year ended December 31, 2020 from $79.0 million for the year ended December 31, 2019. The change is primarily due to increased investments in clinical trials and clinical administration personnel to advance and broaden our clinical development programs, preclinical and basic research to better understand the optimal use of TTFields, product development intended to optimize the delivery of TTFields therapy, and expanded medical affairs efforts to educate the clinical community.
We expect growth in our research and development investments to continue into 2021 as we work to advance our pipeline programs and increase acceptance of Tumor Treating Fields across the global oncology community. We balance our investments in research and development with our organizational capacity to effectively execute our strategic initiatives.
Sales and marketing expenses. Sales and marketing expenses increased by $21.3 million, or 22%, to $118.0 million for the year ended December 31, 2020 from $96.7 million for the year ended December 31, 2019. The change was primarily due to an increase in personnel and professional services costs to support our growing commercial business and reimbursement efforts and an increase in marketing expenses related to the launch of Optune Lua for MPM.
General and administrative expenses. General and administrative expenses increased by $19.5 million, or 22%, to $107.4 million for the year ended December 31, 2020 from $87.9 million for the year ended December 31, 2019. The change was primarily due to an increase in personnel costs, insurance premiums and professional services.
Year ended December 31,
2020 2019 Change % Change
Financial expenses (income), net $ 12,299 $ 7,910 $ 4,389 55 %
Financial expenses, net. Financial expenses, net increased by $4.4 million, or 55%, to $12.3 million for the year ended December 31, 2020 from $7.9 million for the year ended December 31, 2019. The change was primarily due to a prepayment premium related to the 2018 Credit Facility, amortization costs related to the issuance of our
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convertible notes and expenses related to the senior secured revolving credit facility. See Note 10 to the Consolidated Financial Statements.
Year ended December 31,
2020 2019 Change % Change
Income tax $ (1,706) $ (1,594) $ (112) 7 %
Income taxes. Income tax benefits increased by $0.1 million, or 7%, resulting in a tax benefit of $1.7 million for the year ended December 31, 2020 compared to a $1.6 million for the year ended December 31, 2019. The change was primarily a result of the impact of the U.S. CARES Act partially offset by business growth.
Non-GAAP financial measures
We also measure our performance based upon a non-U.S. GAAP measurement of earnings before interest, taxes, depreciation, amortization and shared-based compensation ("Adjusted EBITDA"). We believe Adjusted EBITDA is useful to investors in evaluating our operating performance because it helps investors evaluate and compare the results of our operations from period to period by removing the impact of earnings attributable to our capital structure, tax rate and material non-cash items, specifically share-based compensation.
We calculate Adjusted EBITDA as operating income before financial expenses and income taxes, net of depreciation, amortization and share-based compensation. The following table reconciles net loss (which is the most directly comparable U.S. GAAP operating performance measure) to Adjusted EBITDA.
Year ended December 31,
2020 2019 2018
Net income (loss) $ 19,808 $ (7,230) $ (63,559)
Add: Income tax (1,706) (1,594) 17,617
Add: Financial expenses (income), net 12,299 7,910 12,270
Add: Depreciation and amortization 9,150 8,460 9,006
EBITDA $ 39,551 $ 7,546 $ (24,666)
Add: Share-based compensation 75,721 52,416 39,846
Adjusted EBITDA $ 115,272 $ 59,962 $ 15,180
Adjusted EBITDA increased by $55.3 million, or 92%, to $115.3 million for the year ended December 31, 2020 from $60.0 million for the year ended December 31, 2019. This improvement in fundamental financial performance was driven by net revenue growth coupled with an ongoing commitment to disciplined management of expenses.
Liquidity and capital resources
We have incurred significant losses and cumulative negative cash flows from operations since our founding in 2000. As of December 31, 2020, we had an accumulated deficit of $631.1 million. To date, we have primarily financed our operations through the issuance and sale of equity and the proceeds from long-term loans.
At December 31, 2020, we had $234.7 million in cash and cash equivalents and $607.9 million in short-term investments. At December 31, 2020, our cash, cash equivalents and short-term investments totaled $842.6 million, an increase of $516.5 million compared to $326.1 million at December 31, 2019. The increase in our cash, cash equivalents and short-term investments was primarily due to convertible notes issued, net cash provided by operating activities and the exercise of options.
We believe our cash, cash equivalents and short-term investments as of December 31, 2020 are sufficient for our operations for at least the next 12 months based on our existing business plan and our ability to control the timing of significant expense commitments. We expect that our research, development and clinical trials expenses, sales and marketing expenses and general and administrative expenses will continue to increase over the next several years and may outpace our gross profit. As a result, we may need to raise additional capital to fund our operations.
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The following summary of our cash flows for the periods indicated has been derived from our consolidated financial statements, which are included elsewhere in this Annual Report:
Year ended December 31,
U.S. dollars in thousands 2020 2019 2018
Net cash provided by (used in) operating activities $ 99,148 $ 26,620 $ (1,865)
Net cash provided by (used in) investing activities (472,847) (51,667) (5,493)
Net cash provided by (used in) financing activities 440,209 61,681 69,369
Effect of exchange rate changes on cash and cash equivalents 247 26 27
Net increase (decrease) in cash, cash equivalents and restricted cash $ 66,757 $ 36,660 $ 62,038
Operating activities
Net cash provided by operating activities primarily represents our net income for the periods presented. Adjustments to net income for non-cash items include share-based compensation, depreciation, amortization and asset write-downs. Operating cash flows are also impacted by changes in operating assets and liabilities, principally trade payables, deferred revenues, other payables, prepaid expenses, inventory and trade receivables.
Net cash provided by operating activities was $99.1 million for the year ended December 31, 2020 compared to $26.6 million for the year ended December 31, 2019. Gross profit increased by $125.2 million in 2020 versus 2019, fully funding incremental investments of $53.0 million in research and development and $40.8 million in sales, marketing, general and administrative expenses. The year over year increase in cash provided by operating activities was driven primarily by higher cash earnings, lower interest payments, the receipt of income tax refunds and Zai Lab milestone payments, as well as the timing of receipts and payments in the ordinary course of business.
Upcoming uses of cash in operations will include payments in the normal course of business of $37.5 million in purchase obligations with certain of our suppliers, primarily for the purchase of Product components along with other commitments to purchase goods or services. These amounts include approximately $29.6 million of commitments with three major suppliers. We make such commitments through a combination of purchase orders, supplier contracts, and open orders based on projected demand information. We also have employment agreements with certain employees that require the funding of a specific level of payments if certain events, such as a change in control or termination without cause, occur. In the course of normal business operations, we also have agreements with contract service providers to assist in the performance of our research and development (including clinical trials) and manufacturing activities. We could also enter into additional collaborative research, contract research, manufacturing and supplier agreements in the future, which may require up-front payments and even long-term commitments of cash.
Investing activities
Our investing activities consist primarily of capital expenditures to purchase property and equipment and field equipment, as well as investments in and redemptions of our short-term investments.
Net cash used in investing activities was $472.8 million for the year ended December 31, 2020 compared to net cash used in investing activities of $51.7 million for the year ended December 31, 2019. The net cash used in investing activities for 2020 was primarily attributable to $15.0 million in property and equipment and the purchase of $607.9 million in short-term investments, mostly upon receipt of proceeds from the convertible note issuance, partially offset by $150.0 million in proceeds of short term investments to repay the 2018 Credit Facility. The net cash used in investing activities for 2019 was primarily attributable to $10.5 million in property and equipment and the net purchase of $41.2 million in short-term investments.
Financing activities
To date, our primary financing activities have been the sale of equity and the proceeds from long-term loans.
Net cash provided by financing activities was $440.2 million for the year ended December 31, 2020 compared to $61.7 million for the year ended December 31, 2019. The net cash provided by financing activities for 2020 was primarily attributable to $558.4 million in proceeds from the convertible note issuance and $31.8 million in proceeds from exercise of options and shares related to the ESPP partially offset by $150.0 million in repayment of the 2018 Credit Facility (see below). The net cash provided by financing activities for 2019 was primarily attributable to $61.7 million in proceeds from exercise of options and shares related to the ESPP.
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Convertible Notes
On November 5, 2020, we issued issued $575.0 million aggregate principal amount of 0% Convertible Senior Notes due 2025 (the “Notes”). The net proceeds from the offering were approximately $558.4 million. We intend to use the net proceeds to further advance our clinical and product development programs and to invest in associated pre-commercial and commercial activities, as well as for general corporate purposes.
The Notes are senior unsecured obligations. The Notes do not bear regular interest, and the principal amount of the Notes will not accrete. Special interest, if any, payable in accordance with the terms of the Notes will be payable in cash semi-annually in arrears on May 1 and November 1 of each year, beginning on May 1, 2021. The Notes mature on November 1, 2025, unless earlier repurchased, redeemed or converted.
The Notes are convertible at an initial conversion rate of 5.9439 ordinary shares per $1,000 principal amount of the Notes, which is equivalent to an initial conversion price of approximately $168.24 per ordinary share. In January 2021, we irrevocably elected to settle all conversions of Notes by a combination of cash and our ordinary shares and that the cash portion per $1,000 principal amount of Notes for all conversion settlements shall be $1,000, Accordingly, from and after the date of the election, upon conversion of any Notes, holders of Notes will receive, with respect to each $1,000 principal amount of Notes converted, cash in an amount up to $1,000 and the balance of the conversion value, if any, in our ordinary shares
The Notes are not redeemable prior to November 6, 2023, except in the event of certain tax law changes. We may redeem for cash all or any portion of the Notes, at our option, on or after November 6, 2023 if the last reported sale price of our ordinary shares has been at least 130% of the conversion price then in effect for at least 20 trading days (whether or not consecutive) during any 30 consecutive trading day period (including the last trading day of such period) ending on, and including, the trading day immediately preceding the date on which we provide notice of redemption at a redemption price equal to 100% of the principal amount of the Notes to be redeemed, plus accrued and unpaid special interest, if any, to, but excluding, the redemption date. No sinking fund is provided for the Notes.
Prior to the close of business on the business day immediately preceding August 1, 2025, the Notes are convertible at the option of the holders only upon the satisfaction of certain conditions and during certain periods and if we exercise our right to redeem the Notes as permitted or required by the indenture. On or after August 1, 2025 until the close of the business on the business day immediately preceding the maturity date, holders may convert all or any portion of their Notes at the conversion rate at any time irrespective of the foregoing conditions.
Term loan credit facility
On November 6, 2020, we entered into a new three-year $150.0 million senior secured revolving credit facility with a syndicate of relationship banks (the "2020 Credit Facility"). We may, subject to certain conditions and limitations, increase the revolving credit commitments outstanding under the 2020 Credit Facility or incur new incremental term loans in an aggregate principal amount not to exceed an additional $100 million.
The commitments under the 2020 Credit Facility are guaranteed by certain of our subsidiaries and secured by a first lien on our and certain of our subsidiaries’ assets. Outstanding loans will bear interest at a sliding scale based on the our secured leverage ratio from LIBOR plus 2.75% to LIBOR plus 3.25% per annum. Additionally, the 2020 Credit Facility contains a fee for the unused revolving credit commitments at a sliding scale based on our secured leverage ratio from 0.35% to 0.45%. The 2020 Credit Facility contains financial covenants requiring maintenance of a minimum fixed charge coverage ratio and specifying a maximum senior secured net leverage ratio, as well as customary events of default which include a change of control. As of December 31, 2020, we were in compliance with such covenants.
As of December 31, 2020, we had no outstanding balance borrowed under the 2020 Credit Facility.
For additional information, see Note 12(c) to the Consolidated Financial Statements.
Prepayment of 2018 term loan
In 2018, we entered into a Loan and Security Agreement ("2018 Loan Agreement") pursuant to which we borrowed a term loan in the aggregate principal amount of $150.0 million (the "2018 Credit Facility"). The term loan, which was drawn in full upon execution of the 2018 Loan Agreement, bore interest at 9.0% per annum, payable quarterly in arrears. In 2020, we terminated the 2018 Credit Facility and prepaid the principal amount in full. The prepayment included $150.0 million in principal repayment and $3.0 million in prepayment premium, plus accrued and unpaid interest and expenses payable through the payoff date.
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