Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion of our financial condition and results of operations should be read in conjunction with the consolidated financial statements and the related notes to those statements thereto appearing elsewhere in this Annual Report on Form 10-K filed with the SEC for the year ending December 31, 2022 . Some of the information contained in this discussion and analysis, including information with respect to our plans and strategy for our business, includes forward-looking statements that involve risk, uncertainties and assumptions. Our actual results could differ materially from those discussed in our forward-looking statements for many reasons, including those risks. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this Annual Report. You should read this Annual Report completely, including Part I, Item 1A (Risk Factors) of this Annual Report and the “Cautionary Statement Regarding Forward-Looking Statements” sections of this Annual Report for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by our forward-looking statements contained in the following discussion and analysis. 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.
Overview
We are a biopharmaceutical company focused on developing and commercializing precision therapies for genetically defined cancers with alterations in mTOR pathway genes. Our lead drug product, FYARRO ® , is a form of sirolimus bound to albumin. Sirolimus is a potent inhibitor of the mTOR biological pathway, the activation of which pathway can promote tumor growth. We believe our approach to utilizing albumin bound sirolimus has the potential to produce transformational therapies to cancer patients with mTOR pathway driver alterations where other mTOR inhibitors have not or cannot be effectively exploited due to problems of pharmacology, effective drug delivery, safety, or effective targeting to the disease site.
In November 2021, the U.S. Food and Drug Administration (the “FDA”) approved FYARRO sirolimus protein-bound particles for injectable suspension (albumin-bound) for the treatment of adult patients with locally advanced unresectable or metastatic malignant perivascular epithelioid cell tumor (“PEComa”). On February 22, 2022, we launched FYARRO in the United States for treatment of advanced malignant PEComa. For the fiscal year ended December 31, 2022 , we recorded net revenue from product sales of $15.2 million and net loss of $60.5 million. See “Results of Consolidated Operations” for further discussion of our results.
In addition to advanced malignant PEComa, based on exploratory data from our completed Phase 2 registrational study, Advanced Malignant PEComa Trial (“AMPECT”), and our expanded access program for FYARRO, we have initiated a registration-directed tumor-agnostic Phase 2 study (“PRECISION 1”) of FYARRO in patients with Tuberous Sclerosis Complex 1 and 2 (“ TSC1 & TSC2 ”) alterations. We have completed a Type B meeting with the FDA in which we discussed the trial design and the PRECISION 1 trial was opened for enrollment in the United States during the first quarter of 2022, with dosing of our first patient in March 2022. We anticipate having preliminary data on a meaningful number of patients in the PRECISION 1 trial during the second quarter of 2023.
For more information regarding our business, including FYARRO, AMPECT and the PRECISION 1 trial, see Part I, Item 1 (Business).
Recent Developments
• Leadership Transition . Effective January 1, 2023, our board of directors appointed Brendan Delaney, our former Chief Operating Officer, to President and Chief Executive Officer and Neil Desai, our founder, director, and former-President and Chief Executive Officer, to Executive Chairman. Mr. Delaney was also appointed to serve on our board of directors. Effective March 14, 2023, Mr. Delaney resigned from his position as President and Chief Executive Officer and as a member of our board of directors, and, effective March 15, 2023, our board of directors appointed Scott Giacobello, our Chief Financial Officer, as Interim Chief Executive Officer and President. Mr. Giacobello will continue to serve in his role as Chief Financial Officer in addition to his role as Interim Chief Executive Officer and President. In addition, Dr. Desai, the founder of the company and our President and Chief Executive Officer prior to Mr. Delaney, continues to serve as the Executive Chairman and a member of our board of directors and will assist with the leadership transition. The Board has also initiated an executive search for a successor chief executive officer, and, as such, Mr. Giacobello’s position of Interim Chief Executive Officer and President will end when a successor is appointed.
• 2022 Private Investment in Public Equity (PIPE) Financing . On September 22, 2022, we entered into a securities purchase agreement (“Purchase Agreement”) for a private placement (the “2022 PIPE Financing”) with certain investors (“2022 PIPE Investors”). Upon closing the 2022 PIPE Financing on September 26, 2022, we sold (i) 3,373,526 shares of our common stock, at a purchase price of $12.50 per share, and (ii)
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2,426,493 pre-funded warrants (the “Pre-Funded Warrants”) to purchase shares of our common stock, at a purchase price of $12.4999 per Pre-Funded Warrant. The Pre-Funded Warrants will have an exercise price of $0.0001 per share of common stock, be immediately exercisable and remain exercisable until exercised in full. In connection with the 2022 PIPE Financing, we entered into a Registration Rights Agreement, dated September 22, 2022 (“2022 PIPE Registration Rights Agreement”), with the 2022 PIPE Investors. Pursuant to the 2022 PIPE Registration Rights Agreement, on October 26, 2022, we filed a registration statement with the Securities and Exchange Commission (the "SEC") for the registration for resale of the securities sold under the Purchase Agreement, including the shares issuable upon the exercise of the Pre-Funded Warrants, which such registration statement was declared effective on November 4, 2022.
At the closing of the 2022 PIPE Financing, the total purchase price paid by the 2022 PIPE Investors was approximately $72.2 million, after deducting $0.3 million of our offering expenses. We intend to use the net proceeds from the 2022 PIPE Financing to fund working capital and other general corporate purposes.
• Mirati Collaboration . In October 2022, we entered into a collaboration and supply agreement with Mirati Therapeutics, Inc. (“Mirati”) to evaluate the combination of Mirati’s adagrasib, a KRAS G12C selective inhibitor, and FYARRO in KRAS G12C mutant non-small cell lung cancer (NSCLC) and other solid tumors. Under the terms of the agreement, Mirati will be responsible for sponsoring and operating the Phase 1/2 study and we will supply study drug and jointly share the cost of the study.
The primary objective of this multi-center, single-arm, open-label Phase 1/2 trial is to determine the optimal dose and recommended Phase 2 dose for the combination of adagrasib and FYARRO in patients with KRAS G12C- mutant solid tumors. In addition, the study will investigate the safety, tolerability and efficacy of adagrasib and FYARRO in combination in patients both with and without prior exposure to a KRAS G12C inhibitor. The trial will build on preclinical data showing enhanced anti-tumor efficacy with the combination of adagrasib and FYARRO relative to either agent alone.
BMS License Agreement
We have exclusive rights for certain patents and a non-exclusive license for certain technology and know-how pertaining to ABI-009 (which we refer to as FYARRO) pursuant to an amended and restated license agreement, dated November 15, 2019, as amended August 31, 2021 (the “BMS License Agreement”) with Abraxis BioScience, LLC, a wholly owned subsidiary of Celgene Corporation, which is a wholly owned subsidiary of Bristol-Myers Squibb Company (“BMS”). Under the BMS License Agreement, BMS is entitled to receive certain development milestone payments, royalties on net sales from licensed products under the agreement and any sublicense fees. During the year ended December 31, 2022 , we recorded royalties of $1.1 million under the terms of this agreement, of which $0.4 million in royalties were accrued as of December 31, 2022 . No payments related to milestones under this agreement were paid during the year ended December 31, 2022. See Note 9 to the consolidated financial statements for more information about the BMS License Agreement.
Under the terms of an August 2021 amendment to the license agreement, we paid BMS $5.8 million, representing 50% of the previously outstanding payment obligation under the agreement, following the effective time of the 2021 Private Investment in Public Equity (PIPE) Financing ("2021 PIPE Financing") that occurred in connection with the closing of the reverse acquisition of Aerpio Pharmaceuticals, Inc. Pursuant to the terms of the amendment, the remaining portion of the previously outstanding payment obligation ($5.8 million), which is recorded on our balance sheet as due to licensor, is due on the third anniversary of the effective time of such 2021 PIPE Financing plus any accrued and unpaid interest due thereon.
EOC License Agreement
In December 2020, we entered into the EOC License Agreement with EOC under which we received $14.0 million in January 2021 in non-refundable upfront consideration as partial payment for the rights and licenses granted to EOC by us for the further development and commercialization of FYARRO in the People’s Republic of China, Hong Kong Special Administration Region, Macao Special Administrative Region and Taiwan (the “Licensed Territory”).
In accordance with the BMS License Agreement, we are required to pay 20% of all sublicense fees to BMS. As such, we recognized $2.8 million of license expense in the fourth quarter of 2020 and had a corresponding $2.8 million sublicense payable to BMS on the balance sheet as of December 31, 2020, which was paid in 2021.
During the fourth quarter of 2021, we recognized license revenue and received $1.0 million from EOC for achieving the FDA approval milestone in November 2021. In accordance with the BMS License Agreement, we recognized $0.2 million of license expense in the fourth quarter of 2021 and had a corresponding $0.2 million sublicense payable to BMS on the balance sheet as of December 31, 2021, which was paid in 2022.
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On June 27, 2022, we received written notice from EOC that EOC has elected to terminate the EOC License Agreement, effective immediately. On June 27, 2022, EOC filed a Request for Arbitration with the International Chamber of Commerce’s International Court of Arbitration against us. The arbitration process is ongoing. We intend to defend ourselves vigorously in this matter and pursue all relief to which we are entitled. We are unable to estimate the possible loss or range of loss, therefore no amounts have been accrued as of December 31, 2022. See Notes 9 and 16 to the audited financial statements for more information about the EOC License Agreement, its termination and resulting arbitration.
Impact of Negative Global or National Events
Businesses have been and will continue to be impacted by a number of challenging global and national events and circumstances that continue to evolve, including the COVID-19 pandemic, extreme weather conditions, increased economic uncertainty, inflation, rising interest rates, and conflicts in Eastern Europe and in other countries. The extent of the impact of these events and circumstances on our business, operations and development timelines and plans remains uncertain, and will depend on certain developments, including the duration and scope of the events and their impact on our development activities, third-party manufacturers, and other third parties with whom we do business, as well as its impact on regulatory authorities and our key scientific and management personnel. We have been and continue to actively monitor the potential impacts that these various events and circumstances may have on our business and we take steps, where warranted, to minimize any potential negative impacts on our business resulting from these events and circumstances. For example, as the COVID-19 pandemic has developed, we have taken numerous steps to help ensure the health and safety of our employees. While we have largely resumed normal operations, any resurgence or worsening of the COVID-19 pandemic may cause us to reinstitute certain measures to protect employee safety, including staggered work hours or reduced in-person staffing, that could result in additional disruption and/or delays in our ability to conduct development activities.
We have been and continue to actively monitor our supply chain in light of these challenging global and national events and circumstances, including our third-party materials suppliers. To date, we have experienced some supply disruptions due to the COVID-19 pandemic, including closures at certain chip manufacturers, which led to extended lead times for FYARRO and diversion of certain lab materials needed to support COVID-19 relief efforts. While certain of these disruptions have been resolved since the start of the COVID-19 pandemic, we are continuing to monitor our supply chain and contingency planning is ongoing with our partners to reduce the possibility of an interruption to our development activities or the availability of necessary materials.
The ultimate impact of these global and national events and circumstances, either individually or in aggregate, is highly uncertain and subject to change. To the extent possible, we are conducting business as usual, with necessary or advisable modifications to mitigate potentially negative impacts to our business. For example, during the COVID-19 pandemic, our clinical trials have been, and may continue to be, affected by the closure of offices, lack of resources or closure of borders, among other measures being put in place around the world and we made certain modifications to employee travel, with masking and vaccination requirements in our offices, and with our employees working remotely fully or intermittently. Any continued inability to travel and conduct face-to-face meetings, as well as constraints surrounding hospital infrastructure and staff, can also make it more difficult to enroll and maintain patients in ongoing or planned clinical trials. We will continue to actively monitor the rapidly evolving situation related to these global and national events, and may take further actions to mitigate potential negative impacts to our business, and that may alter our operations, including those that may be required by federal, state or local authorities, or that we determine are in the best interests of our employees and other third parties with whom we do business. At this point, the extent to which these global or national events and circumstances may affect our future business, operations and development timelines and plans, including the resulting impact on our expenditures and capital needs, remains uncertain. We will continue to evaluate the impact that these events could have on our operations, financial position, results of operations and cash flows in fiscal year 2023.
August 2021 Reverse Merger
On May 16, 2021, at which time we were operating as “Aerpio Pharmaceuticals, Inc.,” we entered into: (i) an Agreement and Plan of Merger (“Merger Agreement”) with Aspen Merger Subsidiary, Inc., our wholly-owned subsidiary (“Merger Sub”), and Aadi Subsidiary, Inc. (formerly known as Aadi Bioscience, Inc. (“Private Aadi”)); and (ii) a subscription agreement (“Subscription Agreement”) with certain investors (the “2021 PIPE Investors”), pursuant to which we agreed to sell shares of our common stock to the 2021 PIPE Investors concurrently with the closing of the Merger (as defined below). See Note 1 to our audited financial statements for more information about the Merger Agreement and the Subscription Agreement.
On August 26, 2021, pursuant to the terms of the Merger Agreement and the Subscription Agreement:
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• Merger Sub merged with and into Private Aadi, with Private Aadi surviving as our wholly-owned subsidiary (the “Merger”);
• in connection with and immediately prior to the Merger, we effected a reverse stock split of our common stock at a ratio of 15:1 and changed our name from “Aerpio Pharmaceuticals, Inc.” to “Aadi Bioscience, Inc”;
• at the effective time of the Merger, based on an exchange ratio of 0.3172 (after taking into account the Reverse Stock Split), as calculated under the Merger Agreement (the “Exchange Ratio”), we issued an aggregate of 5,776,660 shares of common stock to the holders of Private Aadi common stock immediately prior to the Merger, including shares of Private Aadi common stock issuable upon the conversion of all shares of preferred stock and convertible promissory notes outstanding immediately prior to the Effective Time;
• at the closing of the Merger, we assumed all of the outstanding and unexercised options to purchase shares of Private Aadi common stock, which options were converted into options to purchase shares of our common stock, as adjusted pursuant to the Merger Agreement based on the Exchange Ratio;
• concurrently with the Closing of the Merger, we issued and sold 11,852,862 shares of common stock to the 2021 PIPE Investors for total gross proceeds of $155 million and, immediately after the closing of the Merger and the 2021 PIPE Financing, the 2021 PIPE Investors and the Private Aadi investors as of immediately prior to the effective time of the Merger owned 55.6% and 29.2%, respectively, of our outstanding common stock on a fully-diluted basis; and
• we entered into a contingent value rights agreement (“CVR Agreement”) pursuant to which each of our stockholders as of immediately prior to the effective time of the Merger became entitled to certain contingent value rights entitling them to receive 90% of the net proceeds (calculated as gross consideration minus certain permitted deductions), if any, received by us under the license agreement, dated June 24, 2018, with Gossamer Bio, Inc., as amended (the “Gossamer License Agreement”), and certain other covered agreements, as specified in the CVR Agreement (see Note 1 to our audited financial statements for more information about the CVR Agreement). The CVR Agreement automatically terminated effective July 24, 2022, the date the Gossamer License Agreement terminated.
Key Trends and Factors Affecting Comparability Between Periods
• Commercial sale of FYARRO was launched on February 22, 2022, for the treatment of patients with advanced malignant PEComa. We recorded net product sales of $15.2 million during the year ended December 31, 2022.
• We have built a cross-functional commercial team consisting of marketing, market access and commercial operations and will continue to strategically build our sales and our commercial infrastructure with capabilities designed to scale when necessary to support future commercial launches. Expenses related to our commercial launch including personnel expenses, sales support, and marketing are included in selling, general and administrative expenses for the year ended December 31, 2022. We expect these expenses will continue to increase in 2023, as compared to 2022, with the ongoing commercialization of FYARRO and preparation for potential future launches.
• We continue to build out our research and development team and we expect our research and development costs will increase in 2023, relative to 2022, as a result of significant expenses related to the PRECISION 1 trial which was open to enrollment during the year ended December 31, 2022, with the first patient dosed in March 2022.
• As a public company our expenses have increased from prior year as a privately held company, including (i) costs to comply with the rules and regulations of the SEC and those of the Nasdaq Capital Market (“Nasdaq”), (ii) legal, accounting and other professional services, (iii) insurance, (iv) investor relations activities, and (v) other administrative and professional services.
Liquidity and Capital Resources
As of December 31, 2022, we had $172.6 million of cash, cash equivalents and short-term investments. Based on our current plans, we believe our existing cash, cash equivalents and short-term investments will enable us to conduct our planned operations into 2025. We have incurred net losses in each year since inception and as of December 31, 2022 we had an accumulated deficit of $203.2 million. These losses have resulted principally from costs incurred in connection with research and development activities, selling, general and administrative costs associated with our operations, and costs associated with the Merger. We expect to continue to incur significant expenses and operating losses for the foreseeable future due to the cost of research and development, including conducting preclinical and clinical trials and identifying and
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designing product candidates, the regulatory approval process for FYARRO outside the United States and in additional indications and any other product candidates we may develop in the future and the commercial launch of FYARRO.
Basis of Presentation
The following discussion highlights our results of operations and the principal factors that have affected our financial condition as well as our liquidity and capital resources for the periods described and provides information that management believes is relevant for an assessment and understanding of the consolidated balance sheets and statements of operations and comprehensive loss presented herein. The following discussion and analysis are based on our consolidated financial statements contained in this Annual Report, which we have prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). You should read the discussion and analysis together with such consolidated financial statements and the related notes thereto.
Components of Statements of Operations and Comprehensive Loss
Revenue
Product Sales, Net
FYARRO was approved by the FDA in November 2021. On February 22, 2022, we launched sales of FYARRO to specialty distributors (“SD”s) and a specialty pharmacy (“SP”). We recognize product sales when the SDs and SP obtain control of the product, which occurs upon delivery. Product sales are recorded at the net sales price, which includes provisions for the following allowances which are reflected either as a reduction to the related account receivable or as an accrued liability, depending on how the allowance is settled:
• Distribution Fees : Distribution fees include distribution service fees paid to the SDs and SP based on a contractually fixed percentage of the wholesale acquisition cost (“WAC”). Distribution fees are recorded as an offset to product sales based on contractual terms at the time the sale is recognized.
• Rebates : Allowance for rebates include mandated discounts under the Medicaid Drug Rebate Program and TRICARE program. Rebates are amounts owed after the final dispensing of the product to a benefit plan participant and are based upon contractual agreements or statutory requirements. The allowance for rebates is based on contracted or statutory discount rates and expected utilization by benefit plan participants. Our estimates for expected utilization of rebates are based on utilization data received from the SDs and SP since product launch. Rebates are generally invoiced and paid in arrears so that the accrual balance consists of an estimate of the amount expected to be incurred for the current quarter’s activity. If actual future rebates vary from estimates, we may need to adjust prior period accruals, which would affect product sales in the period of adjustment.
• Chargebacks : Chargebacks are discounts and fees that relate to contracts with government and other entities purchasing from the SDs and SP at a discounted price. The SDs and SP charge back to us the difference between the price initially paid by the SDs and SP and the discounted price paid to the SDs and SP by these entities. If actual future chargebacks vary from these estimates, we may need to adjust prior period accruals, which would affect product sales in the period of adjustment.
• Co-Payment Assistance : We offer co-payment assistance to commercially insured patients meeting certain eligibility requirement. Co-payment assistance is accrued at the time of product sale to the SDs and SP based on estimated patient participation and average co-pay benefit to be paid per a claim. Our estimated amounts are compared to actual program participation and co-pay amounts paid using data provided by third-party administrators. If actual amounts differ from the original estimates the assumptions being applied are updated and adjustment for prior period accruals will be adjusted in the current period.
• Product Returns : Consistent with industry practice, we offer the SDs and SP limited product return rights for damages, shipment errors, and expiring product, provided that the return is within a specified period around the product expiration date as set forth in the applicable individual distribution agreement. We do not allow product returns for product that has been dispensed to a patient. As we receive inventory reports from the SDs and SP and have the ability to control the amount of product that is sold to the SDs and SP, we estimate future potential product returns based on the on-hand channel inventory data and sell-through data obtained from the SDs and SP. In arriving at our estimate, we also consider historical product returns, the underlying product demand, and industry data specific to the specialty pharmaceutical distribution industry.
Grant Revenue
Grant revenue is derived from federal grants, primarily with the FDA. We have determined that the government agencies providing grants to us are not customers. Grant revenue is recognized when there is reasonable assurance of compliance
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with the conditions of the grant and reasonable assurance that the grant revenue will be received. We recognize grant revenue as reimbursable grant costs are incurred. The costs associated with these reimbursements are reflected as a component of research and development expense in the accompanying statements of operations and comprehensive loss.
With respect to grant revenue derived from reimbursement of direct out-of-pocket expenses for research costs associated with federal contracts, where we act as principal with discretion to choose suppliers, bear credit risk and perform part of the services required in the transaction, we record revenue for the gross amount of the reimbursement. The costs associated with these reimbursements are reflected as a component of research and development expense in the accompanying statements of operations and comprehensive loss.
Operating Expenses
Selling, General and Administrative Expenses
Selling, general and administrative expenses consist primarily of salaries and related benefits, including share-based compensation, related to our executive, finance, business development, sales and marketing, and other corporate functions. Other general and administrative expenses include professional fees for legal, auditing, tax and business consulting services, insurance costs, intellectual property and patent costs, facility costs and travel costs. We expect that selling, general and administrative expenses will increase in the future as we expand our operating activities. Additionally, we have incurred, and expect to continue to incur, significant additional expenses associated with being a public company that we did not incur as a privately-held company, including (i) costs to comply with the rules and regulations of the SEC and those of Nasdaq, (ii) legal, accounting and other professional services, (iii) insurance, (iv) investor relations activities, and (v) other administrative and professional services.
Research and Development Expenses
Research and development expenses, which consist primarily of costs associated with our product research and development efforts, are expensed as incurred. Research and development expenses consist primarily of: (i) employee related costs, including salaries, benefits and share-based compensation expense for employees engaged in scientific research and development functions; (ii) third-party contract costs relating to research, formulation, manufacturing, nonclinical studies and clinical trial activities; (iii) external costs of outside consultants who assist with technology development, regulatory affairs, clinical development and quality assurance; (iv) payments made under our third-party licensing agreements; and (v) allocated facility-related costs.
Costs for certain activities, such as manufacturing, nonclinical studies and clinical trials are generally recognized based on the evaluation of the progress of completion of specific tasks using information and data provided by our vendors and collaborators. Research and development activities are central to our business. We expect to increase our investment in research and development in order to advance FYARRO in additional indications through clinical trials. As a result, we expect that our research and development expenses will increase substantially in the foreseeable future as we continue to invest in research and development activities, pursue clinical development of FYARRO in additional indications and any other product candidates we may develop in the future and expand our product candidate pipeline.
The process of commercialization and conducting the necessary preclinical and clinical research to obtain regulatory approval is costly and time-consuming. Product candidates in later stages of clinical development generally have higher development costs than those in earlier stages of clinical development, primarily due to the increased size and duration of later-stage clinical trials. Accordingly, to the extent that our product candidates continue to advance into clinical trials, including larger and later-stage clinical trials, our expenses will increase substantially and may become more variable.
Impairment of Acquired Contract Intangible Asset
Impairment of acquired contract intangible asset relates to a write down of the acquired contract intangible asset to fair value. During the year ended December 31, 2021, we recognized an impairment of $74.2 million to bring the carrying amount of the contract intangible asset down to its estimated fair value of $3.9 million at August 26, 2021. During the year ended December 31, 2022, w e recognized an impairment charge of $3.7 million to fully impair the contract intangible asset based on Gossamer's termination of the Gossamer License Agreement as a result of Gossamer not meeting its primary or secondary endpoint in the UC-SHIFT clinical trial.
Cost of Goods Sold
Cost of goods sold consist primarily of royalties paid to BMS, costs incurred on sales of FYARRO and costs to manufacture and prepare the product for sales subsequent to the FDA approval in November 2021. Costs incurred prior to the FDA approval were expensed when incurred .
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Other Income, Net
Other income, net consists of the change in fair value of convertible promissory notes and interest expense related to such notes. These expenses are partially offset by interest income earned on cash, cash equivalents and short-term investments, and gain on extinguishment of debt.
Income Tax Expense
During the years ending December 31, 2022 and 2021, we recognized zero and $2,000 of income tax expense on the statement of operations and comprehensive loss, respectively. Since our formation in 2011, we have not recorded any U.S. federal or state income tax benefits for the net losses we have incurred in each year or our earned tax credits, due to our uncertainty of realizing a benefit from those items.
Results of Consolidated Operations:
The following table presents the results of operations for the periods indicated (amounts in thousands):
Year Ended December 31,
2022 2021
Revenue
Product sales, net $ 15,216 $ —
License revenue — 1,000
Grant revenue — 120
Total revenue 15,216 1,120
Operating expenses
Selling, general and administrative 40,176 18,511
Research and development 32,662 19,670
Cost of goods sold 1,335 —
Impairment of acquired contract intangible asset 3,724 74,156
Total operating expenses 77,897 112,337
Loss from operations (62,681) (111,217)
Other income, net 2,168 1,129
Loss before income tax expense (60,513) (110,088)
Income tax expense — (2)
Net loss $ (60,513) $ (110,090)
Comparison of Years Ended December 31, 2022 and 2021
Product Sales, Net
Our product sales, net consist of sales of FYARRO since its launch in the United States on February 22, 2022. Product sales, net for the year ended December 31, 2022 were $15.2 million. There were no product sales for the year ended December 31, 2021.
License Revenue
During the year ended December 31, 2021, we recognized $1.0 million of revenue upon achieving the FDA approval milestone from EOC Pharma as consideration pursuant to the EOC License Agreement. This revenue was recognized when earned. No license revenue was recognized during the year ended December 31, 2022.
Grant Revenue
Grant revenue amounts can vary from period to period depending on the funding and work performed. Grant revenue decreased by $0.1 million for the year ended December 31, 2022 , compared to the same period in 2021, primarily due to a decrease in the eligible expenses for grant reimbursement incurred during 2022 compared to 2021. The period for eligible grant reimbursement with the FDA ended during the year ended December 31, 2021 . There were no new grants during the year ended December 31, 2022 .
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Operating Expenses
Selling, General and Administrative Expenses
Selling, general and administrative expenses for the year ended December 31, 2022 , were $40.2 million, an increase of $21.7 million, compared to $18.5 million for the year ended December 31, 2021.
The increase was driven by the following in support of our increased headcount, commercial and marketing expenses, and expenses related to being a public company. We expect these expenses to continue to increase to support future launches:
• $13.4 million in personnel related expenses due to increased headcount, incentive bonuses and share-based compensation. Sales and administrative headcount increased to 32 em ployees at December 31, 2022 from 17 employees at December 31, 2021;
• $4.0 million of legal, insurance and other related expenses;
• $2.9 million of commercial and marketing expenses; and
• $1.4 million of consulting exp enses.
Research and Development Expenses
The following table presents our research and development expenses for the periods indicated (amounts in thousands):
Year Ended December 31,
2022 2021
Personnel expense $ 18,526 $ 4,359
Consultants 4,543 2,458
External clinical development 8,347 5,838
Clinical drug product manufacturing 818 6,646
Other expense 428 369
Total research and development expense $ 32,662 $ 19,670
Research and development expenses for the year ended December 31, 2022 , were $32.7 million, an increase of $13.0 million, compared to $19.7 million for the year ended December 31, 2021. The increase was primarily driven by a $16.3 million increase in expenses related to headcount, consultants, and other expenses, a $2.5 million increase in clinical development expenses related to the PRECISION 1 trial, offset by a $5.8 million decrease related to clinical drug product manufacturing.
Cost of Goods Sold
Cost of goods sold was $1.3 million reflecting primarily royalties incurred on product sold during the year ended December 31, 2022 . There were no cost of goods sold during the year ended December 31, 2021 .
Impairment of Acquired Contract Intangible Asset
During the year ended December 31, 2022 , we recorded a $3.7 million impairment charge to reduce the carrying value of the intangible asset to its fair value of zero, based on a formal notice of termination we received on April 25, 2022 from Gossamer for the Gossamer License Agreement. The Gossamer License Agreement terminated effective July 24, 2022.
During the year ended December 31, 2021, we recorded a $74.2 million impairment charge to reduce the carrying value of the intangible asset to its fair value to $3.9 million at the Effective Times, as a result of the excess fair value ascribed to the acquired contract intangible asset related to the Merger.
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Other Income, Net
The following table sets forth our other income, net:
Year Ended December 31,
2022 2021
Change in fair value of convertible promissory notes $ — $ 1,585
Gain upon extinguishment of debt — 196
Interest income 2,398 13
Interest expense (230) (665)
Total other income $ 2,168 $ 1,129
Other income, net for the year ended December 31, 2022 , was $2.2 million of income, compared to $1.1 million of income for the year ended December 31, 2021 . The change was primarily driven by interest income of $2.4 million from investment holdings in the year ended December 31, 2022 compared to $1.6 million of non-cash income related to the change in fair value of the convertible promissory notes and a $0.2 million gain recognized on the extinguishment of the Paycheck Protection Program loan forgiven by the Small Business Administration in the year ended December 31, 2021 .
Liquidity and Capital Resources
Overview
As of December 31, 2022, we had $172.6 million of cash, cash equivalents and short-term investments. Prior to and a s of the date of filing this Annual Report on Form 10-K, we had and continue to have access to and control over all our cash, cash equivalents and short-term investments, notwithstanding the closure of Silicon Valley Bank (as discussed below and elsewhere in this Annual Report on Form 10-K). Based on our current plans, we believe our existing cash, cash equivalents and short-term investments will enable us to conduct our planned operations into 2025.
We have incurred net losses in each year since inception and as of December 31, 2022, we had an accumulated deficit of $203.2 million. Our net losses were $60.5 million and $110.1 million for the years ended December 31, 2022 and 2021, respectively. These losses have resulted principally from costs incurred in connection with research and development activities, selling, general and administrative costs associated with our operations, and costs associated with the Merger. We expect to continue to incur significant expenses and operating losses for the foreseeable future due to the cost of research and development, including conducting preclinical studies and clinical trials, identifying and designing product candidates, the regulatory approval process for FYARRO in additional indications, outside the United States and any other product candidates we may develop in the future, and the commercial launch of FYARRO. We expect our expenses, and the potential for losses, to increase substantially as we conduct clinical trials of FYARRO, in additional indications and seek to expand our pipeline.
From inception through December 31, 2022, we received funding of $25.4 million from our initial seed financing and the sale of Series A convertible preferred stock, $9.1 million from the issuance of convertible promissory notes, $145.4 million, net from the 2022 PIPE Financing in connection with the Merger, $29.7 million of cash assumed in the Merger, and $72.2 million, net cash proceeds from the 2022 PIPE Financing.
Shelf Registration Statement; $75M At the Market Offering
On March 17, 2022, we entered into a Sales Agreement (the “Sales Agreement”) with Cowen and Company, LLC (“Cowen”), with respect to an “at the market offering” pursuant to which we may offer and sell, from time to time at our sole discretion, shares of our common stock having aggregate gross proceeds of up to $75.0 million through Cowen as our sales agent. Under the Sales Agreement, we will set the parameters for the sale of shares, including the number of shares to be issued, the time period during which sales are requested to be made, limitations on the number or dollar value of shares that may be sold in any one trading day and any minimum price below which sales may not be made. We will pay Cowen 3.0% of the aggregate gross proceeds from each sale of shares of common stock under the Sales Agreement. As of December 31, 2022, no shares of common stock had been sold under the Sales Agreement.
The shares of our common stock to be offered and sold under the Sales Agreement will be issued and sold pursuant to our shelf registration statement on the Form S-3 (File No. 333-255129), which was filed with the SEC on April 8, 2021, and which became effective on April 15, 2021. We filed a prospectus supplement with the SEC on March 21, 2022 in connection with the offer and sale of the shares pursuant to the Sales Agreement.
The shelf registration statement allows us to sell from time to time up to $150.0 million of common stock, preferred stock, debt securities, warrants, or units comprised of any combination of these securities, for our own account in one or more
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offerings. The shelf registration statement is intended to provide us flexibility to conduct registered sales of our securities, subject to market conditions and our future capital needs. The terms of any offering under the shelf registration statement will be established at the time of such offering and will be described in a prospectus supplement filed with the SEC prior to the completion of any such offering.
On September 22, 2022, the Company entered into the Purchase Agreement for the 2022 PIPE Financing with the 2022 PIPE Investors for the sale by the Company of 3,373,526 shares of the Company’s common stock for a price of $12.50 per share and Pre-Funded Warrants to purchase an aggregate of 2,426,493 shares of the Company's common stock, at a purchase price of $12.4999 per Pre-Funded Warrant. The Pre-Funded Warrants are exercisable at an exercise price of $0.0001 and will be exercisable until exercised in full. The 2022 PIPE Financing closed on September 26, 2022. Aggregated net proceeds, after deducting certain expenses incurred of $0.3 million related to the issuance of the shares were $72.2 million.
The following table summarizes our cash flows for the years presented (amounts in thousands):
Year Ended December 31,
2022 2021
Net cash used in operating activities $ (49,640) $ (22,423)
Net cash (used in) provided by investing activities (132,886) 25,153
Net cash provided by financing activities 72,620 141,804
Net (decrease) increase in cash, cash equivalents and restricted cash $ (109,906) $ 144,534
Operating Activities
Our cash used in operating activities primarily results from our net loss adjusted for non-cash expenses, changes in working capital components, amounts due to contract research organizations to conduct our clinical programs and employee-related expenditures for research and development and selling, general and administrative activities. Our cash flows from operating activities will continue to be affected by spending to commercialize FYARRO in advanced malignant PEComa, advance and support FYARRO in additional indications in the clinic, develop new product candidates, and other operating and general administrative activities, including operating as a public company.
For the year ended December 31, 2022, cash used in operating activities was $49.6 million and resulted from (i) our net loss of $60.5 million, and (ii) a $1.8 million net decrease in our working capital accounts, primarily driven by an increase in accounts receivable and inventory related to the commercial launch of FYARRO in February 2022; offset by (i) a decrease in accounts payable and accrued expenses, and $12.7 million in non-cash adjustments, which was primarily related to share-based compensation expense, the impairment of the contract intangible asset, and depreciation and amortization expense.
For the year ended December 31, 2021, cash used in operating activities was $22.4 million and resulted from (i) our net loss of $110.1 million offset by non-cash adjustments totaling $75.4 million, which was primarily related to impairment of the acquired contract intangible asset of $74.2 million, and (ii) a $12.3 million net increase in our working capital accounts, primarily driven by the receipt of the $14.0 million upfront payment on accounts receivable pursuant to the EOC License Agreement.
Investing Activities
Cash used in investing activities for the year ended December 31, 2022 related to purchases of short-term investments $145.2 million, offset by maturities of $12.8 million.
Cash provided by investing activities for the year ended December 31, 2021 related to cash acquired in connection with the Merger of $29.7 million offset by $4.5 million of transaction related expenses.
Financing Activities
Cash provided by financing activities for the year ended December 31, 2022 related to $72.5 million gross cash proceeds from our 2022 PIPE Financing, $0.4 million from exercise of stock options and $0.3 million in proceeds from the issuances of stock under the ESPP, offset by $0.7 million of financing costs related to the 2021 PIPE Financing and the 2022 PIPE Financing.
Cash provided by financing activities for the year ended December 31, 2021 includes $155.0 million gross cash proceeds from our 2021 PIPE Financing and $0.8 million from exercise of stock options, partially offset by $9.6 million of issuance costs related to the 2021 PIPE Financing, and $4.4 million of dividends paid to preferred stockholders.
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Contractual Obligations and Commitments
In April 2022, we entered into a lease for 10,615 square feet of office space in Morristown, New Jersey. The term of the lease is seventy-three months unless terminated sooner.
Rent expense is being recorded on a straight-line basis. Rent expense related to the Pacific Palisades and Morristown leases was $0.4 million and $0.2 million for the years ended December 31, 2022 and 2021, respectively. See Note 8 to the consolidated financial statements for details related to future lease payments.
In January 2022, we entered into a Negotiated Purchase Order Terms and Conditions for Clinical and Commercial Product, as amended effective as of August 1, 2022 (the “Fresenius Agreement”), with Fresenius Kabi, LLC (“Fresenius Kabi”), pursuant to which Fresenius Kabi will manufacture FYARRO for us and we will purchase FYARRO as a finished drug product from Fresenius Kabi, on a purchase-order basis. The Fresenius Agreement contains specific activities such as non-cancellable commitments, minimum purchase commitments, and binding annual forecasts. Under the Fresenius Agreement, which is effective through March 31, 2024 (or such later date as may be agreed between the parties in writing), we may purchase FYARRO for either clinical or commercial purposes for use in the United States and Canada.
In August 2021, we entered into an amendment to extend the lease of our 2,760 square feet of office space in Pacific Palisades, California. We exercised an option, under our prior lease agreement, to extend the term of the lease for an additional three-year period. Included in the renewal were nine months of rent abatement and a rent escalation clause.
We also have contracts with various organizations to conduct research and development activities, including clinical trial organizations to manage clinical trial activities and manufacturing companies to manufacture the drug product used in the clinical trials. The scope of the services under these research and development contracts can be modified and the contracts cancelled by us upon written notice. In the event of a cancellation, we would be liable for the cost and expenses incurred to date as well as any close out costs of the service arrangement.
Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). These accounting principles require us to make certain estimates, judgements and assumptions that affect the reported amounts of assets and liabilities as of the date of the financial statements, as well as the reported amounts of revenues and expenses during the periods presented. We believe that the estimates, judgments and assumptions are reasonable based upon information available to us at the time that these estimates, judgments and assumptions are made. To the extent there are material differences between these estimates, judgments or assumptions and actual results, our financial statements will be affected. Historically, revisions to our estimates have not resulted in a material change to our financial statements.
While our significant accounting policies are described in more detail in the notes to our consolidated financial statements appearing elsewhere in this Annual Report on Form 10-K, we believe the following accounting policies to be most critical to the judgments and estimates used in the preparation of our consolidated financial statements.
Revenue Recognition
We recognize revenue when a customer obtains control of promised goods or services, in an amount that reflects the consideration which the entity expects to receive in exchange for those goods or services. To determine revenue recognition for arrangements that we determine are within the scope of ASC Topic 606, Revenue from Contracts with Customer (“Topic 606”), the following five steps are performed: (i) identify the contract(s) with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when (or as) we satisfy a performance obligation.
Net Product Sales
We sell our product primarily through a limited number of specialty distributors (SDs) and specialty pharmacy (SP) customers. The delivery of our product represents a single performance obligation for these transactions, and we record net product sales when control is transferred to the customer, which occurs upon receipt by the customer. The transaction price for net product sales represents the amount we expect to receive, which is net of estimated distribution fees, government-mandated rebates, chargebacks, co-payment assistance, and estimated product returns. Accruals are established for these deductions, and actual amounts incurred are offset against applicable accruals. We reflect these accruals as either a reduction in the related account receivable from the distributor or as an accrued liability, depending on the nature of the sales deduction. Sales deductions are based on management's estimates that consider channel mix and experience to date.
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Estimates are assessed periodically and updated to reflect current information. These estimates involve a substantial degree of judgment, in particular, for government-mandated rebates and chargebacks, such as for the Medicaid and 340B programs.
Research and Development Costs
We incur substantial expenses associated with clinical trials. Accounting for clinical trials relating to activities performed by CROs and other external vendors requires us to exercise significant estimates in regard to the timing and accounting for these expenses. We estimate costs of research and development activities conducted by service providers, which include, the conduct of preclinical studies, contract manufacturing activities and clinical activities. The diverse nature of services being provided under CRO and other vendor arrangements, the different terms and milestone arrangements that exist for each type of service and the lack of timely information related to certain clinical activities complicates the estimation of accruals for services rendered by CROs and other vendors in connection with clinical trials. We record the estimated costs of research and development activities based upon the estimated amount of services provided but not yet invoiced and include these costs in the accrued and other current liabilities or prepaid expenses, as applicable, on the balance sheets and within research and development expense on the consolidated statements of operations and comprehensive loss. In estimating the duration of a clinical study, we evaluate the start-up, treatment and wrap-up periods, payment arrangements and services rendered attributable to each clinical trial and fluctuations are regularly tested against payment plans and trial completion assumptions.
We estimate these costs based on factors such as estimates of the work completed and budget provided and in accordance with agreements established with our collaboration partners and third-party service providers. We make significant judgments and estimates in determining the accrued liabilities and prepaid expense balances in each reporting period. As actual costs become known, we adjust our estimates and related accounts on the balance sheet. We have not experienced any material differences between accrued costs and actual costs incurred since our inception.
Our expenses related to clinical trials are based on estimates of patient enrollment and related expenses at clinical investigator sites as well as estimates for the services received and efforts expended pursuant to contracts with multiple research institutions and CROs that may be used to conduct and manage clinical trials on our behalf. We generally accrue expenses related to clinical trials based on contracted amounts applied to the level of patient enrollment and activity. If timelines or contracts are modified based upon changes in the clinical trial protocol or scope of work to be performed, we modify our estimates of accrued expenses accordingly on a prospective basis.
Share-Based Compensation
We recognize all share-based payments to employees, including grants of employee stock options in the consolidated statements of operations and comprehensive loss based on their fair values. All of our share-based awards, to employees, non-employees, officers, and directors, are subject only to service-based vesting conditions. We estimate the fair value of our share-based awards using the Black-Scholes option pricing model, which requires the input of assumptions, including (i) the expected stock price volatility, (ii) the calculation of expected term of the award, (iii) the risk-free interest rate based on the U.S. Treasury yield in effect at the time of the grant for zero-coupon U.S. treasury notes with maturities approximately equal to the expected term of the stock options and (iv) expected dividends. Options granted during the year have a maximum contractual term of ten years. Forfeitures are recognized and accounted for as they occur.
Due to the historical lack of a public market for the trading of our common stock following the Merger and a lack of company-specific historical and implied volatility data, we have based our estimate of expected volatility on the historical volatility of a group of similar companies that are publicly traded. The computation of expected volatility is based on the historical volatility of a representative group of companies with similar characteristics to ours, including stage of product development and life science industry focus. We believe the group selected has sufficient similar economic and industry characteristics and includes companies that are most representative of us.
We have limited historical stock option activity and therefore estimate the expected term of stock options granted to employees, officers, and directors using the simplified method, which represent the average of the contractual term of the stock option and its weighted-average vesting period, to calculate the expected term, as we do not have sufficient historical exercise data to provide a reasonable basis upon which to estimate the expected term for options granted to employees, and utilize the contractual term for options granted to non-employees. The expected term is applied to the stock option grant group as a whole, as we do not expect substantially different exercise or post-vesting termination behavior among our employee population.
Compensation expense related to awards to employees is calculated on a straight-line basis by recognizing the grant date fair value over the associated service period of the award, which is generally the vesting term. For the years ended
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December 31, 2022 and 2021, we recognized share‑based compensation expense, net of estimated forfeitures, in the statements of operations and comprehensive loss as follows (amounts in thousands):
Year Ended December 31,
2022 2021
Selling, general and administrative $ 6,333 $ 1,449
Research and development 3,310 657
Total $ 9,643 $ 2,106
As of December 31, 2022, total unamortized share‑based compensation was $28.8 million which we expect to recognize over a weighted average period of 2.7 years. The intrinsic value of all out standing stock options as of December 31, 2022 w as $2.8 million.
Merger and Acquired Contractual Intangible Asset
Aerpio issued common stock in the Merger based on the terms of the Merger Agreement. For accounting purposes, however, we concluded under GAAP that Private Aadi has acquired Aerpio. We based this conclusion having evaluated the terms of the Merger Agreement and other factors including: (i) the stockholders of Private Aadi owned approximately 66.8% of the voting rights of the Company as of immediately following the Merger (but prior to the 2021 PIPE Financing); (ii) three (3) of seven (7) members of the board of directors of the Company post-Merger were composed of directors designated by Private Aadi under the terms of the Merger Agreement, and one (1) member of the board of directors of the Company post-Merger was a director mutually designated by Private Aadi and Aerpio; (iii) existing members of Private Aadi’s management became the management of the Company post-Merger; (iv) the 2021 PIPE Investors consist of individuals and funds, and for purpose of this analysis, while they owned approximately 55.6% on a fully-diluted basis, as of immediately following the Merger (and after giving effect to the 2021 PIPE Financing), no one individual or fund held more shares than the holders of Private Aadi collectively owned immediately following the Merger and they are not considered to be a single voting group; and (v) following the Merger, the Company is headquartered in Pacific Palisades, California, and all ongoing operations of the combined company are those of Private Aadi.
Further, under GAAP we have accounted for the Merger as a reverse asset acquisition rather than a business combination. Accounting as an asset acquisition is significantly different than the accounting for a merger transaction as a business combination. Among other things, we have not recognized any goodwill on our consolidated balance sheet as there may have been had the Merger been accounted for as a business combination. A central element to the accounting model conclusion is the determination of whether a business or an asset or a group of assets is acquired. A business is defined in ASC 805, Business Combinations, as an integrated set of inputs and processes that are capable of generating outputs that have the ability to provide a return to its investors or owners. Typical inputs include long-lived assets (including intangible assets or rights to use long-lived assets), intellectual property and the ability to obtain access to required resources. Typical processes include strategic, operational and resource management processes that are typically documented or evident through an organized workforce. We considered all of the above factors when determining whether a business was acquired in the Merger and concluded that Aerpio did not meet the definition of a business.
Upon closing of the Merger, substantially all of the fair value is concentrated in cash, working capital and a long-lived contract intangible asset related to Aerpio’s license agreement with Gossamer Bio. Inc., under which 90% of any future net cash proceeds will be remitted to CVR Holders and paid through the CVRs. In accordance with GAAP for asset acquisitions, the excess purchase price over the fair value of the acquired assets and liabilities ($78.1 million) was ascribed to the acquired contract intangible asset. However, due to the significant excess purchase price being allocated over the fair value of the acquired contractual intangible asset, we determined that an indicator of impairment was present, and we assessed the contract intangible asset as compared to expectations of contingent future cash flows. We concluded that our estimate of gross cash flows potentially accruing to us under the license agreement is likely to be less than the excess purchase price of the fair value of the acquired assets and liabilities ascribed to the acquired contract intangible asset. As a result, we performed a valuation of the acquired contract intangible asset and recognized an impairment of $74.2 million to adjust the carrying amount of the contractual intangible asset to its estimated fair value of $3.9 million. During the year ended December 31, 2022, upon receipt of the Notice of Termination, we impaired the contract intangible asset by $3.7 million to its estimated fair value of zero based on receipt of the formal notice of termination from Gossamer for the Gossamer License Agreement.
The license agreement with Gossamer Bio. Inc. includes potential payments to us in the event of certain development and commercialization milestones and sales-based royalties. Our fair value determination of the intangible asset utilized a
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scenario-based, risk-adjusted, discounted cash flow model with respect to the potential development milestone payments and a Monte Carlo option-pricing model with respect to the sales-based milestone and royalty payments:
• We determined fair value of the potential development milestone payments under the license agreement with inputs based on certain subjective assumptions, including (a) the probability of clinical success determined with reference to various academic studies reporting probabilities of approval for clinical trials; (b) an estimate of the time to achievement of the clinical milestones; and (c) a counterparty credit risk premium determined with reference to the borrowing costs of a benchmark group of comparable market participants.
• Application of the Monte Carlo simulation model in valuing the potential sales-based milestone and royalties involves making assumptions for (a) the probability of clinical success determined with reference to various academic studies reporting probabilities of approval for clinical trials; (b) our forecast of potential revenues, revenue uptake rate and the period of time from a prospective commercial launch to peak sales, and an estimate of peak sales for each successfully commercialized product covered under the license agreement; (c) drift equal to the risk free rate on revenues following a multivariate Geometric Brownian Motion; (d) a counterparty credit risk premium determined with reference to the borrowing costs of a benchmark group of comparable market participants; and (e) a revenue metric risk premium determined with reference to a long-term risk-free rate, a weighted-average cost of capital, revenue volatility and asset volatility.
Recent Accounting Pronouncements
See Note 2 to the consolidated financial statements for a discussion of recent accounting pronouncements.