Item 7. Management’s Discussion and Analysis
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with the audited annual consolidated financial statements and the related notes thereto included elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements reflecting our current expectations that involve risks and uncertainties. Actual results may differ materially from those discussed in these forward-looking statements due to a number of factors, including those set forth in the section entitled “Risk Factors” and elsewhere in this Annual Report on Form 10-K. For further information regarding forward-looking statements, please refer to the special note regarding forward-looking statements at the beginning of this Annual Report on Form 10-K. Throughout this discussion, unless the context specifies or implies otherwise, the terms “Company,” “we,” “us” and “our” refer to Omeros Corporation and our wholly owned subsidiaries.
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Overview
We are a clinical-stage biopharmaceutical company committed to discovering, developing and commercializing small-molecule and protein therapeutics for large-market as well as orphan indications targeting immunologic diseases, including complement-mediated diseases and cancers related to dysfunction of the immune system, as well as addictive and compulsive disorders.
Our drug candidate narsoplimab is the subject of a biologics license application (“BLA”) that, following receipt of a CRL, is pending before the the U.S. Food and Drug Administration (“FDA”) for the treatment of hematopoietic stem cell transplant-associated thrombotic microangiopathy (“HSCT-TMA”). We also have multiple Phase 3 and Phase 2 clinical-stage development programs, which are focused on complement-mediated disorders, including immunoglobulin A (“IgA”) nephropathy, atypical hemolytic uremic syndrome (“aHUS”), and COVID-19. We have successfully completed a Phase 1 clinical trial in healthy subjects and are initiating a Phase 1b clinical trial in PNH patients for our MASP-3 inhibitor OMS906 targeting the alternative pathway of complement. We also have successfully completed a Phase 1 study in our phosphodiesterase 7 (“PDE7”) program focused on addiction. In addition, we have a diverse group of preclinical programs, including GPR174, a novel target in immuno-oncology that modulates a new cancer immunity axis that we discovered. We are also advancing other related cancer therapeutics as well as CAR T-cell and adoptive T-cell therapies. Small-molecule and antibody inhibitors of GPR174 are part of our proprietary G protein-coupled receptor (“GPCR”) platform through which we control 54 GPCR drug targets and their corresponding compounds. We also possess a proprietary-asset-enabled antibody-generating technology.
On December 23, 2021, we closed on an Asset Purchase with Rayner Surgical, Inc. (“Rayner”) for the sale of our commercial product OMIDRIA and certain related assets including inventory and prepaid expenses (the “Transaction”). Rayner paid us $126.0 million in cash at closing, and we retained all outstanding accounts receivable as of the closing date. We will receive a royalty on world-wide sales of OMIDRIA and potentially a $200.0 million milestone payment if separate payment for OMIDRIA is secured in the U.S. for a continuous period of at least four years before January 1, 2025.
As a result of the OMIDRIA divestiture, the results of OMIDRIA operations have been reclassified to net income from discontinued operations, net of tax in our consolidated statements of operations and comprehensive loss and excluded from continuing operations for all periods presented (See Net Income from Discontinued Operations, Net of Tax below for additional information).
As of December 31, 2021, we had $157.3 million in cash and cash equivalents and short-term investments available for general corporate use and $38.2 million in accounts receivable, which we expect to collect in full by March 31, 2022.
Results of Operations
Research and Development Expenses
Our research and development expenses can be divided into three categories: direct external expenses, which include clinical research and development and preclinical research and development activities; internal, overhead and other expenses; and stock-based compensation expense. Direct external expenses consist primarily of expenses incurred pursuant to agreements with third-party manufacturing organizations prior to receiving regulatory approval for a drug candidate, contract research organizations (“CROs”), clinical trial sites, collaborators, and licensors and consultants. Costs are reported in preclinical research and development until the program enters the clinic. Internal, overhead and other expenses consist of personnel costs, overhead costs such as rent, utilities and depreciation and other miscellaneous costs. The discontinued operations of OMIDRIA relates to the costs of drug manufacturing stability and quality control testing and costs of employees and consultants. The following table illustrates our expenses associated with these activities:
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Year Ended
Year Ended December 31,
2021
2020
2019
(In thousands)
Continuing research and development expenses:
Direct external expenses:
Clinical research and development:
MASP-2 program - OMS721 (narsoplimab)
$
48,806
$
45,020
$
49,804
MASP-3 program - OMS906
7,005
7,172
—
PDE7 - OMS527
555
1,833
4,066
Total clinical research and development
56,366
54,025
53,870
Preclinical research and development
15,031
10,664
14,291
Total direct external expenses
71,397
64,689
68,161
Internal overhead and other expenses
40,587
36,760
32,155
Stock-based compensation expense
6,791
6,163
6,008
Total continuing research and development expenses
118,775
107,612
106,324
Discontinued research and development expense
3,839
3,205
3,372
Total research and development expenses
$
122,614
$
110,817
$
109,696
Clinical research and development expenses increased $2.3 million between 2021 and 2020 primarily due to increased narsoplimab drug manufacturing costs partially offset by reduced OMS527 toxicology study costs. The change in clinical research and development costs between 2020 and 2019 is primarily due to the migration of OMS906 from preclinical to clinical research and development beginning in the third quarter of 2020 offset by reduced MASP-2 costs.
Preclinical research and development expenses increased $4.4 million in 2021 compared to 2020, primarily due to drug substance, stability and toxicology work on OMS1029 offset by the migration of OMS906 from preclinical to clinical research and development beginning in the third quarter of 2020. The $3.6 million decrease in preclinical research and development expenses in 2020 compared to 2019 was primarily due to the advancement of OMS906 to clinical research and development in the third quarter of 2020.
The increases in internal, overhead and other expenses in all years presented are primarily due to additional employee-related costs and buildout of expanded laboratory facilities to support our research and development activities.
We expect overall continued research and development costs to increase in 2022 as we continue our ongoing Phase 3 clinical programs for narsoplimab and the manufacturing of narsoplimab drug substance to meet our clinical supply needs as well as our commercial requirements should we receive FDA approval for the use of narsoplimab for the treatment of HSCT-TMA. Our accounting policy is to expense all manufacturing costs related to drug candidates until regulatory approval is reasonably assured in either the U.S. or Europe.
At this time, we are unable to estimate with certainty the longer-term costs we will incur in the continued development of our drug candidates due to the inherently unpredictable nature of our preclinical and clinical development activities as well as the potential impact of the COVID-19 pandemic. Clinical development timelines, the probability of success and development costs can differ materially as new data become available and as expectations change. Our future research and development expenses will depend, in part, on the preclinical or clinical success of each drug candidate as well as ongoing assessments of each program’s commercial potential. In addition, we cannot forecast with precision which drug candidates, if any, may be subject to future collaborations, when such arrangements will be secured, if at all, and to what degree such arrangements would affect our development plans and capital requirements.
We are required to expend substantial resources in the development of our drug candidates due to the lengthy process of completing clinical trials and seeking regulatory approval. Any failure or delay in completing clinical trials, or in obtaining regulatory approvals, could delay our generation of product revenue and increase our research and development expenses.
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Selling, General and Administrative Expenses
Our selling, general and administrative expenses are comprised primarily of salaries, benefits and stock-compensation costs for sales, marketing and other personnel who are not directly engaged in research and development. Costs also include marketing and selling expenses, professional and legal services, general corporate costs and an allocation of our occupancy costs.
Year Ended December 31,
2021
2020
2019
(In thousands)
Continuing selling, general and administrative expense:
Selling, general and administrative expenses, excluding stock-based compensation expense
$
46,688
$
41,692
$
32,755
Stock-based compensation expense
8,154
7,614
6,959
Total continuing selling, general and administrative expenses
54,842
49,306
39,714
Discontinued selling, general and administrative expenses
25,428
23,389
24,912
Total selling, general and administrative expenses
$
80,270
$
72,695
$
64,626
The increase in continuing selling, general and administrative expenses, excluding stock-based compensation, during both years ended December 31, 2021 and 2020 was primarily due to increased pre-commercialization activities for narsoplimab for the treatment of HSCT-TMA.
Our continuing selling, general and administrative expenses for 2022 are highly dependent on the approval of narsoplimab as we have not yet hired the narsoplimab field sales force or initiated various commercial launch activities. If narsoplimab is approved in 2022, our continuing selling, general and administrative expenses will increase as we hire the field sales team and initiate commercial launch activities. If narsoplimab is not approved, our continuing selling, general and administrative expenses are expected to be less than in 2021.
Interest Expense
Year Ended December 31,
2021
2020
2019
(In thousands)
Interest expense
$
19,669
$
26,751
$
22,657
Interest expense is primarily comprised of contractual interest and amortization of debt issuance and debt discount related to our 6.25% Convertible Senior Notes (the “2023 Notes”) and 5.25% Convertible Senior Notes (the “2026 Notes”) as well as interest on our finance leases . Interest expense decreased $7.1 million compared to the prior year due to the January 1, 2021 adoption of ASU 2020-06, which eliminated the amortization of the non-cash debt discount on the 2023 and 2026 Notes previously allocated to equity. This decrease was partially offset by the increase in interest related to our 2026 Notes, which were issued in August and September 2020. For more information regarding our debt and our unsecured convertible notes (see Part II, Item 8, “Note 9—Unsecured Convertible Senior Notes”).
Loss on Early Extinguishment of Debt
Year Ended December 31,
2021
2020
2019
(In thousands)
Loss on early extinguishment of debt
$
—
$
13,374
$
—
In August 2020, we repurchased $115.0 million of the outstanding 2023 Notes. We recorded a $13.4 million loss on early extinguishment of debt related to the unamortized discount and issuance costs related to the repurchase.
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Other Income
Year Ended December 31,
2021
2020
2019
(In thousands)
Other income
$
1,740
$
654
$
1,553
Other income principally includes sublease rental income and interest earned on our cash and investments. The variations between years is primarily due to $0.8 million of expenses incurred in 2020 in connection with terminating the portion of the capped call related to the 2023 Notes that we repurchased.
Income Tax Benefit
Year Ended December 31,
2021
2020
2019
(In thousands)
Income tax benefit
$
—
$
23,256
$
19,774
The income tax benefit in 2020 relates to the issuance of the 2026 Notes respectively (see Part II, Item 8, “Note 14—Income Taxes”).
In December 2019, the Financial Accounting Standards Board issued ASU 2019-12, Income Taxes (Topic 740), which is intended to simplify various aspects of the income tax accounting guidance. ASU 2019-12 eliminates the exception to the incremental approach of intra-period tax allocation when there is a loss from continuing operations and income or gain from other items. As the Company prospectively adopted ASU 2019-12 January 1, 2021, we did not apply any intraperiod allocation rules to 2021. However, we reclassified the tax benefit of income from discontinued operations in prior periods to offset losses from continuing operations.
During 2020, we recorded an income tax benefit of $23.3 million from continuing operations comprising $12.0 million related to the issuance of our 2026 and 2023 Notes, and an additional $11.2 million income tax benefit related to the sale of OMIDRIA assets to Rayner into income from continuing operations. During 2019, we recorded $19.7 million of income tax benefit into continuing operations related to OMIDRIA assets sold to Rayner.
Net Income from Discontinued Operations, Net of Tax
On December 23, 2021, we sold our commercial drug, OMIDRIA, to Rayner. As a result of the OMIDRIA divestiture, the results of OMIDRIA operations have been reclassified to discontinued operations in our consolidated statements of operations and comprehensive loss and excluded from continuing operations for all periods presented. Net income from discontinued operations, net of tax is as follows:
Year Ended December 31,
2021
2020
2019
(In thousands)
Net income from discontinued operations, net of tax
$
385,781
$
35,072
$
62,882
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Net income from OMIDRIA operations and the gain recognized on disposition of the asset is shown below:
Year Ended December 31,
2021
2020
2019
(In thousands)
Product sales, net
$
110,735
$
73,813
$
111,805
Royalty income
1,035
—
—
OMIDRIA income
111,770
73,813
111,805
Costs and expenses:
Cost of product sales
1,364
902
865
Research and development
3,839
3,205
3,372
Selling, general and administrative
25,428
23,389
24,912
Total costs and expenses
30,631
27,496
29,149
Income before income tax expense
81,139
46,317
82,656
Income tax expense
(1,006)
(11,245)
(19,774)
Net income from discontinued operations, net of tax
80,133
35,072
62,882
Gain on sale of OMIDRIA, net
305,648
—
—
Net income from discontinued operations, net of tax
$
385,781
$
35,072
$
62,882
Product Sales, Net and Royalty Income
The fluctuation in 2020 product sales, net, reclassed to discontinued operations, was due to COVID-19-related reductions in the number of elective cataract procedures from mid-March 2020 through late June 2020. Additionally OMIDRIA pass-through reimbursement under Medicare Part B expired on October 1, 2020 and OMIDRIA revenues were significantly reduced. In December 2020, CMS confirmed that OMIDRIA qualifies for separate payment when used in the ASC setting, and sales normalized during the first half of 2021.
After the sale of OMIDRIA to Rayner, we receive royalty payments of 50% of U.S. domestic net sales. We will continue to earn royalties at this rate until the earlier of January 1, 2025 or when separate payment for OMIDRIA is secured in the U.S. for a continuous period of at least four years. Should separate payment be achieved during this time, the Company would receive a $200.0-million milestone payment from Rayner. Upon the earlier of qualifying for the milestone payment or January 1, 2025, the royalty rate will be reduced to 30% (the “U.S. base royalty rate”) until the expiration or termination of the last issued and unexpired U.S. patent. The U.S. base royalty rate is reduced to 10% upon the occurrence of certain events such as OMIDRIA no longer being eligible for separate payment. We will also receive a royalty of 15% on OMIDRIA net sales outside the U.S. on a country-by-country basis until the expiration or termination of the last issued and unexpired OMIDRIA patent in such country.
OMIDRIA sales have historically been highly dependent on separate payment under Medicare Part B. Given that OMIDRIA reimbursement might be dependent on CMS’ annual renewals and policy, we would likely experience
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significant fluctuations in period-over-period OMIDRIA royalty earnings should CMS change its non-opioid separate payment policy, which likely would effect CMS’ reimbursement of OMIDRIA.
Deductions to OMIDRIA sales consist of chargebacks, rebates, distribution fees and product return allowances (see Part II, Item 8, “Note 2—Significant Accounting Policies”). The overall percentage deductions to OMIDRIA sales were as follows:
Year Ended December 31,
2021
2020
2019
Deductions percentage to OMIDRIA sales
29.9
%
31.2
%
27.7
%
The gain on the sale of OMIDRIA included in discontinued operations for the year ended December 31, 2021 is as follows:
(In thousands)
Cash proceeds
$
125,993
OMIDRIA contract royalty asset
184,570
Gain on sale of OMIDRIA, gross
310,563
Transaction and closing costs
(1,972)
Restricted Stock Units ("RSUs") granted to transferred employees
(1,419)
Prepaid assets and inventory at cost
(1,524)
Gain on sale of OMIDRIA, net
$
305,648
OMIDRIA Royalties and OMIDRIA Contract Royalty Assets
Upon the closing of the Transaction, we have rights to receive from Rayner future royalties on OMIDRIA net sales at royalty rates that vary based on geography and certain regulatory contingencies. Therefore, future OMIDRIA royalties are treated as variable consideration. The sale of OMIDRIA qualifies as an asset sale. To measure the OMIDRIA contract royalty asset, we used the expected value approach which is the sum of the discounted probability-weighted royalty payments, net of tax, we would receive using a range of potential outcomes, to the extent that it is probable that a significant reversal in the amount of cumulative income recognized will not occur. The contract royalty asset excludes the achievement of the $200.0-million milestone payment and any foreign royalties to the extent it is probable that a significant reversal in the amount of cumulative income recognized will not occur. Royalties earned will be recorded as a reduction to the OMIDRIA contract royalty asset. The amount recorded in discontinued operations in future periods will reflect interest earned on the outstanding OMIDRIA contract royalty asset and any amounts received different from the expected royalties recorded at closing. The OMIDRIA contract royalty asset will also be re-measured periodically using the expected value approach based on actual results and future expectations Any required adjustment to the OMIDRIA contract royalty asset will be recorded into discontinued operations.
On December 22, 2021, the Company granted and expensed RSUs to employees who accepted offers to work for Rayner as a retention incentive to help drive sales of OMIDRIA. The RSUs vest over a two-year period contingent on continued employment at Rayner.
Financial Condition - Liquidity and Capital Resources
As of December 31, 2021, we had $157.3 million in cash, cash equivalents and short-term investments available for general corporate use held primarily in money-market accounts, as compared to $135.0 million at December 31, 2020. As of December 31, 2021, we also had accounts receivable of $38.2 million. We have historically generated net losses and incurred negative cash flows. With the sale of OMIDRIA to Rayner, we had net income of $194.2 million and negative cash flows from operations of $109.7 million as compared to negative cash flows of $100.1 million in the prior year.
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We plan to continue to fund our operations with our cash and investments, our outstanding accounts receivable, OMIDRIA royalties and potentially the $200.0 million milestone related to achieving long-term OMIDRIA separate payment. If FDA approval is granted for narsoplimab for HSCT-TMA within the next twelve months, sales of narsoplimab will also provide funds for our operations. In addition, we have a sales agreement to sell shares of our common stock, from time to time, in an “at the market” equity offering facility through which we may offer and sell shares of our common stock having an aggregate amount of up to $150.0 million. Should it be determined to be strategically advantageous, we could pursue debt financings as well as public and private offerings of our equity securities, similar to those we have previously completed, or other strategic transactions, which may include licensing a portion of our existing technology. Should it be necessary to manage our operating expenses, we would reduce our projected cash requirements by delaying clinical trials, reducing selected research and development efforts, or implementing other restructuring activities. We have $95.0 million of 2023 Notes due in November 2023. We plan to fund the repayment of the 2023 Notes through cash from operations, including narsoplimab HSCT-TMA revenues should approval be granted by FDA, the $200.0 million milestone related to OMIDRIA, strategic transactions, sale of stock or through issuance of additional debt.
Cash Flow Data
Year Ended December 31,
2021
2020
2019
(In thousands)
Selected cash flow data
Cash provided by (used in):
Operating activities
$
(109,722)
$
(100,086)
$
(60,073)
Investing activities
$
193,710
$
(67,031)
$
(3,401)
Financing activities
$
6,319
$
174,534
$
60,697
Operating Activities. Net cash used in operating activities increased for the year ended December 31, 2021 by $9.6 million compared to the same period in 2020. The change in net income adjusted for non-cash items increased by $12.1 million. In addition, we had a $65.7 million increase in the change in operating receivables due to timing of OMIDRIA Medicare Part B reimbursement and a $34.4 million decrease in the change in accounts payable.
Net cash used in operating activities increased for the year ended December 31, 2020 by $40.0 million compared to the same period in 2019. The difference largely resulted from the $53.6 million increase in our net loss from 2019, a $33.0 million increase in cash used in accounts payable and accrued expense, and a $3.6 million increase in cash used for prepaid and other assets. These increases were partially offset by a $43.7 million increase in cash provided from collections of accounts receivable and an increase in non-cash charges of $5.6 million.
Investing Activities. Net cash provided by investing activities increased $260.7 million during 2021 compared to the same period in 2020. This was driven by t he $126.0 million payment made as part of the OMIDRIA asset sale and an increase of $134.7 million in net proceeds from the purchase and sale of investments.
Net cash used in investing activities increased $63.6 million during 2020 compared to the same period in 2019, driven by an increase in purchases of investments of $133.2 million offset by proceeds from sale and maturities of investments of $66.4 million.
Financing Activities. Net cash provided by financing activities during 2021 decreased $168.2 million from the prior year. The decrease was due to receiving cash proceeds of $76.9 million, net, in the prior year, from the issuance of our 2026 Notes, which includes the payments for partial repurchase of our 2023 Notes, payments for debt issuance costs, proceeds from termination of our 2023 capped call, and purchases of capped calls related to our 2026 Notes. In addition, we received net proceeds of $93.7 million from our August 2020 public offering of our common stock.
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Convertible Notes
For more information regarding the 2023 and 2026 Notes see (Part II, Item 8, “Note 8—Unsecured Convertible Senior Notes”).
Line of Credit
We have a Line of Credit Agreement that is secured by all our assets excluding intellectual property and development program inventories and matures on August 2, 2022. The Line of Credit is based upon maintaining a certain amount of accounts receivables including royalty receivables from Rayner. As of December 31, 2021, we had no outstanding borrowings under the Line of Credit Agreement and we were in compliance with all covenants. F or more information regarding the Line of Credit Agreement (s ee Part II, Item 8, “Note 8—Line of Credit”).
Contractual Obligations and Commitments
Operating Leases
We lease our office and laboratory space in The Omeros Building under a lease agreement with BMR - 201 Elliott Avenue LLC. The initial term of the lease ends in November 2027 and we have two options to extend the lease term, each by five years. We lease office and laboratory equipment under various operating and finance lease agreements with initial terms of five years or less. As of December 31, 2021, the remaining aggregate non-cancelable rent payable under the initial term of the lease, excluding common area maintenance and related operating expenses, is $42.9 million.
Convertible Notes
Refer to “Financial Condition—Liquidity and Capital Resources—Convertible Notes” above.
Goods & Services
We have certain non-cancelable obligations under other agreements for the acquisitions of goods and services associated with the manufacturing of our drug candidates, which contain firm commitments. As of December 31, 2021, our aggregate firm commitments are $32.0 million.
We may be required, in connection with in-licensing or asset acquisition agreements, to make certain royalty and milestone payments and we cannot, at this time, determine when or if the related milestones will be achieved or whether the events triggering the commencement of payment obligations will occur. Therefore, such payments are not included in the table above. For information regarding agreements that include these royalty and milestone payment obligations, see Part II, Item 8, “Note 11—Commitments and Contingencies” to our Consolidated Financial Statements in this Annual Report on Form 10-K.
Critical Accounting Policies and Significant Judgments and Estimates
The preparation of our consolidated financial statements, in conformity with U.S. generally accepted accounting principles (“GAAP”), requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances; however, actual results could differ from those estimates. An accounting policy is considered critical if it is important to a company’s financial condition and results of operations and if it requires the exercise of significant judgment and the use of estimates on the part of management in its application. Although we believe that our judgments and estimates are appropriate, actual results may differ materially from our estimates. For a summary of our critical accounting policies, (see Part II, Item 8, “Note 2—Significant Accounting Policies” to our Consolidated Financial Statements in this Annual Report on Form 10-K.
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We believe the following to be our critical accounting policies because they are both important to the portrayal of our financial condition and results of operations and they require critical judgment by management and estimates about matters that are uncertain:
● revenue recognition;
● OMIDRIA royalties and contract asset accounting;
● research and development expenses related to clinical trials;
● accounting for lease agreements, primarily related to our computation of incremental borrowing rate;
● accounting for convertible debt issuances, primarily related to fair valuing debt and issuance costs; and
● stock-based compensation, primarily related to our fair value assumptions.
If actual results or events differ materially from those contemplated by us in making these estimates, our reported financial condition and results of operations for future periods could be materially affected.
Revenue Recognition
Product Sales, Net: W e record revenue from product sales when the product is delivered to our wholesalers which is generally when we satisfy all performance obligations. Product sales are recorded net of wholesaler distribution fees and estimated chargebacks, rebates, returns and purchase-volume discounts. Accruals or allowances are established for these deductions in the same period when revenue is recognized, and actual amounts incurred are offset against the applicable accruals or allowances. We reflect each of these accruals or allowances as either a reduction in the related accounts receivable or as an accrued liability depending on how the amount is expected to be settled.
Chargebacks and Rebates: Provisions for chargebacks are determined utilizing historical and projected payer mix and information regarding sell-through and inventory on-hand received directly from wholesalers. Chargebacks are generally settled within four weeks of recording product sales revenue.
We provide reimbursement support services and financial assistance in the form of a rebate to patients whose commercial insurance is inadequate to cover the full cost of our drug product. We apply an experience ratio based on historical and projected patient claims. This experience ratio is applied to product sales to determine the patient rebate accrual and is reviewed and updated periodically to reflect actual results.
Distribution Fees and Product Return Allowances : We pay our wholesalers a distribution fee for services that they perform for us based on the wholesaler average cost value of their purchases. We record a provision against product sales for these charges at the time of sale to the wholesaler.
We allow for the return of product up to 12 months past its expiration date or for product that is damaged. In estimating product returns, we take into consideration our return experience to date, the remaining shelf-life of product we have previously sold, inventory in the wholesale channel and our expectation that product is typically not held by the health care providers based on the frequency of their reorders.
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OMIDRIA Royalties and OMIDRIA Contract Royalty Asset
Upon the closing of the Transaction, we have rights to receive future royalties from Rayner on OMIDRIA net sales at royalty rates that vary based on geography and certain regulatory contingencies. Therefore, future OMIDRIA royalties are treated as variable consideration. To measure the OMIDRIA contract royalty asset, we used the expected value approach which is the the discounted sum of probability-weighted royalty payments, net of tax, we would receive using a range of potential outcomes, to the extent that it is probable that a significant reversal in the amount of cumulative income recognized will not occur. Our calculations take the net present value of the sum to arrive at the OMIDRIA contract royalty asset stated on the balance sheet. The contract royalty asset excludes the achievement of the $200.0- million milestone payment and any foreign royalties to the extent it is probable that a significant reversal in the amount of cumulative income recognized will not occur. Royalties earned will be recorded as a reduction to the OMIDRIA contract royalty asset. The amount recorded in discontinued operations in future periods will reflect interest earned on the outstanding OMIDRIA contract royalty asset and any amounts received different from the expected royalties recorded at closing. The OMIDRIA contract royalty asset is subject to changes in net sales of OMIDRIA. A 10% change in net sales results in an $18.4 million change in value of the OMIDRIA contract royalty asset, resulting in a potential contract royalty asset valued within the range of $166.7 million to $203.5 million, all else being equal. Changes in net sales could occur due to various risks such as competitors entering the market, technology change as to how cataracts are treated and loss of separate payment status. In determing the value of the OMIDRIA contract royalty asset, we have considered all these factors. The OMIDRIA contract royalty asset will be re-measured periodically using the expected value approach based on actual results and future expectations. Any required adjustment to the OMIDRIA contract royalty asset will be recorded into discontinued operations.
We receive monthly royalty payments based on Rayner’s OMIDRIA product sales in accordance with the Asset Purchase Agreement. Upon the closing of the Transaction, we determined the expected minimum net present value of future OMIDRIA royalty payments and recognized the amount as a gain on the sale of OMIDRIA in discontinued operations on our income statement and as OMIDRIA contract royalty asset on our balance sheet. To determine the OMIDRIA contract royalty asset, we used the expected value approach which is based on the sum of probability-weighted payments we would receive using a range of potential outcomes using a double digit discount rate and the statutory federal income tax rate. The contract royalty asset excludes any revenue which potentially may be reversed in the event of an over estimation. Therefore, we did not include any expectation of receiving the $200.0-million milestone payment or any foreign royalties as we could not judge the probability of those events with certainty.
Royalties earned will be recorded as a reduction to the OMIDRIA contract royalty asset. The amount recorded through earnings in discontinued operations will reflect the time value of money on the outstanding OMIDRIA contract royalty asset. The OMIDRIA contract royalty asset will be evaluated periodically and adjusted using the expected value approach based on actual results and future expectations. Any required adjustments will be recorded into discontinued operations.
Research and Development Expenses
Research and development costs are comprised primarily of:
● contracted research and manufacturing costs;
● clinical study costs;
● costs of personnel, including salaries, benefits and stock compensation;
● consulting arrangements;
● depreciation and an allocation of our occupancy costs; and
● other expenses incurred to sustain our overall research and development programs.
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Contracted research and manufacturing costs are primarily incurred in the development and production of our drug substance and drug candidates. Prior to approval, our estimates are based on the timing of services provided. We record accrued expenses equal to our estimated expense in excess of amount invoiced by the suppliers.
Clinical trial expenses are estimated on a cost per patient that varies depending on the clinical trial site. As actual costs become known to us, we adjust our estimates; these changes in estimates may result in understated or overstated expenses at any given point in time.
Right-of-Use Assets and Related Lease Liabilities
We record operating leases on our Consolidated Balance Sheet as right-of-use assets and recognize the related lease liabilities equal to the fair value of the lease payments using our incremental borrowing rate when the implicit rate in the lease agreement is not readily available. We derived our incremental borrowing rate by assessing rates in recent market transactions, as adjusted for security interests and our credit quality. A change in the calculated incremental borrowing rate of 100 basis points would not be material to our consolidated financial statements.
Convertible Debt Issuances
On January 1, 2021, we adopted Accounting Standards Update (“ASU”) 2020-06, Debt—Debt with Conversion Options (Subtopic 470.20 and Derivatives and Hedging—Contracts in Entity’s Own Equity (Subtopic 815-40) on a modified retrospective basis. ASU 2020-06 removes the separate liability and equity accounting for our convertible senior notes. As of January 1, 2021, we account for our convertible senior notes wholly as debt. Prior to January 1, 2021, we accounted for convertible debt that may be settled wholly or partially in cash upon conversion as having both a liability component (debt) and an equity component (conversion option). The cash conversion guidance applies as the embedded conversion features meet the requirements for a derivative scope exception for instruments that are both indexed to an entity’s own stock and classified in stockholders’ equity in the balance sheet. Principal cash proceeds from the instrument are allocated first to the liability component based on the fair value of non-convertible debt using the income and market-based approaches to determine an effective interest rate for present valuing the cash proceeds. For the income-based approach, we use a convertible bond pricing model that includes several assumptions such as volatility and a risk-free rate. For the market-based approach, we observe the price of derivative price instruments purchased in conjunction with our convertible senior note issuances or evaluate issuances of convertible debt securities by other companies with similar credit risk ratings at the time of issuance. The amount of the equity component is then calculated by deducting the fair value of the liability component from the principal amount of the instrument. Issuance costs from the instrument are then allocated to the liability and equity components in the same proportion as the proceeds. The equity component of the cash principal proceeds and the liability component of the issuance costs represent a debt discount. which we amortized in prior years as non-cash interest expense over the term of the notes method. On
Transactions involving contemporaneous exchanges of cash between the same debtor and creditor in connection with the issuance of a new debt obligation and satisfaction of an existing debt obligation by the debtor are evaluated as a modification or an exchange transaction depending on whether the exchange is determined to have substantially different terms. The 2023 Notes repurchase and issuance of the 2026 Notes) were deemed to have substantially different terms due to the significant difference between the value of the conversion option immediately prior to and after the exchange. Therefore, the repurchase of the 2023 Notes was accounted for as a debt extinguishment.
Stock-Based Compensation
Stock-based compensation expense is recognized for all share-based payments made to employees, directors and non-employees based on estimated fair values. The fair value of our stock options is calculated using the Black-Scholes option valuation model, which requires assumptions, including volatility, forfeiture rates and expected option life. We estimate forfeitures for expense recognition based on our historical experience. Groups of employees that have similar historical forfeiture behavior are considered separately. If any of the assumptions used in the Black-Scholes model change significantly, stock-based compensation expense for new awards may differ materially from that recorded for existing awards and stock-based compensation for non-employees will vary as the awards are re-measured over the vesting term.
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Recent Accounting Pronouncements
Please refer to Part II, Item 8, “Note 2 -- Significant Accounting Policies” to our Consolidated Financial Statements in this Annual Report in Form 10-K for information regarding recent accounting pronouncements.