ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The statements in the discussion and analysis regarding industry outlook, our expectations regarding the performance of our business and the forward-looking statements are subject to numerous risks and uncertainties, including, but not limited to, the risks and uncertainties described in “Risk Factors” and “Cautionary Note Regarding Forward-Looking Statements.” Our actual results may differ materially from those contained in or implied by any forward-looking statements. You should read the following discussion together with the sections entitled “Risk Factors,” “Business” and the audited Consolidated Financial Statements, including the related notes, appearing elsewhere in this Annual Report on Form 10-K. All references to years, unless otherwise noted, refer to our fiscal years, which end on December 31 . As used in this Annual Report on Form 10-K, unless the context suggests otherwise, “we,” “us,” “our,” “the Company” or “RVL” refer to RVL Pharmaceuticals plc (formerly Osmotica Pharmaceuticals plc) and subsidiaries. This discussion and analysis is based upon the historical financial statements of RVL Pharmaceuticals plc and subsidiaries appearing elsewhere in this Annual Report on Form 10-K.
Overview
We are a specialty pharmaceutical company focused on the development and commercialization of products that target markets with underserved patient populations in the ocular medicine and medical aesthetics therapeutic areas.
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In July 2020, we received regulatory approval from the FDA for RVL-1201, or Upneeq, (oxymetazoline hydrochloride ophthalmic solution), 0.1%, for the treatment of acquired blepharoptosis, or droopy or low-lying eyelids in adults. We believe Upneeq is the first non-surgical treatment option approved by the FDA for acquired blepharoptosis. We launched Upneeq in September 2020 to a limited number of eye care professionals with commercialization operations expanded in 2021 among ophthalmology, optometry and oculoplastic specialties. In February 2022, Upneeq was commercially expanded into the medical aesthetics market in the United States. Patients may purchase Upneeq either from eye care or medical aesthetic professionals, or exclusively through RVL Pharmacy, LLC, our wholly-owned pharmacy.
We acquired Upneeq as part of our asset acquisition of RevitaLid, Inc., now known as RVL Pharmaceuticals, Inc., in 2017. As part of the acquisition, we agreed to make future earn-out, milestone and royalty payments based on net sales and regulatory developments with respect to Upneeq. Upneeq is manufactured and supplied to us by Nephron Pharmaceuticals Corporation under an exclusive supply agreement that has a term of five years from the production of the initial commercial batches, and automatically renews for additional one-year periods unless either party provides at least 90 days’ advance written notice of non-renewal.
On July 28, 2020, we entered into a license agreement with Santen Pharmaceutical Co. Ltd (“Santen”), granting Santen exclusive development, registration, and commercialization rights to RVL-1201 in Japan, China, and other Asian countries as well as Europe, the Middle East and Africa (“EMEA”) countries (the “License Agreement”). Santen is responsible for further development of RVL-1201 in the licensed territories. Under the License Agreement, we have received an upfront payment of $25.0 million in 2020 and a license milestone payment of $10.0 million in 2021. On March 29, 2022, we amended the License Agreement, effective March 31, 2022 (as amended, the “Amended License Agreement”), and received $15.5 million to expand the licensed territories to include certain additional EMEA countries and Canada and remove certain regulatory approval milestones from the License Agreement. Under the Amended License Agreement, we may receive additional payments of up to $31.0 million based on development, regulatory and sales milestone payments in Santen’s territories. In addition, during the first five years following the effective date of the Amended License Agreement, Santen was granted an option to expand the territories to include Russia, subject to additional upfront and milestone payments of $2.0 million and $1.0 million, respectively. Further, under the terms of the Amended License Agreement, if we desire to enter into an agreement to license certain rights related to the Amended License Agreement to a third party in Russia, then Santen will have a right to exercise an option to expand the territories to include Russia or to match the terms of the agreement with the third party. We are also entitled to royalty payments on net sales of RVL-1201 in Santen commercialization territories. See Note 5, “ Revenues ,” of our Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K for additional information on our License Agreement with Santen.
On August 27, 2021, we announced the closing of the divestiture of our portfolio of branded and non-promoted products and our Marietta, Georgia, manufacturing facility (collectively, the “Legacy Business”), to certain affiliates of Alora Pharmaceuticals, LLC (“Alora”) for $111.0 million in cash upon closing, subject to certain post-closing adjustments, and up to $60.0 million in contingent milestone payments. Pursuant to the divestiture, we retained the rights to Upneeq and to arbaclofen ER tablets, which is under development for the treatment of spasticity in multiple sclerosis. During the year ended December 31, 2022, we received an aggregate of $5.0 million in cash from Alora related to contingent milestone payments earned in connection with the sale of the Legacy Business.
With the divestiture of the Legacy Business, our commercial operations are conducted by our wholly-owned subsidiary, RVL Pharmaceuticals, Inc. and its subsidiary RVL Pharmacy, LLC (“RVL Pharmacy”). RVL Pharmacy exclusively conducts pharmacy operations dedicated to the processing and fulfillment of prescriptions for Upneeq.
Following the divestiture of the Legacy Business, we are exploring opportunities to sell or out-license our late-stage product candidate arbaclofen ER tablets designed for the alleviation of signs and symptoms of spasticity resulting from multiple sclerosis for which we have completed Phase III clinical trials. In June 2020, we resubmitted our NDA for arbaclofen ER tablets to the FDA. On July 17, 2020, we received notice from the FDA that it considered the resubmission a complete response to the July 9, 2016 action letter and set a goal date for a FDA decision on the NDA of December 29, 2020. On December 28, 2020, we received a complete response letter (“CRL”) indicating the FDA could not approve the NDA in its then current form. The CRL stated that we did not provide adequate justification (including in our most recent NDA amendment) for the statistical analysis of the change from baseline to Day 84 in the Total
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Numeric-transformed Ashworth Scale in the most affected limb (“TNmAS-MAL”) scores comparing arbaclofen ER 40 mg to placebo, one of the co-primary endpoints. On January 23, 2021, we submitted a Type A meeting request to the FDA to discuss the CRL’s recommendations and obtain advice on a path forward for the NDA. The meeting took place on March 4, 2021, during which we explored selective review of the currently available data and options for a path forward for FDA approval, including conducting another clinical study. On August 2, 2021, we submitted a special protocol assessment (“SPA”), to the FDA proposing an additional clinical study for arbaclofen ER. The FDA responded in a letter dated October 15, 2021, indicating that they are unable to issue an agreement on the submitted protocol. On October 10, 2022, we resubmitted a SPA and on November 24, 2022, we received a letter from the FDA indicating that they were unable to issue an agreement on the SPA. On February 8, 2023, we resubmitted a SPA with a revised study protocol and statistical analysis.
Business Update Regarding COVID-19
The COVID-19 pandemic presented a substantial public health and economic challenge around the world. We launched our commercial activities for Upneeq and began engaging with eye care providers to promote Upneeq in September 2020 and have since expanded our field sales force into the medical aesthetics market. In some instances our sales force encountered challenges engaging with healthcare professionals during the pandemic. Although most areas of the United States have re-opened, restrictions on access to offices and other commercial facilities may be reinstated as a result of concerns about the spread of new variants, which may have the potential to affect our ability to conduct our business and the ability of patients to visit their eye care providers and medical aesthetics clinics.
To date, we have been able to continue to supply Upneeq to patients and healthcare professionals without significant disruption, and we do not currently anticipate significant interruption in the near term. Additionally, our third-party contract manufacturing partner for Upneeq has been able to operate its manufacturing facility at or near normal levels. We currently do not anticipate significant interruptions in our manufacturing supply chain due to COVID-19.
In the U.S., our office-based employees have been permitted to work from home since mid-March 2020. During this time, we are ensuring essential staffing levels in our operations remain in place, including maintaining key personnel in our pharmacy.
For additional information on the various risks posed by the COVID-19 pandemic, please read Item 1A. Risk Factors included in this Annual Report on Form 10-K.
Financial Operations Overview
Segment Information
We currently operate in one business segment focused on the commercialization and development of specialty pharmaceutical products that target markets with underserved patient populations. We are not organized by market and are managed and operated as one business. We also do not operate any separate lines of business or separate business entities with respect to Upneeq. A single management team reports to our chief operating decision maker who comprehensively manages our entire business. Accordingly, we do not accumulate discrete financial information with respect to separate product lines and do not have separately reportable segments. See Note 2, “ Summary of Significant Accounting Policies, ” to our Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K.
Components of Results of Operations
Revenues
Our revenues consist of product sales, royalty revenues and licensing revenue.
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Net product sales— Our net product revenues consist of sales of Upneeq. RVL Pharmacy ships Upneeq to our customers pursuant to prescriptions; however, in certain cases where our state pharmacy licenses are pending prescriptions are fulfilled by a third-party pharmacy partner. We refer to these sales as Pharmacy Sales. Additionally, Upneeq is sold directly to physician practices in certain states which permit physicians to dispense Upneeq in their offices or directly to telemedicine partners. We refer to these sales as Direct Dispense sales. Predominately, we collect payment in advance from our customers. From time to time, we may invoice a customer after the products have been delivered in which case payments are typically due within 30 days. We recognize revenue when control has transferred to the customer, which is typically upon delivery to the customer, the physician or the partner as the case may be. The amount of revenue we recognize is equal to the selling price, adjusted for any variable consideration, which largely consists of discounts and disputed chargebacks, at the time revenues are recognized.
Royalty revenue— For arrangements that include sales-based royalties, including milestone payments based on the level of sales, and the license is deemed to be the predominant item to which the royalties relate, we recognize revenue at the later of (i) when the related sales occur, or (ii) when the performance obligation to which some or all the royalty has been allocated has been satisfied (or partially satisfied).
Licensing revenue— For license arrangements with commercial partners that include payments based on the achievement of regulatory approvals or other non-sales milestone, revenue is recognized when the performance obligation identified in the arrangement is completed.
Selling, General and Administrative Expenses
Selling, general and administrative expenses consist primarily of personnel expenses, including salaries and benefits for employees in executive, sales, marketing, finance, accounting, business development, legal, information technology and human resource functions. General and administrative expenses also include corporate facility costs, including rent, utilities, insurance, legal fees related to corporate matters, share based compensation, fees for accounting and other consulting services, including public company costs associated with the preparation of our SEC filings, legal and accounting costs, investor relations costs, director and officer liability insurance costs, as well as costs related to compliance with laws and regulations, including the Sarbanes-Oxley Act of 2002, and the Dodd-Frank Wall Street Reform and Consumer Protection Act.
Research and Development Expenses
Costs for research and development are charged as incurred and include employee related expenses (including salaries and benefits, share based compensation, travel and expenses incurred under agreements with contract research organizations, or CROs, contract manufacturing organizations and service providers that assist in conducting clinical and preclinical studies), costs associated with preclinical activities and development activities and costs associated with quality and regulatory operations.
Costs for certain development activities, such as clinical studies, are recognized based on an evaluation of the progress to completion of specific tasks using data such as patient enrollment, clinical site activations or information provided to us by our vendors on their actual costs incurred. Payments for these activities are based on the terms of the individual arrangements, which may differ from the patterns of costs incurred, and are reflected in our Consolidated Financial Statements as prepaid expenses or accrued expenses as applicable.
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Results of Operations
Comparison of Years Ended December 31, 2022 and 2021
Financial Operations Overview
The following table presents revenues and expenses from continuing operations for the periods indicated (dollars in thousands):
Year Ended December 31,
% Change
Net product sales
Royalty and licensing revenue
Total revenues
Cost of goods sold
Gross profit
Gross profit percentage
Selling, general and administrative expenses
Research and development expenses
Impairments of intangible assets
Total operating expenses
Gain on sales of product rights, net
Operating loss
Interest expense and amortization of debt discount
Change in fair value of debt and interest expense
Change in fair value of warrants
Other non-operating (income) expense, net
Total other non-operating income
Loss before income taxes
Income tax (benefit) expense, continuing operations
Loss from continuing operations
Gain on sales of discontinued operations
Income from discontinued operations before income taxes
Income tax benefit, discontinued operations
Income from discontinued operations, net of tax
Net loss
Revenues
The following table presents total revenues for the periods indicated (dollars in thousands):
Year Ended December 31,
% Change
Net product sales - Upneeq
Royalty and licensing revenue
Total revenues
Total Revenues. Total revenues increased by $32.2 million to $49.7 million for the year ended December 31, 2022, from $17.5 million for the year ended December 31, 2021 primarily due to higher volumes of Upneeq sold and higher licensing revenue from Santen.
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Net Product Sales . Net product sales increased by $26.7 million to $34.2 million for the year ended December 31, 2022, as compared to $7.5 million for the year ended December 31, 2021, primarily due to higher volumes of Upneeq sold, reflecting expanded commercialization into eye care markets and, effective February 2022, the medical aesthetics market.
Royalty and Licensing Revenue. Royalty and licensing revenue increased by $5.5 million to $15.5 million for the year ended December 31, 2022, as compared to $10.0 million for the year ended December 31, 2021, primarily due to changes in milestone revenues recognized under our License Agreement with Santen. See Note 5, “ Revenues ,” of our Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K for additional information on our License Agreement with Santen.
Cost of Goods Sold and Gross Profit Percentage
The following table presents a breakdown of total cost of goods sold for the periods indicated (dollars in thousands):
Year Ended December 31,
% Change
Royalty expense
Depreciation expense
Other costs of goods sold
Total costs of goods sold
Total cost of goods sold increased by $5.9 million to $9.5 million for the year ended December 31, 2022, as compared to $3.6 million for the year ended December 31, 2021. The year over year increase in cost of goods sold was primarily driven by $3.7 million in higher product costs for Upneeq due to higher sales volume and by $2.3 million relating to increased royalties and contingent milestone payments due under an intellectual property license agreement, each attributable to sales of Upneeq.
Gross profit percentage was 81% for the year ended December 31, 2022 compared to 79% for the year ended December 31, 2021, primarily due to higher licensing revenues in 2022 compared to 2021. Excluding licensing revenues, gross profit percentage from net product sales was 72% and 52% in the 2022 and 2021 periods, respectively, reflecting improved overhead absorption driven by higher volumes and more favorable average selling prices in the 2022 period.
Selling, General and Administrative Expenses
Selling, general and administrative expenses decreased by $5.5 million to $82.0 million for the year ended December 31, 2022, as compared to $87.5 million for the year ended December 31, 2021. The year over year decrease in selling, general and administrative expenses was primarily influenced by $8.4 million in lower legal and other professional fees, $2.4 million in lower share-based compensation expense, $1.1 million in lower debt and equity issuance and transactional fees and $0.7 million in lower restructuring related expenditures, partially offset by $6.9 million in higher net compensation costs primarily for our expanded salesforce and $0.8 million of higher credit card fees.
Selling, general and administrative expenses for the years ended December 31, 2022 and 2021 include various restructuring-related expenditures, including severance, of $2.9 million and $3.5 million, respectively, and share-based compensation expenses of $3.4 million and $5.8 million, respectively.
See Notes 19, “ Restructuring Expenses ,” and 14, “ Share-Based Compensation ,” of our Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K.
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Research and Development Expenses
The following table summarizes our research and development (“R&D”) expenses incurred for the periods indicated (dollars in thousands):
Year Ended December 31,
% Change
Arbaclofen ER
RVL-1201 (Upneeq)
Other research and development
Total research and development expenses
R&D expenses decreased by $2.9 million to $4.0 million for the year ended December 31, 2022, as compared to $6.9 million for the year ended December 31, 2021. The year over year decrease in R&D expenses primarily reflects $1.2 million in lower project spending, $0.3 million in lower share-based compensation expense and $1.2 million in restructuring expenses particular to the 2021 period.
R&D expenses include share-based compensation expenses of $0.6 million and $0.9 million for the years ended December 31, 2022 and 2021, respectively.
Impairments of Intangible Assets
Based on the results of quantitative impairment assessments performed relative to arbaclofen ER, an in-process research and development project-based intangible asset, we recognized impairment charges of $13.3 million and $7.9 million for the years ended December 31, 2022 and 2021, related to delays in anticipated commercialization of the product candidate, if approved.
See Note 9, “ Goodwill and Indefinite-Lived Intangible Assets ,” of our Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K for additional information on our impairments.
Interest Expense and Amortization of Debt Discount
Interest expense and amortization of debt discount increased by less than $0.1 million to $3.1 million in the year ended December 31, 2022, as compared to $3.0 million in the year ended December 31, 2021. The year over year increase was attributable to our recognition of $3.1 million of amortization expense from the second tranche financial commitment asset, particular to the 2022 period, substantially offset by the absence of interest expense in the 2022 period in this caption.
Beginning in the fourth quarter of 2021, our recognition of interest expense on our Senior Secured Notes has been classified within the separate caption titled “Change in fair value of debt and interest expense” pursuant to our elections related to fair value accounting (see “Change in Fair Value of Debt and Interest Expense and Change in Fair Value of Warrants” section below).
See Note 12, “ Financing Arrangements ,” of our Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K for additional information on our indebtedness.
Change in Fair Value of Debt and Interest Expense and Change in Fair Value of Warrants
Changes in the fair value of our Senior Secured Notes and warrants, each newly issued in October 2021, resulted in gains of $2.9 million and $1.3 million, respectively, for the year ended December 31, 2022 and (losses) gains of $(1.0) million and $5.6 million, respectively, for the year ended December 31, 2021. Changes in the fair value of our Senior Secured Notes includes $7.1 million and $1.3 million of related interest expense for the 2022 and 2021 periods, respectively.
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See Note 21, “ Financial Instruments and Fair Value Measurements ,” of our Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K for additional information on our recurring fair value measurements.
Other Non-operating (Income) Expense, Net
Other non-operating (income) expense, net was $(6.3) million and $1.3 million for the years ended December 31, 2022 and 2021, respectively. Non-operating income in the 2022 period was primarily attributable to our receipt of an aggregate of $5.0 million in cash from Alora related to contingent milestone payments earned in connection with the sale of the Legacy Business. Non-operating expense in the 2021 period was primarily attributable to $1.3 million of asset disposal costs related to asset disposal costs recognized under a restructuring program.
See Notes 4, “ Discontinued Operations ,” and 22, “ Subsequent Events ,” of our Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K for additional information on the Alora contingent milestone payments.
Income Tax (Benefit) Expense
The following table summarizes our income tax (benefit) expense and effective tax rate for the periods indicated (dollars in thousands):
Year Ended December 31,
Loss before income taxes, continuing operations
Income tax (benefit) expense, continuing operations
Effective income tax rate
Income tax (benefit) expense decreased by $0.3 million to less than $(0.1) million benefit for the year ended December 31, 2022, from $0.3 million expense for the year ended December 31, 2021, primarily related to our recognition of individually minor net income taxes during the respective periods.
Liquidity and Capital Resources
Our principal sources of liquidity are cash and cash equivalents and borrowings available under our Note Purchase Agreement. Our primary uses of cash are to fund operating expenses, including commercialization costs associated with Upneeq, capital expenditures, and debt service payments.
Our Note Purchase Agreement provides for the issuance of Senior Secured Notes in an aggregate principal amount of up to $100.0 million in three separate tranches. The first tranche of Senior Secured Notes, initially issued by the Company to Athyrium Opportunities IV Acquisition 2 LP and subsequently assigned to Athyrium Opportunities IV Acquisition LP, was in an aggregate principle amount equal to $55.0 million on October 12, 2021. The second tranche of Senior Secured Notes was issued by the Company to Athyrium Opportunities IV Co-Invest 1 LP (the “New Purchaser”) in an aggregate principle amount equal to $20.0 million on August 8, 2022. At any time prior to April 15, 2023, upon the satisfaction of certain conditions, including a minimum liquidity requirement and minimum net product sales target for Upneeq, we may request the issuance of the third tranche Senior Secured Notes in an aggregate principal amount of up to $25.0 million.
The Senior Secured Notes bear interest at an annual rate of 9.0% plus adjusted three-month term SOFR, with a floor of 1.50% and a cap of 3.00%, payable in cash quarterly in arrears. At December 31, 2022, the interest rate on our Senior Secured Notes was 12.0%, at the adjusted three-month term SOFR cap. In the year ended December 31, 2022, we obtained waivers from the applicable purchasers under the Note Purchase Agreement of mandatory repayments of an aggregate of $5.0 million in principal of the Senior Secured Notes as otherwise required under the Note Purchase Agreement in exchange for a consent fee of $0.2 million, resulting in net retained proceeds of $4.8 million.
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The restrictive covenants in the Note Purchase Agreement require us to comply with certain minimum liquidity requirements and minimum quarterly net product sales requirements. Under the terms of the Note Purchase Agreement, we are required to maintain unrestricted cash and cash equivalents in an amount greater than or equal to $12.5 million and, as of the end of each fiscal quarter, we are required to maintain consolidated Upneeq net product sales greater than or equal to specified quarterly thresholds (currently at $7.0 million for the fiscal quarter ending March 31, 2023, and increasing in $1.0 million increments each quarter thereafter until the quarter ending June 30, 2024, for which quarter and all subsequent quarters the threshold is $12.0 million). At December 31, 2022, we were in compliance with all covenants under the Note Purchase Agreement. See Notes 12, “ Financing Arrangements ,” and 22, “ Subsequent Events ,” to our Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K.
On August 4, 2022, we entered into a series of share subscription agreements the (“2022 Share Subscription Agreements”) with Athyrium Opportunities IV Co-Invest 2 LP, Avista Healthcare Partners, L.P., Brian Markison and James Schaub (together, the “Equity Purchasers”), pursuant to which we agreed to sell and issue to the Equity Purchasers, in a private placement, 15,451,612 ordinary shares in the aggregate (the “2022 PIPE Shares”). On August 8, 2022, we issued and sold to the Equity Purchasers the 2022 PIPE Shares at a purchase price of $1.55 per ordinary share for aggregate gross proceeds to us of approximately $24 million, before deducting offering expenses payable by us.
On October 12, 2021, we completed a follow-on offering and issued and allotted 14,000,000 ordinary shares and warrants to purchase up to 14,000,000 ordinary shares, at a public offering price of $2.50 per share and accompanying warrant. The aggregate net proceeds from the follow-on offering were approximately $32.5 million after deducting underwriting commissions and offering expenses. See Note 20, “ Shareholders’ Equity and Warrant Liabilities ,” to our Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K.
Going Concern
At December 31, 2022, we had cash and cash equivalents of $44.5 million, an accumulated deficit of $569.2 million and total long-term debt with aggregate principal amounts of $75.0 million, with such maturities commencing in March 2024 and extending through October 2026. In addition, our primary indebtedness contains various restrictive covenants including minimum liquidity and minimum quarterly product sales requirements. For the years ended December 31, 2022 and 2021, we incurred net losses from continuing operations of $51.7 million and $82.8 million, respectively, and used $37.8 million and $54.7 million, respectively, in cash from operating activities.
The divestiture of the Legacy Business in 2021 resulted in the loss of substantially all of our revenue generating assets. Our current business plan is focused on the continued commercialization and growth of Upneeq, which has and will continue to diminish our cash flows in at least the near term. We will require additional capital to fund our operating needs, including the expanded commercialization of Upneeq and other activities. We expect to incur significant expenditures and sustain operating losses in the future.
We do not believe that current sources of liquidity will be sufficient to fund our planned expenditures and meet our obligations, including the minimum liquidity covenant, for at least 12 months following the date the Consolidated Financial Statements contained in this Annual Report on Form 10-K are issued without raising additional funding. As a result, there is a substantial doubt as to our ability to operate as a going concern. If we are not successful in executing our strategic plans described below, we expect that our current cash on hand, together with the net proceeds of anticipated sales of Upneeq, may not be sufficient to meet the minimum liquidity covenant through the end of the third quarter of 2023. Our ability to continue as a going concern will require us to obtain additional funding, generate positive cash flow from operations and/or enter into strategic alliances or sell assets.
Our plans to address these conditions include pursuing one or more of the following options to secure additional funding, none of which can be guaranteed or is entirely within our control, i) raise funds through additional sales of ordinary shares, through equity sales agreements with broker/dealers or other public or private equity financings, ii) raise funds through borrowings under new and/or existing debt facilities and/or convertible debt, and/or iii) raise non-dilutive funds through product collaborations and/or to partner or sell a portion or all rights to any of our assets.
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There can be no assurance that we will receive cash proceeds from any of these potential sources or, to the extent cash proceeds are received, such proceeds would be sufficient to support our current operating plan for at least the next 12 months from the date the Consolidated Financial Statements contained in this Annual Report on Form 10-K are issued. The sale of additional equity or convertible debt securities may result in additional dilution to our shareholders. If we raise additional funds through the issuance of debt securities or preferred shares, these securities could provide for rights senior to those of our ordinary shares and could contain covenants that would restrict our operations. Additional funds may not be available when we need them, on terms that are acceptable to us, or at all.
The Consolidated Financial Statements contained in this Annual Report on Form 10-K have been prepared on a going concern basis, which assumes the realization of assets and settlement of liabilities in the normal course of business, and therefore do not include any adjustments to the amount and classification of assets and liabilities that may be necessary should we be unable to continue as a going concern.
Cash Flows
The following table provides information regarding our consolidated cash flows, including our continuing operations and discontinued operations, for the periods indicated (dollars in thousands):
Year Ended December 31,
$ Change
Net cash used in operating activities
Net cash provided by investing activities
Net cash provided by (used in) financing activities
Net increase (decrease) in cash and cash equivalents
Net cash from operating activities
Cash flows from operating activities are primarily driven by earnings from operations (excluding the impact of non-cash items), the timing of cash receipts and disbursements related to accounts receivable and accounts payable and the timing of inventory transactions and changes in other working capital amounts. Net cash used in operating activities was $37.8 million and $54.7 million for the years ended December 31, 2022 and 2021. The decrease in cash used in operating activities was primarily as a result of lower net loss after considering non-cash adjustments and from a favorable change in net cash used to fund working capital assets and liabilities.
Net cash from investing activities
Net cash provided by investing activities was $0.1 million and $116.5 million for the years ended December 31, 2022 and 2021, respectively. The decrease in cash from investing activities was primarily attributable to proceeds of $110.8 million from the disposition of the Legacy Business in August 2021 and $7.3 million from the sale of Osmolex product rights in January 2021, each particular to the 2021 period, partially offset by lower purchases of property, plant and equipment in the 2022 period.
Net cash from financing activities
Net cash provided by financing activities of $41.8 million for the year ended December 31, 2022, largely reflects financing transactions that raised $43.9 million in proceeds, comprised of $23.9 million in aggregate gross proceeds from the private placement of ordinary shares and, concurrently, $20.0 million from the issuance of second tranche Senior Secured Notes. Net cash used in financing activities of $135.3 million for the year ended December 31, 2021, largely reflected $221.4 million of debt repayments under a prior credit agreement, partially offset by net proceeds from the issuance of first tranche Senior Secured Notes, ordinary shares and warrants and insurance financing loans.
See Notes 12, “ Financing Arrangements ,” and 20, “ Shareholders’ Equity and Warrant Liabilities ,” of our Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K for additional information on the above referenced financing activities.
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Critical Accounting Estimates
The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the amounts reported throughout the financial statements. Those estimates and assumptions are based on our best estimates and judgment. We evaluate our estimates and assumptions on an ongoing basis using historical experience and known facts and circumstances. We adjust our estimates and assumptions when we believe the facts and circumstances warrant an adjustment. As future events and their effects cannot be determined with precision, actual results could differ significantly from those estimates.
We consider the policies and estimates discussed below to be critical to an understanding of our financial statements because their application places the most significant demands on our judgment. Specific risks for these critical accounting policies are described in the following sections. For all these policies, we caution that future events rarely develop exactly as forecast, and such estimates naturally require adjustment.
Our discussion of critical accounting policies and estimates is intended to supplement, not duplicate, our summary of significant accounting policies so that readers will have greater insight into the uncertainties involved in these areas. For a summary of all our significant accounting policies see Note 2, “ Basis of Presentation and Summary of Significant Accounting Policies ,” to our Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K.
Testing Goodwill and Indefinite-Lived Intangible Assets for Impairment
Subsequent to the divestiture of the Legacy Business, we continue to carry significant amounts of goodwill from prior acquisitions and substantial value for an indefinite-lived in-process research and development, or IPR&D, intangible asset relating to arbaclofen ER on our balance sheet. At December 31, 2022, the combined carrying value of goodwill and indefinite-lived intangible assets, net of impairment charges, was $69.8 million or 54% of our total assets. See Note 9, “ Goodwill and Other Intangible Assets ,” to our Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K.
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On October 1 of each year, we perform annual impairment testing of our goodwill and indefinite-lived intangible assets, or more frequently whenever an event or change in circumstance occurs that would require reassessment of the recoverability of those assets. The impairment analysis for goodwill and indefinite-lived intangible assets consists of an optional qualitative test potentially followed by a quantitative analysis. These measurements rely upon significant judgment from management described as follows:
The qualitative analysis for goodwill and indefinite-lived intangible assets requires us to identify potential factors, including, but not limited to, changes, if any, in our market capitalization, carrying values, the status of regulatory and commercial success risks, competitive trends or related cash flow projections that may result in an impairment and estimate whether such factors would warrant performance of a quantitative test;
The quantitative goodwill impairment test, when performed, requires us to estimate the fair value of our single reporting unit. We estimate the fair value of our reporting unit using a weighted average of up to three valuation methods based on discounted cash flows, market multiples and/or market references. These valuation methods require management to make various assumptions, including, but not limited to, future profitability, cash flows, discount rates, weighting of valuation methods and the selection of comparable publicly traded companies; and
The quantitative test for indefinite-lived intangible assets, when performed, is determined using a discounted cash flow model that necessitates the development of estimated net cash flows for each asset, the appropriate discount rate to select for each future cash flow stream, the assessment of each asset’s life cycle, the potential regulatory and commercial success risks, and competitive trends impacting each asset and related cash flow stream as well as other factors. IPR&D assets are also subject to adjustments reducing their anticipated revenues and costs by a probability of success, or POS, factor based upon empirical research of probabilities a new drug candidate would be approved based on the candidate’s stage of clinical development.
Our estimates are based on historical trends, management’s knowledge and experience and overall economic factors, including projections of future earnings potential. Developing future cash flows in applying the income approach requires us to evaluate our intermediate to longer-term strategies, including, but not limited to, estimates about sales growth, operating margins, capital requirements, inflation and working capital management. The development of appropriate rates to discount the estimated future cash flows requires the selection of risk premiums, which can materially impact the present value of future cash flows. Selection of an appropriate peer group and/or market reference transactions under the market approach involves judgment, and an alternative selection of guideline companies or market references could yield materially different market multiples. Weighing the different value indications involves judgment about their relative usefulness and comparability to the reporting unit. A variety of the above-referenced valuation assumptions are based on significant inputs not observable in the market and thus our quantitative tests, when performed, represent Level 3 measurements within the fair value hierarchy. The use of different inputs and assumptions could increase or decrease the resulting estimated fair values and the amounts of related impairments, if any.
There was no impairment of goodwill during the years ended December 31, 2022 and 2021. Concurrent with the divestiture of our Legacy Business in August 2021, goodwill of $45.0 million was allocated based on relative fair value of the Legacy Business. As a result, $55.8 million in goodwill remains on our balance sheet at December 31, 2022. A sustained decline in our market capitalization, even if due to macroeconomic or industry-wide factors, could put pressure on the carrying value of our goodwill and cause us to conduct additional impairment tests.
Based on the results of IPR&D impairment assessments performed relative to arbaclofen ER, we recognized impairment charges of $13.3 million and $7.9 million during the years ended December 31, 2022 and 2021, respectively, related to delays in anticipated commercialization of the product candidate, if approved. At December 31, 2022, $13.9 million in indefinite-lived IPR&D intangible assets remains on our balance sheet. The use of any different valuation inputs would have increased or decreased our recognized impairment charges. Further delays in the anticipated timing of commercialization of arbaclofen ER and/or material changes in legal, market and/or regulatory risks may cause us to conduct additional impairment tests.
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A determination that all or a portion of our goodwill and/or IPR&D asset is impaired, although a non-cash charge to operations, could have a material adverse effect on our business, consolidated financial condition and results of operations.
Calculating Expense for Share-Based Compensation Arrangements
Our employees and directors have received various long-term compensation awards, including from time-to time, stock options, restricted stock units, performance stock units, and other share-based awards. We calculate expense for some of those awards using fair value estimates based on significant unobservable inputs. See Note 14, “ Share-Based Compensation ,” to our Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K.
During the year ended December 31, 2022 we recognized $4.0 million of aggregate share compensation expense. During the year ended December 31, 2021 we recognized $7.0 million of aggregate share compensation expense, which included, the acceleration of the vesting of certain stock options and restricted stock units and all performance stock units under our incentive compensation plans in connection with the divestiture of the Legacy Business.
At December 31, 2022, there were approximately:
2.5 million stock options outstanding under the 2018 Equity Incentive Plan, with aggregate unrecognized share compensation expense related to unvested awards of $1.2 million, which is expected to be recognized over a weighted-average remaining service period of 1.6 years; and
1.0 million restricted stock units outstanding under the 2018 Equity Incentive Plan, with aggregate unrecognized share compensation expense related to unvested awards of $1.9 million, which is expected to be recognized over a weighted-average remaining service period of 1.5 years.
Share compensation expense is measured at the date of grant, based on the fair value of an award and recognized ratably over its vesting term, which is generally the vesting period on a graded vesting basis. We determine the fair value of restricted stock units based on the market price of our ordinary shares at the grant date, which is objectively determinable and not subject to significant unobservable inputs.
We estimate the grant date fair value of stock options and performance stock units using a Black-Scholes Merton option-pricing model and a Monte Carlo simulation model, respectively. The assumptions used in our models represent management's best estimates and involve a number of variables, uncertainties and assumptions and the application of management's judgment, as they are inherently subjective. The most significant unobservable input is the volatility of our stock price. A public quotation was first established for our ordinary shares in October 2018, which often does not provide us with an adequate historical basis to reasonably estimate the expected volatility of our ordinary shares over the expected life of an award. Accordingly, we generally estimate volatility based on a weighting of our own stock price volatility and/or the historical stock price trends of similar entities within our industry over a period of time commensurate with the expected term.
The fair value of our stock options and performance stock units would have differed had we selected different peers, assigned different weighting assumptions between our own and peer volatility or used different techniques to estimate volatility.
Increasing our estimated volatility assumption by 500 basis points, or 5 percent, for all stock options issued in 2022 at the date of grant would increase our 2022 share compensation expense by an immaterial amount and also increase our aggregate unrecognized share compensation cost related to unvested awards at December 31, 2022 by an immaterial amount.
Estimating the Value of Financial Instruments Remeasured at Fair Value on a Recurring Basis
Our Senior Secured Notes, a material component of long-term debt, and warrants, as reflected within warrant liabilities, a material component of total liabilities, have each been measured and carried at fair value since their issuance in October 2021. Changes in the estimated fair value of such instruments are recognized as a non-cash gain or loss in the consolidated statements of operations and comprehensive loss. Such instruments represent financial liabilities whose
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measurement contains significant unobservable inputs, which management considers to be Level 3 measurements under the fair value hierarchy. See Note 21, “ Financial Instruments and Fair Value Measurements ,” to our Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K.
Changes in the fair value of our Senior Secured Notes and warrants during the year ended December 31, 2022 resulted in gains recognized through earnings of $2.9 million and $1.3 million, respectively, with a resultant fair value at December 31, 2022 of $(55.5) million and $(2.0) million, respectively.
We use a discounted cash flow technique, an income-based approach, to determine the fair value of the Senior Secured Notes. This technique relies upon an assumption of pricing the Senior Secured Notes to their maturity (without mandatory or voluntary prepayments) and incorporates inputs such as contractual repayment terms, maturity, and discount rate. The most significant unobservable input for the Senior Secured Notes is the discount rate which we estimate by performing a yield analysis that relies upon the discount rate observed in the initial issuance of the Senior Secured Notes as well as certain benchmark debt instruments with observable pricing from which we draw conclusions on the change in the discount rate from period to period.
We use the Black-Scholes Merton option-pricing model to value the warrants. This model incorporates transaction details such as our stock price, contractual terms, maturity, risk free rates, and volatility. The most significant unobservable input for the warrant liabilities is volatility. Given the limited trading volume and period of time that our stock has been traded in an active market, the expected volatility is estimated by taking the average historical price volatility for industry peers, consisting of several public companies in our industry that are similar in size, stage, or financial leverage, over a period of time commensurate to the expected term of the warrants.
Remeasuring the fair value of our Senior Secured Notes and warrants on a recurring basis through earnings requires the estimation of significant unobservable inputs, and thereby requires significant demands on our judgment. Using different estimates or assumptions would have materially affected our results in 2022 and subsequent periods. For example, as of December 31, 2022:
A 100 basis point, or one percent, decrease or increase to the rate we used to discount future cash flows under our Senior Secured Notes would have increased or decreased, respectively, the estimated fair value of our Senior Secured Notes and changed the associated gains or losses recognized through 2022 earnings by $1.4 million; and
A 1,000 basis point, or ten percent, decrease or increase to the estimated volatility assumption under our warrants would have increased or decreased, respectively, the estimated fair value of our warrants and decreased or increased, respectively, the associated gains recognized through 2022 earnings by $0.9 million.
Estimating Valuation Allowances on Deferred Tax Assets
We are required to estimate the degree to which tax assets and loss carryforwards will result in a future income tax benefit, based on our expectations of future profitability by tax jurisdiction. We provide a valuation allowance for deferred tax assets that we believe will more likely than not go unutilized. If it becomes more likely than not that a deferred tax asset will be realized, we reverse the related valuation allowance and recognize an income tax benefit for the amount of the reversal. See Note 17, “ Income Taxes ,” to our Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K.
At December 31, 2022, we had federal net operating loss carryforwards of $70.2 million, state net operating loss carryforwards of $139.2 million, net operating loss carryforwards in certain foreign tax jurisdictions of $109.9 million which will begin to expire in 2026 and total tax credit carryforwards of $8.6 million, primarily consisting of Federal Orphan Drug Tax Credits that are expected to be fully realized prior to their expiration, beginning in 2036. We also had federal capital loss carryforwards of $95.8 million at December 31, 2022, which will expire in 2026.
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At December 31, 2022, our valuation allowance on deferred tax assets was $64.9 million, which primarily consists of $16.7 million relating to $209.3 million net operating loss carryforwards and $20.1 million relating to $95.8 million of federal capital loss carryforwards, none of which are expected to be realized.
We must make assumptions and judgments to estimate the amount of valuation allowance to be recorded against our deferred tax assets, which take into account current tax laws and estimates of the amount of future taxable income, if any. Realization of the deferred tax assets is dependent on a variety of factors, some of which are subjective in nature, including the generation of future taxable income, the amount and timing of which are uncertain. In evaluating the ability to recover the deferred tax assets, we consider all available positive and negative evidence, including cumulative income in recent fiscal years, the forecast of future taxable income exclusive of certain reversing temporary differences and significant risks and uncertainties related to our business. In determining future taxable income, management is responsible for assumptions utilized including, but not limited to, the amount of U.S. federal, state and international pre-tax operating income, the reversal of certain temporary differences, carryforward periods available to us for tax reporting purposes, the implementation of feasible and prudent tax planning strategies and other relevant factors. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates that we are using to manage the underlying business.
We assess the need for a valuation allowance each reporting period and would record any material changes that may result from such assessment to income tax expense in that period. Changes to any of the assumptions or judgments could cause our actual income tax obligations to differ from our estimates.
