The following discussion contains management's discussion and analysis of our financial condition and results of operations and should be read together with the unaudited condensed financial statements and related notes include in Part I, Item 1 of this Quarterly Report on Form 10-Q and in conjunction with our Annual Report on Form 10-K for the year endedDecember 31, 2019 and other documents previously filed with theSEC . 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 Item 1A "Risk Factors" of this Quarterly Report on Form 10-Q. Actual results may differ materially from those contained in any forward-looking statements. You should carefully read "Special Note Regarding Forward-Looking Statements" and Item 1A "Risk Factors" of Part II of this Quarterly Report on Form 10-Q.
Overview
We are a performance beauty company with a customer-centric approach focused on delivering breakthrough products in the self-pay aesthetic market. InFebruary 2019 , we received the approval of our first product Jeuveau® (prabotulinumtoxinA-xvfs) from theU.S. Food and Drug Administration , or FDA. InMay 2019 , we commercially launched Jeuveau® inthe United States . Jeuveau® is a proprietary 900 kDa purified botulinum toxin type A formulation indicated for the temporary improvement in the appearance of moderate to severe glabellar lines, also known as "frown lines," in adults. Our primary market is the self-pay aesthetic market, which includes medical products purchased by physicians and other customers that are then sold to consumers or used in procedures for aesthetic indications that are not reimbursed by any third-party payor, such as Medicaid, Medicare or commercial insurance. We believe we offer customers and consumers a compelling value proposition with Jeuveau®. Currently, onabotulinumtoxinA (BOTOX) is the neurotoxin market leader, and prior to the approval of Jeuveau®, was the only known 900 kDa botulinum toxin type A complex approved inthe United States . We believe aesthetic physicians generally prefer the performance characteristics of the complete 900 kDa neurotoxin complex and are accustomed to injecting this formulation. InAugust 2018 , we received approval fromHealth Canada for the temporary improvement in the appearance of moderate to severe glabellar lines in adult patients under 65 years of age. We began marketing Jeuveau® inCanada inOctober 2019 through our distribution partnerClarion Medical Technologies, Inc. , orClarion . InSeptember 2019 , we also received approval from theEuropean Commission , to market the product in all 28 EU member states,Iceland ,Norway andLiechtenstein . We currently plan to launch Jeuveau® inEurope in 2021. We have a limited history of generating revenue from Jeuveau® and have never been profitable. As ofSeptember 30, 2020 , we had an accumulated deficit of$265.4 million . We recorded net revenues of$17.7 million and$36.0 million for the three and nine months endedSeptember 30, 2020 , respectively. We recorded net losses of$11.5 million and$52.3 million for the three and nine months endedSeptember 30, 2020 , respectively. We expect to continue to incur significant expenses for the foreseeable future as we continue marketing efforts for Jeuveau® and maintain our regulatory approvals. Potential Impact of Adverse Ruling by theU.S. International Trade Commission on our Business As described elsewhere in this Quarterly Report, onJanuary 30, 2019 , Allergan, plc (nowAllergan Limited ) andAllergan, Inc. ,who we refer to collectively asAllergan and Medytox, Inc. , or Medytox filed a complaint against us andDaewoong Pharmaceuticals Co., Ltd. , or Daewoong in theU.S. International Trade Commission , or ITC alleging that Jeuveau® is manufactured based on misappropriated trade secrets of Medytox and therefore the importation of Jeuveau® is an unfair act. The ITC matter is entitled In the Matter of Certain Botulinum Toxin Products. The ITC instituted an investigation as ITC Inv. No. 337-TA-1145. InJuly 2020 , the Administrative Law Judge assigned to the ITC action to which we are a party issued an initial determination in which the judge found a violation of Section 337 of the Tariff Act of 1930 had occurred by reason of a misappropriation of trade secrets and recommended the entry of an exclusion order that would prevent us from importing Jeuveau® intothe United States for a period of ten years and a cease and desist order that would prevent us from selling Jeuveau® inthe United States for the same period of time. A final determination by the ITC is expected to be issued inNovember 2020 , with such final determination subject to a 60-day presidential review period before becoming final. In order to make any sales of Jeuveau® during the presidential review period we would be required to pay a bond at a rate set by the ITC for any sales 36 -------------------------------------------------------------------------------- Table of Contents during the period. Except in certain limited circumstances, the amount of the bond may make any sales during the period prohibitively expensive. We strongly disagree with the initial determination by the Administrative Law Judge and intend to continue to vigorously defend ourselves in this matter. Specifically, we petitioned for review with respect to subject matter jurisdiction, standing, trade secret existence and misappropriation, and domestic industry, including the existence of such domestic industry as well as any actual or threatened injury thereto. In the event that the ITC's final determination affirms the Administrative Law Judge's initial determination, we would be prevented from importing Jeuveau® intothe United States and from marketing and selling Jeuveau® inthe United States , which would prevent the Company from generating revenue from its sole product, Jeuveau® and would materially and adversely affect our ability to carry out our business and to continue as a going concern. Even if we are successful in having the decision modified or reversed during the presidential review or in appealing any such final determination, we may find it difficult or be prevented from importing, marketing or selling Jeuveau® inthe United States during the pendency of those events. Further, any modification of the Administrative Law Judge's initial determination in the ITC's final determination or any final decision following any such presidential review or other appeal may nonetheless still result in restrictions on our ability to import and market and sell Jeuveau® inthe United States , which could also materially and adversely affect our ability to generate revenue from Jeuveau®, to carry out our business, and to continue as a going concern. In any such event, we may be required to seek protection under the bankruptcy laws, including a possible liquidation of our assets, or may be forced to reduce, significantly restructure or discontinue our operations entirely, any of which would have a material adverse effect on our business, financial position, results of operations, or cash flows, would cause our stock price to decline and would also result in reputational harm. Even if we are successful, the ITC action may result in reputational damage or other collateral consequences. In addition, it is expected that an event of default under our credit agreement with Oxford would occur after the imposition of an exclusion order and cease and desist order and Oxford would be able to declare an event of default after the exhaustion of all appeals that we may have or earlier. If Oxford were to declare an event of default under the credit facility and exercise its remedies, it would materially and negatively affect our business, results of operation, financial condition and could result in our declaring bankruptcy. Impact of COVID-19 Outbreak on Our Business A novel strain of coronavirus (COVID-19) was first identified inWuhan, China inDecember 2019 , and subsequently declared a pandemic by theWorld Health Organization . The COVID-19 outbreak has caused economic and social disruption on an unprecedented scale. This disruption has resulted in business closures acrossthe United States and significant job loss due to quarantines, government-mandated actions, stay-at-home orders and other restrictions. While it is not possible to know the full extent of these impacts as of the date this filing, we are disclosing potentially material items of which we are aware. Health and Safety In response to the COVID-19 outbreak, we have taken and will continue to take temporary precautionary measures intended to help minimize the risk of COVID-19 to our employees, including requiring our employees and sales professionals, to work remotely if required by their local government and maintaining social distancing during any in-person work-related meetings. We expect to continue to implement these measures until we determine that the COVID-19 pandemic is adequately contained for purposes of our business, and we may take further actions as government authorities require or recommend or as we determine to be in the best interests of our employees, customers, business partners and third-party service providers. Financial position and results of operations The COVID-19 outbreak and restrictions intended to slow the spread of COVID-19 have resulted in temporary business closures for many of our customers and, starting inmid-March 2020 , have negatively affected our sales. Jeuveau® is utilized in elective procedures, the costs of which are borne by the consumer and not third-party payors. As a result of the COVID-19 outbreak and restrictions intended to slow its spread, these elective procedures declined dramatically inMarch 2020 due to the temporary business closures or deferment of the elective procedures. While the impact of the COVID-19 outbreak on theU.S. aesthetic neurotoxin market was significant during the first half of 2020, we experienced a relatively significant increase in sales starting inJune 2020 that continued into the third quarter of 2020 as many states started easing restrictions on elective procedures and many of our customers re-opened their businesses. However, due to the uncertainty of the recovery and the recent increase in COVID-19 infections, we cannot reasonably estimate the immediate and full impact of the COVID-19 outbreak on our ongoing business, results of operations and overall financial performance. Furthermore, even after the current COVID-19 outbreak has subsided, we may continue to experience negative impacts to our business and financial results if customers continue to defer or avoid altogether elective procedures to administer Jeuveau® due to the continued perceived risk of infection or concern of a resurgence of the COVID-19 outbreak as well as COVID-19's global economic impact, 37 -------------------------------------------------------------------------------- Table of Contents including decreases in consumer discretionary spending and any economic slowdown or recession that has occurred or may occur in the future. In light of the negative impacts of the COVID-19 outbreak, we took the following measures to reduce our operating expenses to conserve our cash resources inApril 2020 : •delaying non-essential projects and suspending discretionary spending; •reducing our headcount by over 100 employees; •temporarily reducing executive salaries and Board of Directors fees; •reducing the size of our Board by two members; and •delaying the European launch of Jeuveau®, which is now expected in 2021. As a result of our headcount reductions, we are increasingly utilizing our proprietary digital platform to support sales in the current COVID-19 environment. Asset and liability valuation As ofSeptember 30, 2020 , we did not have any impairment with respect to our goodwill or long-lived assets, including intangible assets. Because the full extent of the impact of the COVID-19 outbreak and restrictions intended to slow the spread of COVID-19 are unknown at this time, they could, under certain circumstances, cause impairment and result in a non-cash impairment charge being recorded in future periods. Any continued adverse impact of the COVID-19 outbreak and restrictions intended to slow its spread could also cause us to make further adjustments in the future to the fair value of our contingent royalty obligation payable toEvolus Founders, which is based on Level 3 inputs using a discounted cash flows method, and these adjustments could be significant. Such Level 3 inputs that might be further impacted by uncertainties due to the COVID-19 outbreak include projected and timing of net revenues during the payment period, which terminates in the quarter following the 10-year anniversary of the first commercial sale of Jeuveau® inthe United States , the discount rate and the timing of payments. Other estimates used in the preparation of financial statements Additionally, any continued adverse impact of the COVID-19 outbreak and restrictions intended to slow its spread might also impact other estimates and assumptions utilized to prepare our financial statement in conformity with GAAP. Such significant estimates relate to net revenues, allowance for doubtful accounts, fair value measurements, inventory valuations, income tax valuations, and stock-based compensation, among others. Liquidity The COVID-19 outbreak has negatively impacted and disrupted the global economy and financial markets which could interfere with our ability to access financing when and on terms that we desire. As ofSeptember 30, 2020 , we had$110.1 million in cash, cash equivalents and short-term investments and$133.0 million in long-term debt. InJuly 2020 , we received$40 million from Daewoong in exchange for the Convertible Promissory Note, or Daewoong Convertible Note (as described in more detail in "-Liquidity and Capital Resources" below). We do not have any near-term maturities on our long-term debts. The principal payment of the Oxford Term Loan may start inMay 2022 . Interest on the Daewoong Convertible Note is initially paid in kind and will begin to be paid in cash if and when the Oxford Term Loan is repaid in full. Our promissory note payable to theEvolus Founders matures inNovember 2021 . The Daewoong Convertible Promissory Note is due inJuly 2025 unless earlier converted into our shares. Although there is uncertainty related to the anticipated impact of the recent COVID-19 outbreak on our future results, we believe our business model, our current cash reserves and the steps we have taken to reduce our operating expenses position us to manage our business for at least the next twelve months as the outbreak continues. The adequacy of our current liquidity and capital resources would be materially adversely affected in the event of a negative outcome in the ITC action. See "-Formation of Committee of the Board of Directors" and "-Liquidity and Capital Resources" for additional information regarding our liquidity and capital resources, our current and future capital requirements and the assumptions and risks underlying those projections. We continue to monitor the rapidly evolving situation and guidance from international and domestic authorities, including federal, state and local public health authorities and may take additional actions based on their recommendations. In these 38 -------------------------------------------------------------------------------- Table of Contents circumstances, there may be developments outside our control requiring us to adjust our operating plan. As such, given the dynamic nature of this situation, we cannot reasonably estimate the full impact of COVID-19 on our financial condition, results of operations or cash flows in the future. In addition, see Part II. Item 1A, "Risk Factors," included herein for updates to our risk factors regarding risks associated with the COVID-19 outbreak. Formation of Independent Committee of the Board of Directors As described above, in the event that the ITC's final determination affirms the Administrative Law Judge's initial determination, we would be prevented from importing Jeuveau® intothe United States and from marketing and selling Jeuveau® inthe United States , which would prevent the Company from generating revenue from the Company's sole product, Jeuveau® and would materially and adversely affect our ability to carry out our business and to continue as a going concern. Even if we are successful in having the decision modified or reversed during the presidential review or in appealing any such final determination, we may find it difficult or be prevented from importing, marketing or selling Jeuveau® inthe United States during the pendency of those events. Further, any modification of the Administrative Law Judge's initial determination in the ITC's final determination or any final decision following any such presidential review or other appeal may nonetheless still result in restrictions on our ability to import and market and sell Jeuveau® inthe United States , which could also materially and adversely affect our ability to generate revenue from Jeuveau®, to carry out our business, and to continue as a going concern. As a result of the challenging conditions described above, we have formed a committee of independent members of our Board of Directors (the "Committee") to evaluate all available alternatives in the event of a negative outcome in the ITC action. The Committee has engaged outside legal counsel and financial advisors to assist with this process. The Committee, with its outside advisors' assistance, is evaluating such alternatives to maximize our business, liquidity and financial position in the event of negative outcome in the ITC action. Daewoong License and Supply Agreement In 2013, we andDaewoong Pharmaceuticals Co. Ltd. , or Daewoong, entered into the Daewoong Agreement pursuant to which we have an exclusive distribution license to Jeuveau® from Daewoong, for aesthetic indications inthe United States , EU,Great Britain ,Canada ,Australia ,Russia , C.I.S. andSouth Africa , as well as co-exclusive distribution rights with Daewoong inJapan . Under the Daewoong Agreement, we are required to make certain minimum annual purchases in order to maintain the exclusivity of the license. These minimum purchase obligations are contingent upon the occurrence of future events, including receipt of governmental approvals and our future market share in various jurisdictions. While we anticipate that we will be able to meet the minimum purchase obligations, the COVID-19 outbreak may make meeting those obligations more difficult. In connection with our entry into the Daewoong Agreement, we made an upfront payment to Daewoong of$2.5 million . Upon FDA approval inFebruary 2019 and EMA approval inSeptember 2019 , we paid$2.0 million and$1.0 million milestone payments, respectively. Under the Daewoong Agreement, the maximum aggregate amount of milestone payments that could be owed to Daewoong upon the satisfaction of all milestones is$13.5 million . As ofSeptember 30, 2020 , Daewoong is eligible to receive remaining contingent milestone payments of up to$10.5 million . Under the Daewoong Agreement, Daewoong is responsible for all costs related to the manufacturing of Jeuveau®, including costs related to the operation and upkeep of its manufacturing facility, and we are responsible for all costs related to obtaining regulatory approval, including clinical expenses, and commercialization of Jeuveau®. We had the option to expand the permitted use of the product beyond aesthetic indications and into therapeutic indications. This option was assigned toAEON Biopharma, Inc. which was previously known asAlphaeon Corporation , orAlphaeon ,who exercised the option by remitting payment directly to Daewoong inNovember 2018 . Royalties and Notes Payable to Evolus Founders We are obligated to make the following future payments to the founders ofEvolus (i) quarterly royalty payments of a low single digit percentage of net sales of Jeuveau® and (ii) a$20.0 million promissory note that matures inNovember 2021 . The obligations set forth in (i) above will terminate in the quarter following the 10-year anniversary of the first commercial sale of Jeuveau® inthe United States . The fair value of the obligations set forth in items (i) and (ii) are valued quarterly and are referred to in our financial statements as the "contingent royalty obligation." 39 -------------------------------------------------------------------------------- Table of Contents Results of Operations Comparison of the Three Months EndedSeptember 30, 2020 and 2019 The following table summarizes our results of operations for the periods indicated: Three Months Ended September 30, (in millions) 2020 2019 Change Revenue:$ 17.7 $ 13.2 $ 4.5 Cost of sales (excludes amortization of intangible assets) 4.9 3.7 1.2 Gross profit 12.8 9.5 3.3 As a percentage of net revenues 72.5 % 71.8 % Operating expenses: Selling, general and administrative 21.9 30.9 (9.0) Research and development 0.4 0.7 (0.3) Revaluation of contingent royalty obligation payable to Evolus Founders (2.5) 1.8 (4.3) Depreciation and amortization 1.7 1.2 0.5 Total operating expenses 21.6 34.6 (13.0) Loss from operations (8.8) (25.1) 16.3 Non-operating expense, net (2.7) (2.0) (0.7) Loss before income taxes: (11.5) (27.1) 15.6 Income tax expense (benefit) - (0.1) 0.1 Net loss$ (11.5) $ (27.0) $ 15.5 Net Revenues We currently operate in one reportable segment and all of our net revenues are derived from sales of Jeuveau®. Net revenues consist of revenues, net of adjustments primarily for customer rebates and rewards related to the consumer loyalty program. Revenues are recognized when the control of the promised goods is transferred to the customer in an amount that reflects the consideration allocated to the related performance obligation and to which we expect to be entitled in exchange for those products or services. Net revenues of Jeuveau® sales increased by$4.5 million , or 34%, to$17.7 million for the three months endedSeptember 30, 2020 from$13.2 million for the three months endedSeptember 30, 2019 , primarily due to higher sales volume inthe United States and service revenue associated with international sales. For the three months endedSeptember 30, 2020 , we continued to experience a significant increase in sales volume as many of our customers re-opened their businesses. We anticipate that our net revenues will continue to fluctuate during the COVID-19 outbreak and for a period of time thereafter due to the expected reduced or deferred spending on Jeuveau® procedures by consumers. In addition, in the event that the ITC's final determination affirms the Administrative Law Judge's initial determination in the ITC action, we will be prevented from importing Jeuveau® intothe United States and from marketing and selling Jeuveau® inthe United States , which will prevent us from generating revenue from our sole product. See "Potential Impact of Adverse Ruling by theU.S. International Trade Commission on our Business" above. Cost of Sales Our cost of sales, which primarily consisted of the cost of inventory purchased from Daewoong, increased by$1.2 million , or 31%, to$4.9 million for the three months endedSeptember 30, 2020 from$3.7 million for the three months endedSeptember 30, 2019 due to higher sales volume. We anticipate that our cost of sales will fluctuate as our revenues fluctuate. Our gross profit as a percentage of net revenues was 72.5% and 71.8% for the three months endedSeptember 30, 2020 and 2019, respectively. The increase in gross profit percentage was due to changes in marketing programs for the three months endedSeptember 30, 2020 . Our gross profit may fluctuate in the future as we implement various marketing programs that may affect the average selling price of Jeuveau®. 40 -------------------------------------------------------------------------------- Table of Contents Selling, General and Administrative Selling, general and administrative expenses decreased by$9.0 million , or, 29.0% to$21.9 million for the three months endedSeptember 30, 2020 from$30.9 million for the three months endedSeptember 30, 2019 , primarily resulting from delaying non-essential projects and suspending discretionary spending as a measure we have taken to reduce our operating expenses to minimize the impact of COVID-19 on our business. Personnel-related expenses, including stock-based compensation, decreased by$1.6 million as a result of the termination of over 100 employees inApril 2020 . During the three months endedSeptember 30, 2019 , we also incurred expenses under the Jeuveau® Experience Treatment, or J.E.T., program that ended inAugust 2019 . Selling, general and administrative expenses may fluctuate in the future primarily due to potential changes in marketing strategies. Research and Development Research and development expenses decreased by$0.3 million , or 49.5%, to$0.4 million for the three months endedSeptember 30, 2020 from$0.7 million for the three months endedSeptember 30, 2019 . The decrease primarily resulted from delaying non-essential projects and suspending discretionary spending as a measure we have taken to reduce our operating expenses to minimize the impact of COVID-19 on our business. We expect our overall research and development expense to increase if and when we seek to develop further product candidates and pursue regulatory approvals in other jurisdictions. Revaluation of Contingent Royalty Obligation Payable to Evolus Founders The change in the fair value of the contingent royalty obligation payable to Evolus Founders is recorded in operating expenses in each reporting period. During the three months endedSeptember 30, 2020 and 2019, the revaluation gain of$2.5 million and charge of$1.8 million , respectively, were primarily driven by changes in management assumptions relating to lower revenue forecasts due to the impact of the COVID-19 outbreak, increased discount rate due to our increased cost of capital following the decline of our stock price, uncertainties surrounding the ITC action and timing of cash flows. Depreciation and Amortization Depreciation and amortization increased by$0.5 million , or 45.1%, to$1.7 million for the three months endedSeptember 30, 2020 from$1.2 million for the three months endedSeptember 30, 2019 . The increase was primarily attributable to amortization of the internal-use software costs over two years. Non-Operating Expense,Net Non -operating expense, net, increased by$0.7 million , or 36.6%, to$2.7 million for the three months endedSeptember 30, 2020 from$2.0 million for the three months endedSeptember 30, 2019 , primarily due to lower interest income on our short-term investments. Income Taxes (Benefit) Expense Income tax benefit was trivial for the three months endedSeptember 30, 2020 compared to an income tax benefit of$0.1 million for the three months endedSeptember 30, 2019 . 41 -------------------------------------------------------------------------------- Table of Contents Results of Operations Comparison of the Nine Months EndedSeptember 30, 2020 and 2019 The following table summarizes our results of operations for the periods indicated: Nine Months Ended September 30, (in millions) 2020 2019 Change Revenue:$ 36.0 $ 15.5 $ 20.5 Cost of sales (excludes amortization of intangible assets) 11.0 4.4 6.6 Gross profit 25.0 11.1 13.9 As a percentage of net revenues 69.4 % 71.7 % Operating expenses: Selling, general and administrative 70.8 83.3 (12.5) Research and development 1.0 3.6 (2.6) Revaluation of contingent royalty obligation payable to Evolus Founders (9.9) 8.0 (17.9) Depreciation and amortization 5.2 2.7 2.5 Restructuring costs 3.0 - 3.0 Total operating expenses 70.0 97.5 (27.5) Loss from operations (45.0) (86.4) 41.4 Non-operating expense, net (7.1) (4.0) (3.1) Loss before income taxes: (52.1) (90.4) 38.3 Income tax expense (benefit) 0.2 (14.9) 15.1 Net loss$ (52.3) $ (75.5) $ 23.2 Net Revenues We commercially launched and began shipping Jeuveau® to customers inthe United States inMay 2019 . Net revenues of Jeuveau® sales increased by$20.5 million , or 132.3%, to$36.0 million for the nine months endedSeptember 30, 2020 from$15.5 million for the nine months endedSeptember 30, 2019 , primarily due to higher sales volume inthe United States as partially offset by lower average selling price and service revenue associated with international sales. We anticipate that our net revenues will continue to fluctuate during the COVID-19 outbreak and for a period of time thereafter due to the expected reduced or deferred spending on Jeuveau® procedures by our customers. In addition, in the event that the ITC's final determination affirms the Administrative Law Judge's initial determination in the ITC action, we will be prevented from importing Jeuveau® intothe United States and from marketing and selling Jeuveau® inthe United States , which will prevent us from generating revenue from our sole product. See "Potential Impact of Adverse Ruling by theU.S. International Trade Commission on our Business" above. Cost of Sales Our cost of sales, which primarily consisted of the cost of inventory purchased from Daewoong, increased by$6.6 million , or 151.7%, to$11.0 million for the nine months endedSeptember 30, 2020 from$4.4 million for the nine months endedSeptember 30, 2019 due to higher sales volume. We anticipate that our cost of sales will fluctuate as our revenues fluctuate. Our gross profit as a percentage of net revenues was 69.4% and 71.7% for the nine months endedSeptember 30, 2020 and 2019, respectively. The decrease in gross profit percentage during the nine months endedSeptember 30, 2020 was primarily due to promotions offered to customers in the first quarter of 2020. Our gross profit may fluctuate in the future as we implement various marketing programs that may affect the average selling price of Jeuveau®. Selling, General and Administrative Selling, general and administrative expenses decreased by$12.5 million , or 15.0%, to$70.8 million for the nine months endedSeptember 30, 2020 from$83.3 million for the nine months endedSeptember 30, 2019 , primarily resulting from delaying non-essential projects and suspending discretionary spending to minimize the impact of COVID-19 on our business. 42 -------------------------------------------------------------------------------- Table of Contents During the nine months endedSeptember 30, 2019 , we also incurred expenses under the Jeuveau® Experience Treatment, or J.E.T., program that ended inAugust 2019 . Personnel-related expenses, including stock-based compensation, increased by$3.9 million as a result of hiring aU.S. sales force in the second quarter of 2019, which was partially offset by terminating over 100 employees in 2020. Selling, general and administrative expenses may fluctuate in the future primarily due to potential changes in marketing strategies. Research and Development Research and development expenses decreased by$2.6 million , or 71.8%, to$1.0 million for the nine months endedSeptember 30, 2020 from$3.6 million for the nine months endedSeptember 30, 2019 . The decrease was primarily attributable to the completion of theU.S. clinical trial activities related to Jeuveau® and delaying non-essential projects and suspending discretionary spending to minimize the impact of COVID-19 on our business. We expect our overall research and development expense to increase if and when we seek to develop further product candidates and pursue regulatory approvals in other jurisdictions. Revaluation of Contingent Royalty Obligation Payable to Evolus Founders The change in the fair value of the contingent royalty obligation payable to Evolus Founders is recorded in operating expenses in each reporting period. During the nine months endedSeptember 30, 2020 and 2019, the revaluation gain of$9.9 million and charge of$8.0 million , respectively, were primarily driven by changes in management assumptions relating to lower revenue forecasts due to the impact of the COVID-19 outbreak, increased discount rate due to our increased cost of capital following the decline of our stock price, uncertainties surrounding the ITC action and timing of cash flows. Depreciation and Amortization Depreciation and amortization increased by$2.5 million , or 93.4%, to$5.2 million for the nine months endedSeptember 30, 2020 from$2.7 million for the nine months endedSeptember 30, 2019 . This was primarily attributable to amortization of the distribution right asset related to Jeuveau® over 20 years starting inFebruary 2019 as well as amortization of the internal-use software costs over two years. Restructuring Costs Restructuring costs primarily included$3.0 million of termination benefits of over 100 employees we separated to minimize the impact of COVID-19 on our business during the nine months endedSeptember 30, 2020 . Non-Operating Expense,Net Non -operating expense, net, increased by$3.1 million , or 75.3%, to$7.1 million for the nine months endedSeptember 30, 2020 from$4.0 million for the nine months endedSeptember 30, 2019 , primarily due to higher interest expense on the long-term debt fromOxford Finance, LLC borrowed inMarch 2019 and lower interest income on our short-term investments. Income Taxes (Benefit) Expense Income tax expense was$0.2 million for the nine months endedSeptember 30, 2020 compared to an income tax benefit of$14.9 million for the nine months endedSeptember 30, 2019 . Upon the reclassification of the indefinite-lived IPR&D intangible asset to a definite-lived distribution right intangible asset in the first quarter of 2019 upon FDA approval of Jeuveau®, the related deferred tax liability became a source of future taxable income in the assessment of the realization of deferred tax assets, and as a result,$14.9 million of the previously existing valuation allowance was released in the nine months endedSeptember 30, 2019 . Liquidity and Capital Resources As ofSeptember 30, 2020 , we had cash and cash equivalents of$85.1 million , short-term investments of$25.0 million , working capital of$119.7 million , long-term debt of$133.0 million and stockholders' equity of$35.1 million . We have a limited history of generating revenues and only began shipping Jeuveau® inMay 2019 . We have incurred operating losses to date and have an accumulated deficit of$265.4 million as ofSeptember 30, 2020 as a result of ongoing efforts to develop and commercialize Jeuveau®, including providing selling, general and administrative support for these operations. We had net losses of$52.3 million and$75.5 million for the nine months endedSeptember 30, 2020 and 2019, 43 -------------------------------------------------------------------------------- Table of Contents respectively, and we used net cash in operating activities of$55.6 million and$77.5 million for the nine months endedSeptember 30, 2020 and 2019, respectively. Management expects operating losses and negative operating cash flows to continue for at least the next 12 months. In the event that the ITC's final determination in the ITC action described above affirms the Administrative Law Judge's initial determination, we would be prevented from importing Jeuveau® intothe United States and from marketing and selling Jeuveau® inthe United States , which would prevent us from generating revenue from our sole product, Jeuveau® and would materially and adversely affect our ability to carry out our business and to continue as a going concern. Even if we are successful in having the decision modified or reversed during the presidential review or in appealing any such final determination, we may find it difficult or be prevented from importing, marketing or selling Jeuveau® inthe United States during the pendency of those events. Further, any modification of the Administrative Law Judge's initial determination in the ITC's final determination or any final decision following any such presidential review or other appeal may nonetheless still result in restrictions on our ability to import and market and sell Jeuveau® inthe United States , which could also materially and adversely affect our ability to generate revenue from Jeuveau®, to carry out our business, and to continue as a going concern. In any such event, we may be required to seek protection under the bankruptcy laws, including a possible liquidation of our assets, or may be forced to reduce, significantly restructure or discontinue our operations entirely, any of which would have a material adverse effect on our business, financial position, results of operations, or cash flows, would cause our stock price to decline and would also result in reputational harm. See "Potential Impact of Adverse Ruling by theU.S. International Trade Commission on our Business" and "Formation of Independent Committee of the Board of Directors" in the section entitled "Overview" of Item 2. Management's Discussion and Analyses for further discussion. The COVID-19 outbreak and restrictions intended to slow its spread have adversely affected, and are expected to continue to adversely affect, our business, financial condition, results of operations and cash flows. See "Impact of COVID-19 Outbreak on Our Business" in the section entitled "Overview" of Item 2. Management's Discussion and Analyses for further discussion. The Oxford Loan and Security Agreement OnMarch 15, 2019 , or the closing date, we entered into a loan and security agreement, or the credit facility, withOxford Finance, LLC , as collateral agent, or Oxford, and the lenders party thereto from time to time, pursuant to which the lender will make term loans available to us of up to$100.0 million , or the credit facility. The credit facility provides that the term loans are funded in two advances. The first tranche of$75.0 million was funded on the closing date, and the second tranche of$25.0 million could have been drawn, at our request, no later thanSeptember 30, 2020 , upon achieving specified minimum net sales milestones and no event of default is occurring. As ofSeptember 30, 2020 , we did not meet the net sales milestone to draw the second tranche, and the$25.0 million tranche is no longer available to us. The credit facility bears an annual interest rate equal to the greater of 9.5%, or the 30-dayU.S. Dollar LIBOR rate plus 7.0%. We have agreed to pay interest only pursuant to the credit facility for the first 36 months untilMay 2022 , which will be followed by a 23-month amortization period. Upon the earliest to occur of the maturity date, the acceleration of the term loans, or the prepayment of the term loans, we will be required to pay to Oxford a final payment of 5.5% of the full principal amount of the term loans funded, or the final payment. We may elect to prepay all amounts owed prior to the maturity date, provided that a prepayment fee is also paid, which shall be equal to 2.0% of the amount prepaid if the prepayment occurs afterMarch 15, 2020 and on or prior toMarch 15, 2021 , or 1.0% of the amount prepaid if the prepayment occurs thereafter, or the Prepayment Fee. If the term loans are accelerated following the occurrence of an event of default, we will be required to immediately pay to Oxford an amount equal to the sum of all outstanding principal of the term loans plus accrued and unpaid interest thereon through the prepayment date, the final payment, the Prepayment Fee, and all other obligations that are due and payable, including payment of Oxford's expenses and interest at the default rate with respect to any past due amounts. The credit facility is secured by substantially all of our assets. The credit facility includes affirmative and negative covenants applicable to us, our current subsidiary and any subsidiaries we may create in the future. The affirmative covenants include, among others, covenants requiring us to maintain our legal corporate existence and governmental approvals, deliver certain financial reports, maintain insurance coverage and satisfy certain requirements regarding deposit accounts. The negative covenants include, among others, restrictions on us transferring collateral, incurring additional indebtedness, engaging in mergers or acquisitions, paying dividends or making other distributions, making investments, creating liens, selling assets and suffering a change in control, in each case subject to certain exceptions. The credit facility also includes events of default, the occurrence and continuation of which could cause interest to be charged at a default interest rate equal to the applicable rate plus 5.0% and Oxford, as collateral agent, with the right to exercise 44 -------------------------------------------------------------------------------- Table of Contents remedies against us and the collateral securing the credit facility, including foreclosure against the property securing the credit facility, including by obtaining control over our bank and investment accounts and taking our cash. These events of default include, among other things, any failure by us to pay principal or interest due under the credit facility, a breach of certain covenants under the credit facility, our insolvency, a material adverse change, the occurrence of any default under certain other indebtedness and one or more judgments against us, the institution of certain temporary or permanent relief in connection with our pending litigation, or the breach, termination or other adverse events under the Daewoong Agreement. InJuly 2020 , the Administrative Law Judge assigned to the ITC action to which we are a party issued an initial determination in which the judge found a violation of Section 337 of the Tariff Act of 1930 had occurred by reason of a misappropriation of trade secrets and recommended the entry of a an exclusion order that would prevent us from importing Jeuveau® intothe United States for a period of ten years and a cease and desist order that would prevent us from selling Jeuveau® inthe United States for the same period of time. A final determination by the ITC is expected to be issued inNovember 2020 , with such final determination subject to a 60-day presidential review period before becoming final. We strongly disagree with the initial determination by the Administrative Law Judge and intend to continue to vigorously defend ourself in this matter. Specifically, the Company petitioned for review with respect to subject matter jurisdiction, standing, trade secret existence and misappropriation, and domestic industry, including the existence of such domestic industry as well as any actual or threatened injury thereto. In the event that the ITC's final determination affirms the Administrative Law Judge's initial determination, we would be prevented from importing Jeuveau® intothe United States and from marketing and selling Jeuveau® inthe United States for a period of ten years. Even if we are successful in having the decision modified or reversed during the presidential review or in appealing any such final determination, we may find it difficult or be prevented from importing, marketing or selling Jeuveau® inthe United States during the pendency of those events. Further, any modification of the Administrative Law Judge's initial determination in the ITC's final determination or any final decision following any such presidential review or other appeal may nonetheless still result in restrictions on our ability to import and market and sell Jeuveau® inthe United States . In any of these scenarios, it is expected that an event of default of the Oxford credit facility would occur after the imposition of an exclusion order and cease and desist order and Oxford would be able to declare an event of default after the exhaustion of all appeals that the Company may have or earlier. If Oxford were to declare an event of default under the credit facility and exercise its remedies, it would materially and negatively affect our business, results of operation, financial condition and could result in our declaring bankruptcy. The credit facility also provides us with the ability, under certain conditions, to obtain up to a$25.0 million revolving line of credit secured by our inventory, accounts receivable and cash proceeds of both. Oxford has the right of first refusal, but not the obligation, to provide such a revolving line of credit. In light of the COVID-19 outbreak and the related global economic disruptions it has caused, there is no guarantee that we would continue to meet the conditions necessary to obtain the line of credit or that, given lending constraints during the outbreak, such a line would be available from Oxford or other lenders to us on terms favorable to us or at all. The Daewoong Convertible Note OnJuly 6, 2020 , we entered into a Convertible Promissory Note Purchase Agreement with Daewoong for the purchase and sale of a Convertible Promissory Note for the principal amount of$40 million , which we refer to as the Daewoong Convertible Note, which was funded onJuly 30, 2020 . Additionally, onJuly 6, 2020 , we, Daewoong, andOxford Finance, LLC entered into a Subordination Agreement pursuant to which the Convertible Note will be subordinated to our obligations under that certain Loan and Security Agreement, dated as ofMarch 15, 2019 , by and between Oxford and us. The Daewoong Convertible Note bears interest at a rate of 3.0% payable semi-annually in arrears onJune 30th andDecember 31st of each year and matures onJuly 30, 2025 , subject to earlier conversion as provided below. Interest is initially paid in kind by adding the accrued amount thereof to the outstanding principal amount on a semi-annual basis onJune 30th andDecember 31st of each calendar year for so long as any principal amount under the Oxford Term Loan remains outstanding and the Subordination Agreement has not been terminated. Interest will begin to be paid in cash if and when the Oxford Term Loan is repaid in full and the Subordination Agreement has been terminated. During the term, the Daewoong Convertible Note will be convertible at the option of Daewoong beginning on the date that is 12 months from the date of issuance, subject to certain suspensions of that conversion right in the event of a final determination of the ITC action resulting in an exclusion order with respect to Jeuveau® as further set forth in the Daewoong Convertible Note. The initial conversion price of the Daewoong Convertible Note is$13.00 per share. The conversion price of the Daewoong Convertible Note is subject to adjustment for stock splits, dividends or distributions, recapitalizations, spinoffs or similar transactions. The Daewoong Convertible Note and the shares of our common stock issuable upon 45 -------------------------------------------------------------------------------- Table of Contents conversion of the Daewoong Convertible Note have not been registered under the Securities Act and may not be offered or sold inthe United States absent registration or an applicable exemption from registration requirements. Starting 27 months from the date of issuance, we may prepay the Daewoong Convertible Note without penalty, provided that we provide Daewoong with at least ten business days' written notice during which Daewoong may convert all or any portion of the Daewoong Convertible Note at the conversion price. Further, in the event we are awarded any recovery pursuant to a final, non-appealable award or judgment issued by a court of competent jurisdiction over the parties, or pursuant to any settlement acceptable in the sole and absolute discretion of each of us and Daewoong, for any indemnification or other claim for damages by us under the Daewoong Agreement, the amount of the Daewoong's or its affiliate's indemnification obligation with respect to such award, judgment or settlement shall be reduced on a dollar-for-dollar basis and will be offset by the amount of the then-outstanding principal amount of the Daewoong Convertible Note and any accrued but unpaid interest thereon. Operating Leases Our corporate headquarters is located inNewport Beach, California , in a facility that we subleased untilJanuary 2020 under a non-cancelable operating lease for a fixed amount each month. OnMay 15, 2019 , we entered into a non-cancelable operating lease for the same office facility with the original lessor. This non-cancelable operating lease commenced onFebruary 1, 2020 and expires onJanuary 31, 2025 with an option to extend the term for an additional 60 months. Lease payments increase based on an annual rent escalation clause that occurs on eachFebruary 1 anniversary. We may, under certain circumstances, terminate the lease on the 36 months anniversary of the lease commencement date by providing a written notice 12 months prior to such anniversary and paying a termination fee equal to six months basic rent plus certain other expenses. We have an option to extend the term of the lease for an additional 60 months. Current and Future Capital Requirements We believe that our current capital resources, which consist of cash, cash equivalents and short-term investments, will be sufficient to fund operations through at least the next twelve months based on our expected cash burn rate from the date of the issuance of this Quarterly Report on Form 10-Q. We have based our projections of operating capital requirements on assumptions that may prove to be incorrect and we may use all our available capital resources, which consist of cash, cash equivalents and short-term investments, sooner than we expect. Because of the numerous risks and uncertainties associated with research, development and commercialization of our products, we are unable to estimate the exact amount of our operating capital requirements. Our future funding requirements will depend on many factors, including, but not limited to: •our ability to generate revenue and continue as a going concern if the ITC affirms the initial determination issued by the Administrative Law Judge in a final determination and imposes an exclusion order preventing us from importing Jeuveau® intothe United States and a cease and desist order that would prevent us from marketing and selling Jeuveau® inthe United States ; •the potential declaration of an event of default by Oxford in the event that ITC issues a final determination affirming the initial determination of the Administrative Law Judge and imposes an exclusion order preventing us from importing Jeuveau® intothe United States and a cease and desist order that would prevent us from selling Jeuveau® inthe United States , which would allow Oxford to exercise its remedies such as demanding immediate repayment of our debt plus all related final and prepayment fees or obtain control of our bank and investment accounts and take the amount owed; •the severity and duration of the COVID-19 outbreak; •the results of any other current and any future legal proceedings, including any potential remedies such as monetary damages or injunctive relief barring the importation, sales or marketing of Jeuveau®; •our ability to maintain compliance with the covenants in the Oxford credit facility and avoid an event of default so that our long-term debt with Oxford remains outstanding; •the number and characteristics of any future product candidates we develop or acquire; 46 -------------------------------------------------------------------------------- Table of Contents •the timing of any cash milestone payments to Daewoong if we successfully achieve certain predetermined milestones; •our ability to forecast demand for our products, scale our supply to meet that demand and manage working capital effectively •the cost of manufacturing our product or any future product candidates and any products we successfully commercialize, including costs associated with building our supply chain; •the cost of commercialization activities for Jeuveau® or any future product candidates are approved or cleared for sale, including marketing, sales and distribution costs; •the cost of maintaining a sales force, the productivity of that sales force, and the market acceptance of our products; •our ability to establish and maintain strategic collaborations, licensing or other arrangements and the financial terms of any such agreements that we may enter into; •any product liability or other lawsuits related to our products; •the expenses needed to attract and retain skilled personnel; •the costs associated with being a public company; •the costs involved in preparing, filing, prosecuting, maintaining, defending and enforcing patent claims, including ongoing litigation costs related to Jeuveau® and the outcome of this and any other future patent litigation we may be involved in; and •the timing, receipt and amount of sales of any future approved or cleared products, if any. Until such time, if ever, as we can generate substantial product revenue to cover our costs of operations, we expect to finance our cash needs by entering into licensing or collaboration agreements with partners, other debt or equity financings, or other sources of financing. Sufficient funds may not be available to us at all or on attractive terms when needed from these sources. To the extent that we raise additional capital through the future sale of equity, the ownership interests of our stockholders will be diluted, and the terms of these securities may include liquidation or other preferences that adversely affect the rights of our existing common stockholders. If we raise additional funds through the issuance of debt securities, these securities could contain covenants that would restrict our operations. We may require additional capital beyond our currently anticipated amounts. If we are unable to obtain additional funding from these or other sources when needed, or to the extent needed. we may need to significantly reduce our controllable and variable expenditures and current rate of spending through reductions in staff and delaying, scaling back, or suspending certain research and development, sales and marketing programs and other operational goals. These events may occur even if we are ultimately successful in the ITC action. Cash Flows The following table summarizes our cash flows for the periods indicated: Nine Months Ended September 30, (in millions) 2020 2019 Net cash (used in) provided by: Operating activities$ (55.6) $ (77.5) Investing activities (7.5) (37.4) Financing activities 38.3 60.8 Change in cash and cash equivalents (24.8) (54.1) Cash and cash equivalents, beginning of period 109.9 93.2 Cash and cash equivalents, end of period$ 85.1 $ 39.1 47
-------------------------------------------------------------------------------- Table of Contents Operating Activities Cash used in operating activities was$55.6 million for the nine months endedSeptember 30, 2020 compared to$77.5 million for the nine months endedSeptember 30, 2019 . The decrease in net cash used in operating activities reflects the decrease in net loss as well as timing of receipts from customers and payments to vendors in the ordinary course of business. For the nine months endedSeptember 30, 2020 , operating activities used$55.6 million of cash, which primarily resulted from our net loss of$52.3 million as adjusted for certain non-cash charges including$8.0 million of stock-based compensation expense, a gain of$9.9 million in revaluation of our contingent royalty obligation,$2.4 million of provision of allowance for doubtful accounts and$5.2 million of depreciation and amortization. Net operating assets and liabilities changed by$11.4 million primarily driven by timing of collections from customers and payments to vendors. For the nine months endedSeptember 30 2019 , operating activities used$77.5 million of cash, which primarily resulted from our net loss of$75.5 million as adjusted for certain non-cash charges including$7.0 million of stock-based compensation expense, a charge of$8.0 million in revaluation of our contingent royalty obligation, a gain of$14.9 million of deferred income tax provision and$2.7 million of depreciation and amortization. Net operating assets and liabilities changed by$6.0 million primarily driven by timing of collections from customers and payments to vendors. We expect our cash flows from operating activities to fluctuate as we experience extended customer collection cycles and execute operating expenses reduction efforts. Investing Activities Cash used in investing activities was$7.5 million for the nine months endedSeptember 30, 2020 compared to$37.4 million for the nine months endedSeptember 30, 2019 . The decrease in cash used in investing activities was attributable to a decrease in purchases of short-term investments net of maturities as well as lower additions to capitalized software for the nine months endedSeptember 30, 2020 . Financing Activities Cash used in financing activities was$38.3 million for the nine months endedSeptember 30, 2020 , compared to$60.8 million of cash provided by financing activities for the nine months endedSeptember 30, 2019 . Cash used in financing activities in the 2020 period primarily resulted from the proceeds of$40.0 million received from the Convertible Note inJuly 2020 as partially offset by payments of contingent royalty obligations to the Evolus Founders and debt obligations. Cash provided by financing activities for the 2019 period primarily resulted from the proceeds of$71.7 million received from our Oxford credit facility net of discounts and issuance costs, partially offset by a$9.3 million payment of contingent royalty obligations to the Evolus Founders and a$2.0 million payment to Daewoong upon FDA approval of Jeuveau® inFebruary 2019 . Indebtedness See "-Liquidity and Capital Resources" for a description of our credit facility with Oxford and convertible note with Daewoong. Off-Balance Sheet Arrangements We do not have any off-balance sheet arrangements as defined in the rules and regulations of theSEC . We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or for any other contractually narrow or limited purpose. Critical Accounting Policies Management's discussion and analysis of our financial condition and results of operations are based on our financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and related disclosure of contingent assets and liabilities, revenue and expenses at the date of the financial statements as well as the expenses 48
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Table of Contents incurred during the reporting period. Generally, we base our estimates on historical experience and on various other assumptions in accordance with GAAP that we believe to be reasonable under the circumstances. Actual results may differ materially from these estimates under different assumptions or conditions and such differences could be material to the financial position and results of operations. On an ongoing basis, we evaluate our judgments and estimates in light of changes in circumstances, facts and experience. InMay 2020 , we announced the launch of a consumer loyalty program, which allows participating customers to earn rewards for qualifying treatments to their patients (i.e. consumers) using Jeuveau® and redeem the rewards for Jeuveau® in the future at no additional cost. The loyalty program represents a customer option that provides a material right and, accordingly, is a performance obligation. At the time Jeuveau® product is sold to customers, the invoice price is allocated between the product sold and the estimated material right reward ("Reward") that the customer might redeem in the future. The standalone selling price of the Reward is measured based on historical sales data, average selling price of Jeuveau® at the time of redemption, expected customer and consumer participation rates in the loyalty program, and estimated number of qualifying treatments to be performed by customers. The portion of invoice price allocated to the Reward is initially recorded as deferred revenue. Subsequently, when customers redeem the Reward and the related product is delivered, the deferred revenue is reversed and included in net revenue. There have been no other material changes to our critical accounting policies and estimates as discussed in our Annual Report on Form 10-K filed for the year endedDecember 31, 2019 . Recently Issued and Adopted Accounting Pronouncements We describe the recently issued and adopted accounting pronouncements that apply to us in Note 2, Summary of Significant Accounting Policies-Recent Accounting Pronouncements.
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