GW PHARMACEUTICALS PLC The following discussion contains management's discussion and analysis of our financial condition and results of operations and should be read together with "Selected Financial Data" and the historical consolidated financial statements and the notes thereto included in "Financial Statements and Supplementary Data". This discussion contains forward-looking statements that reflect our plans, estimates and beliefs and involve numerous risks and uncertainties, including but not limited to those described in the "Risk Factors" section of this Annual Report. Actual results may differ materially from those contained in any forward-looking statements. You should carefully read "Information Regarding Forward-Looking Statements" and "Risk Factors."
Overview
GW Pharmaceuticals plc was founded in 1998 and is a public limited company incorporated under the laws ofEngland andWales . Our ordinary shares were admitted to trading on the Alternative Investment Market, or AIM, a market operated byLondon Stock Exchange plc , under the symbol GWP onJune 28, 2001 . OnMay 1, 2013 , we completed our initial public offering of ADSs, on the Nasdaq Global Market. Our ADSs are traded under the symbol GWPH. We cancelled the admission of our ordinary shares to trading on AIM onDecember 5, 2016 and our shares are now traded exclusively on Nasdaq. We are a biopharmaceutical company focused on discovering, developing and commercializing novel therapeutics from our proprietary cannabinoid product platform in a broad range of disease areas. In over 20 years of operations, we have established a world leading position in the science, development and commercialization of plant-derived cannabinoid therapeutics through our proven drug discovery and development processes, our intellectual property portfolio, regulatory, manufacturing, and commercial expertise. Our lead cannabinoid product is Epidiolex, a pharmaceutical formulation of cannabidiol for which we retain global commercial rights. Epidiolex is approved inthe United States for the treatment of seizures associated with Lennox-Gastaut syndrome (LGS) and Dravet syndrome, in patients two years of age and older. LGS and Dravet syndrome are severe childhood-onset, drug-resistant epilepsy syndromes. We launched Epidiolex inthe United States inNovember 2018 . InSeptember 2019 , we received approval from theEuropean Commission for Epidyolex (the trade name inEurope for Epidiolex) for use as adjunctive therapy of seizures associated with LGS or Dravet syndrome, in conjunction with clobazam, for patients two years of age and older. We have launched Epidyolex inGermany and theU.K. and are planning launches inFrance ,Italy andSpain during 2020. We continue to develop Epidiolex for additional indications. InMay 2019 , we announced positive results from a Phase 3 trial in the use of Epidiolex to treat seizures associated withTuberous Sclerosis Complex , or TSC, a rare genetic disorder that causes non-malignant tumors to form in many different organs that affects approximately 50,000 individuals inthe United States and one million worldwide. OnFebruary 3, 2020 , we announced that we had submitted a supplemental New Drug Application to theU.S. Food and Drug Administration , or FDA, to expand the Epidiolex label to include the treatment of seizures associated with TSC. We expect to file for supplemental approval for the TSC indication inEurope in the first quarter of 2020. We have received Orphan Drug Designation from the FDA and the Committee for Orphan Medical Products for TSC (we previously received the same designations for Dravet syndrome and LGS). We have begun recruiting patients for a pivotal trial of Epidiolex in the treatment of Rett syndrome, a rare, non-inherited neurodevelopmental disorder affecting approximately one in 10,000 to 15,000 live female births. This trial focuses on the behavioral abnormalities associated with the disorder. We have a deep pipeline of additional cannabinoid product candidates that includes compounds in Phase 1, Phase 2, and Phase 3 trials. Our most advanced pipeline asset is nabiximols, for which we expect to commence a pivotal clinical program in the first half of 2020 in the treatment of spasticity due to multiple sclerosis. We anticipate commercializing nabiximols in theU.S. using our in-house commercial organization. Nabiximols is already approved in over 25 countries outsidethe United States for the treatment of spasticity due to multiple sclerosis under the brand name Sativex. We are advancing plans to commence clinical programs for nabiximols in 2020 in spasticity due to spinal cord injury and post-traumatic stress disorder.
In addition to nabiximols, our pipeline includes cannabinoid product candidates for schizophrenia, autism spectrum disorder, and Neonatal Hypoxic Ischemic Encephalopathy.
Change of Fiscal Year
We changed our fiscal year end to
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Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in accordance with accounting principles generally accepted inthe United States orU.S. GAAP. These accounting principles require us to make certain estimates, judgments 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. The significant accounting estimates that we believe are important to aid in fully understanding and evaluating our reported financial results include the following:
Revenue recognition
We recognize revenue when our customer obtains control of promised goods or services, in an amount that reflects the consideration which we expect to receive in exchange for those goods or services. To determine revenue recognition for arrangements that are within the scope of Accounting Standards Codification (ASC) Topic 606, Revenue from Contracts with Customers (Topic 606), we perform the following five steps: (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. We only applies the five-step model to contracts when it is probable that we will collect the consideration we are entitled to in exchange for the goods or services we transfer to the customer. At contract inception, once the contract is determined to be within the scope of Topic 606, we assess the goods or services promised within each contract and determine those that are performance obligations and assess whether each promised good or service is distinct. We then recognize as revenue the amount of the transaction price that is allocated to the respective performance obligation when (or as) the performance obligation is satisfied. Revenue for our product sales has not been adjusted for the effects of a financing component as we expect, at contract inception, that the period between when we transfer control of the product and when we receive payment will be one year or less. Product shipping and handling costs are included in cost of product sales.
Epidiolex
Epidiolex was approved by the FDA inJune 2018 . That approval became effective when theUnited States Drug Enforcement Agency (DEA) took action to change the classification of Epidiolex from a Schedule I controlled substance to a Schedule V controlled substance, thereby allowing Epidiolex to be prescribed and distributed inthe United States . OnNovember 1, 2018 , we launched sales of Epidiolex to specialty pharmacies (SPs) and specialty distributors (SDs). We recognize revenue from product sales upon receipt of product at the SPs and SDs, the date at which the control is transferred, net of 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 SPs and SDs based on a contractually fixed percentage of the wholesale acquisition cost (WAC), and prompt payment discounts. Distribution fees are recorded as an offset to revenue based on contractual terms at the time revenue from the sale is recognized. Rebates: Allowances for rebates include mandated discounts under the Medicaid Drug Rebate Program and the Medicare Part D prescription drug benefit, and contractual rebates with commercial payers. 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 is based on utilization data received from the SPs 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, plus an accrual balance for prior quarters' unpaid rebates. If actual future rebates vary from estimates, we may need to adjust prior period accruals, which would affect revenue in the period of adjustment. Chargebacks: Chargebacks are discounts and fees that relate to contracts with government and other entities purchasing from the SDs at a discounted price. The SDs charge back to us the difference between the price initially paid by the SDs and the discounted price paid to the SDs by these entities. We also incur group purchasing organization fees for transactions through certain purchasing organizations. We estimate sales with these entities and accrue for anticipated chargebacks and organization fees, based on the applicable contractual terms. If actual future chargebacks vary from these estimates, we may need to adjust prior period accruals, which would affect revenue in the period of adjustment.
Co-Payment Assistance: We offer co-payment assistance to commercially insured patients meeting certain eligibility requirements. Co-payment assistance is accrued for based on actual program participation and estimates of program redemption using data provided by third-party administrators.
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Product Returns: Consistent with industry practice, we offer the SPs and SDs
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 SPs and SDs and have the
ability to control the amount of product that is sold to the SPs and SDs, we are
able to make a reasonable estimate of future potential product returns based on
this on-hand channel inventory data and sell-through data obtained from the SPs
and SDs. In arriving at its estimate, we also considers historical product
returns, the underlying product demand, and industry data specific to the
specialty pharmaceutical distribution industry.
On September 23, 2019 , we announced that the European Commission approved the
marketing authorization for Epidyolex (the trade name in Europe for Epidiolex)
for use as adjunctive therapy of seizures associated with LennoxGastaut
syndrome, or LGS, or Dravet syndrome, in conjunction with clobazam, for patients
two years of age and older. We recognize revenue from product sales in Europe
upon delivery of the product, which is the point at which control of the goods
is transferred to the customer. We recognize revenue net of standard discounts
and allowances, which are reflected as accrued liabilities.
We also sell Epidiolex in certain markets outside of the United States under
early access programs that enable patients to receive the product prior to
regulatory approval. Revenue under early access programs is generally recognized
when the product is delivered.
Sativex
Our product sales of Sativex, sold outside ofthe United States for the treatment of spasticity due to multiple sclerosis, or MS, are made pursuant to license agreements with commercial partners. Under these license agreements, we sell fully labeled Sativex vials to our commercial partners for a contractually agreed price, which is generally based on percentages of the commercial partners' in-market net selling price charged to end customers. Product net sales revenue related to Sativex shipments to commercial license partners is recognized when shipped, at which point the customer obtains control of the product. We commercialize Sativex inAustralia and New Zealand through a consignment relationship with a local distributor. Product net sales revenues related to Sativex sales inAustralia and New Zealand are recognized when the product is sold through to the end customer. The Sativex license agreements contain provisions for us to earn future variable consideration in the form of regulatory milestone payments, sales-based milestone payments, and royalty payments. We have no further performance obligations related to the regulatory milestone payments and these amounts will be recognized in accordance with Topic 606 when receipt of these payments becomes probable and there is no significant risk of revenue reversal. Revenue related to the sales-based milestone payments and product royalty payments are subject to the sales-based royalty exception under Topic 606 and will be recognized when the underlying sales are made.
Share-Based Compensation
We recognize share-based compensation expense for grants of stock options under our long-term incentive plans to employees and non-employee members of the board of directors based on the grant-date fair value of those awards. The grant-date fair value of an award is generally recognized as compensation expense over the award's requisite service period. Expense related to awards with graded vesting is generally recognized over the vesting period using the accelerated attribution method. We use the Black-Scholes model to compute the estimated fair value of stock option awards. Using this model, fair value is calculated based on assumptions with respect to (i) expected volatility of the Company's ADS price, (ii) the periods of time over which employees and members of the board of directors are expected to hold their options prior to exercise (expected lives), (iii) expected dividend yield on the ordinary shares, and (iv) risk-free interest rates. Share-based compensation expense also includes an estimate, which is made at the time of grant, of the number of awards that are expected to be forfeited. This estimate is revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.
Inventory
Inventory is stated at the lower of cost or estimated net realizable value. We use a combination of standard and actual costing methodologies to determine the cost basis for our inventories, which approximates actual cost. Inventory is valued on a first-in, first-out basis. We reduce our inventory to net realizable value for potentially excess, dated or obsolete inventory based on an analysis of forecasted demand compared to quantities on hand, as well as product shelf life.
Our inventory production process includes the cultivation of botanical raw material. Because of the duration of the cultivation process, a substantial portion of our inventory will not be sold within one year. Consistent with the practice in other industries that cultivate botanical raw materials, all inventory is classified as a current asset.
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We capitalize inventory costs associated with our products upon regulatory
approval when, based on management's judgment, future commercialization is
considered probable and the future economic benefit is expected to be realized;
otherwise, such costs are expensed. Prior to FDA approval of Epidiolex, all
costs related to the manufacturing of Epidiolex were charged to research and
development expense in the period incurred.
Prior toSeptember 30, 2017 , we benefited from the U.K. Small and Medium-sized Enterprise R&D Tax Credit scheme, or the SME scheme, under which we were able to obtain a refundable credit of up to 33.4% of eligible research and development expenses incurred by ourU.K. domiciled entities. Eligible expenses generally include employment costs for research staff, consumables and certain internal overhead costs incurred as part of research projects. Additionally, subcontracted research expenses are eligible for a cash rebate of up to approximately 21.68%. Due to the increase in the size of our employee workforce in theU.K. and our annual net revenues, beginning inOctober 1, 2017 we are subject to theU.K. R&D Expenditure Credit scheme, or the RDEC scheme, available to larger companies, which has a significantly lower credit than the SME scheme. The majority of our pipeline research, clinical trials management and the Epidiolex and Sativex chemistry and manufacturing controls development activities, which are generally carried out by a subsidiary in theU.K. , are eligible for inclusion under the SME and RDEC schemes. Reimbursable credits accrued under these schemes reduce our research and development expense in the period that the qualifying expenses are incurred. We estimate a benefit under the RDEC scheme of$4.0 million for the year endedDecember 31, 2019 ,$0.8 million for the three months endedDecember 31, 2018 , and a$4.3 million benefit for the year endedSeptember 30, 2018 . We develop estimates at each reporting date for the amount of the reimbursable research and development tax and expense credits and ultimately make reimbursement claims fromHer Majesty's Revenue and Customs , or HMRC, as part of the annualU.K. tax return. Such claims are complex and require management to interpret and applyU.K. research and development tax legislation to our specific circumstances which requires the use of certain assumptions in estimating the portion of current year research costs that are eligible for the claim. If actual reimbursements differ from our estimates, adjustments to prior period accruals would affect the amount of research and development expense in the period of the adjustment. Deferred Income Taxes Deferred tax is accounted for using the asset and liability method that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the financial statement carrying amount and the tax bases of assets and liabilities at the applicable tax rates. As ofDecember 31, 2019 , we have deferred tax assets of$134.2 million , offset by deferred tax liabilities of$1.6 million and a valuation allowance of$114.5 million . A valuation allowance is provided when it is more-likely-than-not that some portion or all of the deferred tax assets will not be realized. Future realization of the tax benefit of a deferred tax asset depends on the existence of sufficient taxable income of the appropriate character (for example, ordinary income or capital gain) within the carryback or carryforward period available under the tax law. We consider the following possible sources of taxable income when assessing whether there is sufficient taxable income to realize a tax benefit for deductible temporary differences and carryforwards:
• future reversals of existing taxable temporary differences;
• future taxable income exclusive of reversing temporary differences and
carryforwards;
• taxable income in prior carryback year(s) if carryback is permitted under
the tax law; and
• tax-planning strategies.
We consider both positive and negative evidence regarding realization of the
deferred tax assets and the subjectivity of this evidence. This assessment
includes estimating future taxable income, scheduling reversals of temporary
differences, evaluating expectations of future profitability, determining refund
potential in the event of net operating loss carrybacks, and evaluating
potential tax-planning strategies.
We have generated losses in the United Kingdom since inception and expect to
generate tax losses next year and therefore the deferred tax assets arising in
the United Kingdom do not meet the more-likely-than-not of being realized
threshold. Accordingly, there continues to be a full valuation allowance against
deferred taxes in the U.K.
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-------------------------------------------------------------------------------- OurU.S. subsidiary,Greenwich Biosciences, Inc. , is currently profitable and incurs aU.S. tax liability on taxable profits earned inthe United States . Due to the commercialization of Epidiolex inthe United States and income related to service agreements between ourU.S. andU.K. operating subsidiaries, ourU.S. subsidiary is forecast to continue to generate taxable income in future periods. In determining whether the deferred tax asset is more-likely-than-not of being realized, we have taken into account the history of taxable profits, the forecast of future taxable income, including whether future originating temporary deductible differences are likely to be realized, and the reversal of temporary taxable deductions. We have determined that the deferred tax forGreenwich Biosciences, Inc. is more-likely-than-not to be realized and therefore have no valuation allowance against theU.S. deferred tax balances. ForecastingU.S. taxable income is by nature subject to known and unknown risks, uncertainties, assumptions and other factors that could negatively impact our ability to realize the value of our deferred tax assets. These risks include our ability to successfully grow our product sales of Epidiolex in the U.S. market and source future product development work to theU.S. subsidiary. If we determine in the future that an amount of ourU.S. deferred tax assets fail to meet the more-likely-than-not to be realizable threshold, there will be a negative impact on our provision for income taxes and the amount of deferred tax assets recognized in our consolidated balance sheet. The amount of deferred taxes for ourU.S. subsidiary included in our consolidated balance sheets is$18.1 million and$8.7 million as ofDecember 31, 2019 and 2018, respectively.
Recent Accounting Pronouncements
See Item 15 of Part IV, "Notes to Consolidated Financial Statements-Note 2-Summary of Significant Accounting Policies."
Results of Operations
The following table summarizes the results of our operations for the years endedDecember 31, 2019 and 2018. The income statement data for the year endedDecember 31, 2019 are derived from the audited consolidated financial statements included in Item 6 - Selected Financial Data. The income statement data for the year endedDecember 31, 2018 are derived from our unaudited consolidated financial statements for that period. Year Ended December 31, 2019 2018 Increase/Decrease (in thousands) Consolidated Statement of Operations Data: Revenues: Product net sales$ 310,331 $ 14,866 $ 295,465 Other revenue 1,001 533 468 Total revenues 311,332 15,399 295,933 Operating expenses: Cost of product sales 27,199 6,644 20,555 Research and development 142,678 146,627 (3,949 ) Selling, general and administrative 259,880 165,727 94,153 Total operating expenses 429,757 318,998 110,759 Loss from operations (118,425 ) (303,599 ) 185,174 Interest income 8,464 5,490 2,974 Interest expense (1,087 ) (1,230 ) 143 Other income 104,117 - 104,117 Foreign exchange (loss) gain (2,272 ) (6,105 ) 3,833 Loss before income taxes (9,203 ) (305,444 ) 296,241 Income tax (benefit) expense (184 ) (187 ) 3 Net loss$ (9,019 ) $ (305,257 ) $ 296,238 58
-------------------------------------------------------------------------------- The following table summarizes the results of our operations for the three months endedDecember 31, 2018 and 2017. The income statement data for the three months endedDecember 31, 2018 are derived from the audited consolidated financial statements included in Item 6 - Selected Financial Data. The income statement data for the three months endedDecember 31, 2017 are derived from our unaudited consolidated financial statements for that period. Three Months Ended December 31, 2018 2017 Increase/Decrease (in thousands) Consolidated Statement of Operations Data: Revenues: Product net sales $ 6,617 $ 2,220 $ 4,397 Other revenue 37 1,772 (1,735 ) Total revenues 6,654 3,992 2,662 Operating expenses: Cost of product sales 1,829 1,171 658 Research and development 29,086 36,195 (7,109 ) Selling, general and administrative 49,083 25,174 23,909 Total operating expenses 79,998 62,540 17,458 Loss from operations (73,344 ) (58,548 ) (14,796 ) Interest income 2,449 604 1,845 Interest expense (295 ) (314 ) 19 Foreign exchange (loss) gain (982 ) 160 (1,142 ) Loss before income taxes (72,172 ) (58,098 ) (14,074 ) Income tax (benefit) expense (266 ) 3,718 (3,984 ) Net loss$ (71,906 ) $ (61,816 ) $ (10,090 ) The following table summarizes the results of our operations for the years endedSeptember 30, 2018 and 2017: Years Ended September 30, 2018 2017 Increase/Decrease (in thousands) Consolidated Statement of Operations Data: Revenues: Product net sales$ 10,469 $ 7,957 $ 2,512 Other revenue 2,268 672 1,596 Total revenues 12,737 8,629 4,108 Operating expenses: Cost of product sales 5,986 4,521 1,465 Research and development 153,736 112,249 41,487 Selling, general and administrative 141,818 58,020 83,798 Total operating expenses 301,540 174,790 126,750 Loss from operations (288,803 ) (166,161 ) (122,642 ) Interest income 3,645 2,063 1,582 Interest expense (1,249 ) (951 ) (298 ) Foreign exchange (loss) gain (4,963 ) (6,442 ) 1,479 Loss before income taxes (291,370 ) (171,491 ) (119,879 ) Income tax (benefit) expense 3,797 (1,032 ) 4,829 Net loss$ (295,167 ) $ (170,459 ) $ (124,708 ) Product net sales Our product net sales include sales of Epidiolex, which we launched inthe United States inNovember 2018 and began to sell in certain European markets in late 2019, and sales of Sativex outside ofthe United States pursuant to license agreements with commercial partners. We also sell Epidiolex through certain early access programs outside ofthe United States . 59 -------------------------------------------------------------------------------- Product net sales for the year endedDecember 31, 2019 were comprised of$296.4 million in net sales of Epidiolex and$13.9 million in net sales of Sativex. The$295.4 million increase in product net sales to$310.3 million for the year endedDecember 31, 2019 compared to$14.9 million for the year endedDecember 31, 2018 was primarily due to theNovember 2018 launch of Epidiolex inthe United States . Product net sales in the three months endedDecember 31, 2018 were comprised of$4.7 million in net sales of Epidiolex and$1.9 million in net sales of Sativex. The$4.4 million increase in product net sales to$6.6 million for the three months endedDecember 31, 2018 compared to$2.2 million for the three months endedDecember 31, 2017 was primarily due to theNovember 2018 launch of Epidiolex inthe United States . Product net sales increased$2.5 million in the year endedSeptember 30, 2018 to$10.5 million compared to$8.0 million in the year endedSeptember 30, 2017 . The increase in product net sales in the year endedSeptember 30, 2018 was primarily due to increases in sales of Sativex inEurope ,Canada andIsrael .
Other revenue
Other revenue primarily consists of milestone revenue related to our Sativex license agreements and research and development fee revenue related to license and collaboration agreements.
Other revenue in the year ended
Other revenue in the three months endedDecember 31, 2018 consists of remaining development fees related to the Otsuka license agreement. Other revenue in the three months endedDecember 31, 2017 primarily consists of previously deferred development fee revenue that was recognized upon the termination of the Otsuka license agreement. The reduction in other revenue in the three months endedDecember 31, 2018 compared to the three months endedDecember 31, 2017 was primarily due to the termination of the Otsuka license agreement which occurred in December of 2017. Other revenue in the year endedSeptember 30, 2018 consists of$2.1 million of research and development fee revenue related to the Otsuka license agreement that was terminated in the first quarter of the fiscal year endedSeptember 30, 2018 and$0.2 million of milestone revenue related to the achievement of a Sativex regulatory approval milestone. Other revenue in the year endedSeptember 30, 2017 consists of$0.7 million of research and development fees related to the Otsuka license agreement. The increase in development fee revenue in the year endedSeptember 30, 2018 is due to deferred research and development fees that were recognized in the fiscal year endedSeptember 30, 2018 in conjunction with the termination of the Otsuka license agreement.
Cost of product sales
Cost of sales increased$20.6 million , or 309%, in the year endedDecember 31, 2019 to$27.2 million , or 9% of product net sales, compared to$6.6 million , or 45% of product net sales in the year endedDecember 31, 2018 . The increase in cost of sales in dollars is primarily due to an increase in product net sales, primarily due to the launch of Epidiolex in theU.S. The reduction in cost of sales as a percentage of product net sales is due to the positive impact of directly commercializing Epidiolex in theU.S. in the year endedDecember 31, 2019 . In the year endedDecember 31, 2018 , the majority of product net sales were sales of Sativex outside of theU.S. through license partners. Cost of sales increased$0.7 million , or 56% in the three months endedDecember 31, 2018 to$1.8 million , or 28% of product net sales, compared to$1.2 million , or 53% of product net sales in the three months endedDecember 31, 2017 . The increase in cost of sales in dollars is primarily due to an increase in product net sales, which is primarily due to the launch of Epidiolex in theU.S. The reduction in cost of sales as a percentage of product net sales is due to the positive impact in the three months endedDecember 31, 2018 of directly commercializing Epidiolex in theU.S. compared to the similar period in the prior year when products net sales consisted only of Sativex sales outside of theU.S. through license partners. Cost of sales increased$1.5 million , or 32%, in the year endedSeptember 30, 2018 to$6.0 million , or 57% of product net sales, compared to$4.5 million , or 57% of product net sales in the year endedSeptember 30, 2017 . The increase in cost of sales in dollars is primarily due to the increase in product net sales in the year endedSeptember 30, 2018 compared to the year endedSeptember 30, 2017 . 60
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Research and development expenses
We believe that our future revenues and cash flows are most likely to be
affected by the successful development and approval of our significant
late-stage research and development candidates. As of
• Epidiolex for the treatment of tuberous sclerosis complex (
and Europe )
• Nabiximols for spasticity associated with MS (United States )
On
We have completed our Phase 3 trial of Epidiolex for the treatment of TSC. InMay 2019 , we reported positive top-line Phase 3 results and inDecember 2019 we reported additional positive trial data. OnFebruary 3, 2020 , we announced that we submitted a supplemental new drug application with the FDA for this indication, and we, expect to seek supplemental approval inEurope in early 2020. InDecember 2017 , we terminated our license agreement with Otsuka and we have reacquired full ownership of the development and commercialization rights to nabiximols inthe United States . We have had several meetings with the FDA to discuss the optimal regulatory pathway forU.S. approval of nabiximols and are now in the process of planning an additional clinical program, which is expected to commence in early 2020. Research and development expenses consist of internal and external costs to conduct our pre-clinical studies and clinical trials, payroll costs associated with employing our team of research and development staff, share-based payment expenses, property costs associated with leasing laboratory and office space to accommodate our research teams, costs of growing botanical raw material, costs of processing product for clinical trials, costs of consumables used in the conduct of our in-house research programs, payments for research work conducted by sub-contractors and sponsorship of work by our network of academic collaborative research scientists, costs associated with safety studies and costs associated with the development of Epidiolex, Sativex, and our other pipeline product candidates. Research and development expense is presented net of reimbursements from reimbursable tax and expenditure credits from theU.K. government. We track all research and development expenditures against detailed budgets but do not seek to allocate all research and development costs by individual project. In 2018, we began to track external third-party costs for clinical trials by product candidate. In prior years we tracked costs for historical nabiximols projects funded by Otsuka, but other costs were not allocated to individual projects. The components of R&D expense for the years endedDecember 31, 2019 and 2018, three months endedDecember 31, 2018 and 2017 and the year endedSeptember 30, 2018 are as follows: Years Ended Three Months Ended Year Ended December 31, December 31, September 30, 2019 2018 2018 2017 2018 (in thousands) External clinical trial expense Epidiolex$ 28,020 $ 33,970 $ 8,936 $ 7,508 $ 33,262 Nabiximols$ 3,837 $ 33 $ 69 $ 45 - Other programs 8,413 2,645 770 296 1,460 Total external clinical trial expense 40,270 36,648 9,775 7,849 34,722 Otsuka funded research and development - 565 - - 565 Research and development tax and expense credits (3,992 ) (4,090 ) (759 ) (994 ) (4,325 ) Other internal research and development 106,400 113,504 20,070 29,340 122,774 Total research and development expense$ 142,678 146,627$ 29,086 $ 36,195 $ 153,736 61
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The components of R&D expense for the years endedSeptember 30, 2017 , are as follows: Year Ended September 30, 2017 (in thousands) Otsuka funded research and development $ 669 Other research and development 137,587 Research and development tax and expense credits (26,007 ) Total research and development expense$ 112,249 R&D expenses decreased$3.9 million , or 3%, to$142.7 million for the year endedDecember 31, 2019 compared to$146.6 million the year endedDecember 31, 2018 . R&D expenses decreased$7.1 million , or 20%, to$29.1 million for the three months endedDecember 31, 2018 compared to$36.2 million the three months endedDecember 31, 2017 . The decrease in R&D expenses in both periods was primarily due to the prior period impact of inventory production costs for Epidiolex that were charged to R&D expenses prior to FDA approval inJune 2018 . R&D expenses increased$41.5 million , or 37.0%, to$153.7 million in the year endedSeptember 30, 2018 compared to$112.2 million in the year endedSeptember 30, 2017 . The increase in R&D expenses was primarily due to an increase in personnel and related costs, including share-based compensation expense, related to an increase in our global R&D headcount, an increase in costs to prepare the Epidiolex regulatory submissions in theU.S. andEurope , an increase in costs of growing high CBD plant material for Epidiolex, which prior to the achievement of regulatory approval in theU.S. were included in R&D expenses, and a decrease in theU.K. research and development tax and expense credits due to the transition out of the SME scheme and into the RDEC scheme in theU.K.
Sales, general and administrative expenses
Sales, general and administrative, or SG&A, expenses consist primarily of salaries and benefits related to our executive, commercial, and corporate support functions, expenses associated with our commercial activities, and other general administration expenses. We expect that sales, general and administrative expenses will increase in the future as we expand our operating activities and continue to build our commercial team in preparation for the launch of Epidiolex in additional markets inEurope . SG&A expenses increased$94.2 million , or 57%, to$259.9 million in the year endedDecember 31, 2019 compared to$165.7 million in 2018. The increase in SG&A expenses in 2019 was primarily due to an increase in employee-related expenses driven by the build-out of our commercial functions inthe United States andEurope , costs related to the launch of Epidiolex inEurope , an increase in our corporate support functions, and an increase in insurance expenses. SG&A expenses increased$23.9 million , or 95%, to$49.1 million in three months endedDecember 31, 2018 compared to$25.2 million in 2017. The increase in SG&A expenses in 2018 was primarily due to an increase in employee-related expenses driven by the build-out of our commercial functions in theU.S. andEurope , costs related to theNovember 2018 launch of Epidiolex in theU.S. , an increase in all of our corporate support functions, and, to a smaller degree, an increase in insurance expenses and an increase audit and legal fees related to our transition to domestic registrant status with theSEC . SG&A expenses increased$83.8 million , or 144.4%, to$141.8 million in the year endedSeptember 30, 2018 compared to$58.0 million in the year endedSeptember 30, 2017 . The increase in SG&A expenses in 2018 was primarily due to an increase in employee-related expenses driven by the build-out of our commercial functions in theU.S. andEurope , pre-launch costs related to theNovember 2018 launch of Epidiolex in theU.S. , an increase in all of our corporate support functions, and, to a smaller degree, an increase in insurance expenses and an increase audit and legal fees related to our transition to domestic registrant status with theSEC . Interest Income Interest income increased$3.0 million in the year endedDecember 31, 2019 to$8.5 million compared to interest income of$5.5 million in the year endedDecember 31, 2018 . The increase in interest income in 2019 is primarily due to higher average cash and cash equivalent balances in 2019 compared to 2018 and an increase in interest rates on money market funds during the period. Interest income increased$1.8 million in the three months endedDecember 31, 2018 to$2.4 million compared to interest income of$0.6 million during the three months endedDecember 31, 2017 . The increase in interest income in 2018 is primarily due to higher average cash and cash equivalent balances in 2018 compared to 2017 and increases in interest rates on money market funds during the period. 62
-------------------------------------------------------------------------------- Interest income increased$1.5 million in the year endedSeptember 30, 2018 to$3.6 million compared to interest income of$2.1 million in the year endedSeptember 30, 2017 . The increase in interest income in 2018 is primarily due to higher average cash and cash equivalent balances in 2018 compared to 2017 and a small increase in interest rates during the period.
Interest Expense
Interest expense for the year endedDecember 31, 2019 was$1.1 million and interest expense for the year endedDecember 31, 2018 was$1.2 million . Interest expense is primarily related to our finance lease liabilities, which did not significantly fluctuate in 2019 compared to 2018. Interest expense remained consistent during the three months endedDecember 31, 2018 of$0.3 million compared to interest expense of$0.3 million in the three months endedDecember 31, 2017 . Interest expense increased$0.2 million in the year endedSeptember 30, 2018 to$1.2 million compared to interest expense of$1.0 million in the year endedSeptember 30, 2017 . The increase in interest expense in 2018 is primarily due to the increase in finance lease liabilities in 2018 compared to 2017.
Other income
Other income for the year endedDecember 31, 2019 consisted of$104.1 million in net proceeds from the sale of the priority review voucher that we received from the FDA in connection with the approval of Epidiolex inthe United States .
Foreign currency exchange loss
Foreign currency exchange gains and losses are driven primarily by financial assets and liabilities denominated in a currency other than the transacting entity's functional currency. A significant majority of our cash balances are denominated inU.S. dollars and the functional currency of theGW Pharmaceuticals plc legal entity for the year endedSeptember 30, 2017 was the British Pound. Accordingly, a substantial portion of foreign currency transaction losses in the year endedSeptember 30, 2017 were related to the impact of exchange rate changes between theU.S. dollar and British Pound on theU.S. dollar denominated cash deposits held byGW Pharmaceuticals plc . OnOctober 1, 2017 , theU.S. dollar became the functional currency ofGW Pharmaceuticals plc . Beginning onOctober 1, 2017 , our primary exposure to foreign currency exchange gains and losses is the British Pound denominated cash balances held byGW Pharmaceuticals plc and intercompany balances between subsidiaries with different functional currencies. Foreign currency exchange loss for the year endedDecember 31, 2019 was$2.3 million compared to a foreign currency exchange loss of$6.1 million in the year endedDecember 31, 2018 . The decrease in the foreign exchange loss in 2019 was due primarily to a smaller year over year change in the foreign currency exchange rates of theU.S. dollar and British Pound compared to the change in rates for the similar period in 2018. Foreign currency exchange loss for the three months endedDecember 31, 2018 was$1.0 million compared to a foreign currency exchange gain of$0.2 million in the three months endedDecember 31, 2017 . The increase in the foreign exchange loss in the three months endedDecember 31, 2018 compared to the prior year period was due primarily to a due to a strengthening of theU.S. dollar against the British Pound in the three months endedDecember 31, 2018 . Foreign currency exchange loss for the year endedSeptember 30, 2018 was$5.0 million compared to a foreign currency exchange loss of$6.4 million in the year endedSeptember 30, 2017 . The decrease in the foreign exchange loss in 2018 was due primarily to a change in our foreign currency exchange rate exposure due to theU.S. dollar becoming the functional currency ofGW Pharmaceuticals plc onOctober 1, 2017 . Income tax expense (benefit) Income tax benefit for both the year endedDecember 31, 2019 and the year endedDecember 31, 2018 was$0.2 million . An increase in the income tax benefit inDecember 31, 2019 primarily related to excess tax benefits for stock compensation was fully offset by an increase in state taxes. Income tax benefit for the three months endedDecember 31, 2018 was$0.3 million compared to an income tax expense of$3.7 million for the three months endedDecember 31, 2017 . The decrease in income tax expense for 2018 was primarily due to the remeasurement of the federal portion of ourU.S. subsidiary's deferred tax assets and liabilities recorded in the three months endedDecember 31, 2017 , the period of enactment of the Tax Cuts and Jobs Act. 63 -------------------------------------------------------------------------------- Income tax expense for the year endedSeptember 30, 2018 was$3.8 million compared to an income tax benefit of$1.0 million for the year endedSeptember 30, 2017 . The increase in income tax expense for 2018 was primarily due to the remeasurement of the federal portion of ourU.S. subsidiary's deferred tax assets and liabilities to the enacted tax rate expected to apply when the temporary differences are to be realized. The President ofthe United States signed into law the Tax Cuts and Jobs Act onDecember 22, 2017 which among a broad range of tax reform measures, reduced the corporate tax rate from 35% to 21% effectiveJanuary 1, 2018 . The negative impact of the remeasurement of deferred tax assets was partially offset by a reduction in taxes on current period income due to the decline in theU.S. statutory tax rate.
Liquidity and Capital Resources
In recent years, we have incurred significant net losses and negative cash flows from operations. We have largely funded our operations from issuances of equity securities, government expense and tax credits, and the sale of our priority review voucher. Our cash flows may fluctuate, are difficult to forecast and will depend on many factors, including:
• the timing of achievement of future Epidiolex regulatory approvals and
commercial launches in
• the extent to which we seek to retain development rights to our pipeline
of new product candidates or whether we seek to out-license them to a
partner who will fund future research and development expenditure in
return for a right to share in future commercial revenue;
• the extent of success in our early pre-clinical and clinical stage
research programs which will determine the amount of funding required to
further the development of our product candidates;
• the terms and timing of new strategic collaborations;
• the number and characteristics of the product candidates that we seek to
develop;
• the outcome, timing and cost of regulatory approvals of our product
candidates;
• the costs involved in filing and prosecuting patent applications and
enforcing and defending potential patent claims; and
• the costs of hiring additional skilled employees to support our continued
growth.
We believe that our cash and cash equivalents as of
Cash Flows
The following table summarizes the results of our cash flows for the years ended
Years Ended Three Months Ended Years Ended
December 31, December 31, September 30,
2019 2018 2018 2017 2018 2017
(in thousands)
Net cash used in operating
activities $ (123,469 ) $ (254,770 ) $
(74,460 )
61,629 $ (42,896 ) (18,750 ) (8,741 ) (32,887 ) (20,097 ) Net cash provided by (used in) financing
activities 1,946$ 324,479 324,468 297,743 297,754 (1,213 ) Cash and cash equivalents at end of the year$ 536,933 $ 591,497 $ 591,497 $ 559,227 $ 354,913 $ 322,154 Operating activities As ofDecember 31, 2019 , we had cash and cash equivalents totaling$536.9 million compared to$591.5 million as ofDecember 31, 2018 . Net cash used in operating activities decreased by$131.3 million to$123.5 million during the year endedDecember 31, 2019 compared to$254.8 million for the year endedDecember 31, 2018 . The decrease in cash used is attributable to a$295.4 million increase in net product sales, partially offset by a$20.6 million increase in cost of product sales, a$94.2 million increase in SG&A expenses, and a$60.1 million increase in cash used to fund changes in net operating assets and liabilities. 64 -------------------------------------------------------------------------------- Net cash used in operating activities increased by$22.9 million to$74.5 million during the three months endedDecember 31, 2018 compared to$51.6 million for the three months endedDecember 31, 2017 . The increase in cash used is primarily attributable to net loss of$72.2 million adjusted for non-cash items, including depreciation and amortization expense of$2.5 million and stock-based compensation of$9.7 million . Net cash used in operating activities increased by$82.9 million to$231.9 million for the year endedSeptember 30, 2018 compared to$149.0 million for the year endedSeptember 30, 2017 . The increase in cash used in operating activities was primarily due to the increase in research and development expenses, including the cost of growing high CBD plant material for Epidiolex prior to the achievement of regulatory approval in theU.S. , and increased SG&A expenses related to the ramp up of commercialization activities and corporate support functions. Investing activities Net cash provided by investing activities increased by$104.5 million to$61.6 million during the year endedDecember 31, 2019 compared to net cash used in investing activities of$42.9 million for the year endedDecember 31, 2018 . The increase in cash provided by investing activities is primarily due to the sale of our priority review voucher inApril 2019 .
Net cash used in investing activities increased by
Net cash used in investing activities increased by$12.8 million to$32.9 million for the year endedSeptember 30, 2018 compared to$20.1 million for the year endedSeptember 30, 2017 . The increase in cash used in investing activities was primarily due to the continued expansion of our manufacturing facilities.
Financing activities
Financing activities provided a decrease in net cash of
Financing activities provided an increase in net cash of$26.8 million to$324.5 million during the three months endedDecember 31, 2018 compared to$297.7 million during the three months endedDecember 31, 2017 . The increase in cash provided by financing activities is primarily due to net proceeds of$324.6 million received from our equity offering inOctober 2018 . Net cash provided by financing activities increased by$298.9 million to$297.7 million for the year endedSeptember 30, 2018 compared to cash used in financing activities of$1.2 million for the year endedSeptember 30, 2017 . The increase in cash provided by financing activities was primarily due to net proceeds of$297.9 million from our equity offering inDecember 2017 .
Equity Financings
In
In
Off Balance Sheet Arrangements
We do not have any off-balance sheet arrangements.
65--------------------------------------------------------------------------------
Tabular Disclosure of Contractual Obligations
The following table summarizes our contractual obligations as atDecember 31, 2019 . Payments Due by Period Less than More than Total 1 year 1 - 3 years 3 - 5 years 5 years (in thousands) Operating lease obligations$ 34,917 $ 5,900 $ 10,097 $ 7,483 $ 11,437 Finance lease obligations 9,788 729 1,450 1,436 6,173 Purchase obligations 38,975 23,126 13,874 658 1,317 Landlord financing obligations 14,143 1,266 2,532 2,532 7,813
Total contractual obligations
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