SNNA Sienna Biopharmaceuticals Inc

PART I. FINANCIAL INFORMATION

See accompanying notes.

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Sienna Biopharmaceuticals, Inc.

(Debtor-In-Possession)

For periods subsequent to the Petition Date, the Company will apply the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 852, “Reorganizations”, in preparing its consolidated financial statements. ASC 852 requires that financial statements distinguish transactions and events that are directly associated with the reorganization from the ongoing operations of the business. Accordingly, certain revenues, expenses, realized gains and losses and provisions for losses that are realized or incurred in the bankruptcy proceedings have been recorded in Reorganization items in the unaudited condensed consolidated statement of operations. In addition, the unaudited condensed consolidated balance sheet has distinguished pre-petition liabilities subject to compromise from those that are not and post-petition liabilities. Obligations that may be impacted by the bankruptcy reorganization process have been classified as liabilities subject to compromise. These liabilities are reported at the amounts expected to be allowed by the Bankruptcy Court, even if they may be settled for lesser amounts. Where there is uncertainty about whether a secured claim will be paid or impaired pursuant to the Chapter 11 Proceeding, the Company has classified the entire amount of the claim as a liability subject to compromise.

Sale Process

The Company is pursuing a variety of strategic transactions, including potentially a sale of all or substantially all of its assets. In connection with the Chapter 11 Proceeding, on October 22, 2019, the Company filed a motion seeking authority from the Bankruptcy Court to sell up to substantially all of its assets and approval of procedures in connection therewith (the “Bidding Procedures and Sale Motion”). The Bankruptcy Court has scheduled hearings on the Bidding Procedures and Sale Motion for November 12, 2019 in connection with the approval of the bidding procedures and on December 10, 2019 in connection with the approval of any sale. If the Company is unable to find a viable strategic partner or is otherwise unable to consummate a strategic transaction, or confirm a Chapter 11 plan of reorganization or liquidation, it could be forced to liquidate under Chapter 7 of the Bankruptcy Code.

SVB Loan Agreement

The Company is party to the Loan and Security Agreement, dated as of June 29, 2018, as amended on January 28, 2019 (the “SVB Loan Agreement”), with Silicon Valley Bank (“SVB”). See Note 8 “SVB Loan Agreement”. The filing of the Chapter 11 Proceeding is an “Event of Default” under the SVB Loan Agreement. The occurrence of an Event of Default in connection with a voluntary bankruptcy proceeding under the SVB Loan Agreement automatically triggers the unpaid principal amount of all outstanding loans, all interest accrued and unpaid thereon and certain fees to become immediately due and payable, and SVB may seek relief from the Bankruptcy Court in connection with its rights.

On September 16, 2019, prior to filing the Chapter 11 Proceeding, and as a condition to SVB’s consent to the Company’s use of cash collateral to fund its operations during the Chapter 11 Proceeding, the Company made a payment to SVB in the amount of $21.3 million, which included $20.0 million of principal plus the 6.5% final payment fee of $1.3 million under the SVB Loan Agreement, and excluded the prepayment fee which SVB agreed to waive. The remaining aggregate principal balance outstanding under the SVB Loan Agreement is $10.0 million. See Note 8 “SVB Loan Agreement”.

Executive Compensation Plans

On September 11, 2019, the Board of Directors of the Company approved a management retention plan (the “MRP”) and key employee incentive bonus plan (the “KEIP”). The MRP and the KEIP are designed to retain senior executives through the completion of the Chapter 11 Proceeding and a potential asset sale and/or exit investment. The KEIP provides for a tiered one-time bonus for each of the Executive Officers in the event the Company consummates either (a) the sale of all or substantially all of its assets over a minimum aggregate level of proceeds (an “Asset Sale”) or (b) an exit investment in which a party sponsors a Chapter 11 reorganization and invests over a minimum level of funds in the Company (an “Exit Investment”), and such officer is employed by the Company on such date. Subject to the terms of the Bankruptcy Court’s order approving the KEIP, the amount of the one-time bonus ranges from 25% to 62.5% of such officer’s annual compensation in the event of an Asset Sale and, in the event of an Exit Investment, the Executive officers are entitled to a one-time bonus equal to 62.5% of such officer’s annual compensation; provided, that in the event of an Asset Sale or Exit Investment with proceeds to the Company greater than a specified level, such officers are eligible to receive a pro-rata portion of 2.5% of the proceeds above such level. The MRP provides for a retention bonus for each of the Executive Officers, the amount of which ranges from 33% to 50% of such officer’s annual compensation. The retention bonuses under the MRP are earned in four installments subject to the officer being employed with the Company on such date: 25% on September 13, 2019; 25% on the 45^th day following Petition Date, 25% on the 90^th day following the Petition Date; and 25% on the earlier of the closing of a sale of all or substantially all of the Company’s assets or the effective date of the Chapter 11 plan.

2. Liquidity Risks and Going Concern

The Company has experienced losses and negative cash flows for a number of years and continued to incur operating losses in the first nine months of 2019, and funded cash used in operating activities with cash from investing and financing activities. On September 16, 2019 the Company commenced the Chapter 11 Proceeding to provide for an orderly restructuring and sale process and pursue financial and strategic alternatives.

The filing of the Chapter 11 Proceeding raises substantial doubt about the Company’s ability to continue as a going concern. The accompanying unaudited condensed consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts, or amounts and classification of liabilities that might result from this uncertainty. The Company’s ability to continue as a going concern is contingent upon its ability to continue to manage and operate its business and assets as a debtor-in-possession under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of the Bankruptcy Code and the orders of the Bankruptcy Court, and to successfully develop and, subject to the Bankruptcy Court’s approval, implement a plan of reorganization or sale process, among other factors. In the event the Company sells all or substantially all of its assets in a sale process, or otherwise is unable to obtain funding for its continued operations, the Company may liquidate either under Chapter 11 or Chapter 7 of the Bankruptcy Code.

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Furthermore, the realization of assets and the satisfaction of liabilities are subject to uncertainty. While operating as debtor-in-possession under Chapter 11, the Debtor may sell or otherwise dispose of or liquidate assets or settle liabilities, subject to the approval of the Bankruptcy Court or as otherwise permitted in the ordinary course of business and subject to the applicable orders of the Bankruptcy Court, for amounts other than those reflected in the accompanying unaudited condensed consolidated financial statements. Any such actions occurring during the Chapter 11 Proceeding confirmed by the Bankruptcy Court could materially impact the amounts and classifications of assets and liabilities reported in the interim unaudited condensed consolidated financial statements.

3. Significant Accounting Policies

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States, or GAAP, and the applicable rules and regulations of the Securities and Exchange Commission, or the SEC, regarding interim financial reporting. As permitted under those rules, certain footnotes or other financial information that are normally required by GAAP have been condensed or omitted.

Going Concern

The accompanying unaudited condensed consolidated financial statements are prepared assuming the Company will continue as a going concern, which contemplates the realization of assets and liquidation of liabilities in the normal course of business.

Unaudited Condensed Consolidated Financial Statements

The accompanying financial information for the three and nine months ended September 30, 2019 and 2018 are unaudited. The unaudited condensed consolidated financial statements have been prepared on the same basis as the annual audited consolidated financial statements and, in the opinion of management, reflect all adjustments, which include only normal recurring adjustments, necessary to present fairly the Company’s financial position as of September 30, 2019 and its results of operations for the three and nine months ended September 30, 2019 and 2018 and cash flows for the nine months ended September 30, 2019 and 2018. The results for interim periods are not necessarily indicative of the results expected for the full fiscal year or any other period(s).

Principles of Consolidation

The unaudited condensed consolidated financial statements include the accounts of Sienna Biopharmaceuticals, Inc. and results of its wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated. For the three and nine months ended September 30, 2019 and 2018, the subsidiaries’ net loss included in the Company’s consolidated statement of operations was $19.0 million and $19.7 million, and $0.5 million and $2.9 million, respectively.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts and disclosures reported in the condensed consolidated financial statements and accompanying notes. Actual results could differ materially from those estimates. Management considers many factors in selecting appropriate financial accounting policies and controls, and in developing the estimates and assumptions that are used in the preparation of these consolidated financial statements. Management must apply significant judgment in this process. In addition, other factors may affect estimates, including expected business and operational changes, sensitivity and volatility associated with the assumptions used in developing estimates and whether historical trends are expected to be representative of future trends. The estimation process often may yield a range of potentially reasonable estimates of the ultimate future outcomes and management must select an amount that falls within that range of reasonable estimates. The most significant estimates in the Company’s consolidated financial statements relate to equity awards, warrants, clinical trial accruals and the valuation of contingent consideration obligations and the impairment assessment of the in-process research and development and goodwill incurred in connection with the acquisition of Creabilis plc, or Creabilis. Although these estimates are based on the Company’s knowledge of current events and actions it may undertake in the future, actual results may ultimately materially differ from these estimates and assumptions.

Segment Reporting

Operating segments are identified as components of an enterprise about which separate discrete financial information is available for evaluation by the chief operating decision-maker in making decisions regarding resource allocation and assessing performance. The Company views its operations and manages its business in one operating segment and one reportable segment, primarily in the United States.

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Reclassifications

Certain reclassifications have been made to prior year amounts to conform to the current year presentation. The reclassifications were not material to the unaudited condensed consolidated financial statements.

Cash and Cash Equivalents

The Company’s investment policy limits investments to certain types of instruments such as certificates of deposit, money market instruments, and obligations issued by U.S. government and U.S. government agencies, and places restrictions on maturities and concentration by type and issuer. The Company considers all highly liquid securities with original final maturities of three months or less from the date of purchase to be cash equivalents. As of September 30, 2019, cash and cash equivalents are comprised of funds in cash and U.S. Treasury money market funds. From time to time, the Company maintains cash balances in excess of amounts insured by the Federal Deposit Insurance Corporation. The accounts are monitored by management to mitigate the risk.

Restricted Cash

The Company classifies cash balances that are legally restricted pursuant to contractual arrangements as restricted cash. At September 30, 2019 and December 31, 2018, the Company held $0.2 million and $0.2 million of restricted cash related to cash collateralized standby letters of credit in connection with obligations under the facility lease and secured collateral for its corporate credit cards.

Fair Value Measurements

The Company’s financial instruments, in addition to those presented in Note 7, “Fair Value Measurements”, include restricted cash, accounts payable, accrued liabilities and the SVB Loan Agreement financing. The carrying amount of restricted cash, accounts payable and accrued liabilities approximate fair value because of the short-term nature of these instruments. Further, due to the short term maturity of the SVB Loan Agreement, the Company believes the carrying amount of the loan approximates its fair value. At September 30, 2019, the carrying amount of the loan is included in liabilities subject to compromise in the condensed consolidated balance sheet.

Property and Equipment

Property and equipment are stated at cost less accumulated depreciation. Depreciation on property and equipment is calculated using the straight-line method over the estimated useful lives of the assets which range from three to five years. Maintenance and repairs are expensed as incurred. The Company reviews the carrying values of its property and equipment for possible impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. There were no material impairments recognized during the nine months ended September 30, 2019 and the year ended December 31, 2018.

In-process Research and Development and Goodwill

Intangible assets acquired in a business combination are recognized separately from goodwill and are initially recognized at their fair value at the acquisition date (which is regarded as their cost). Intangible assets related to acquired in-process research and development are treated as indefinite lived intangible assets and are not amortized until they become definite lived assets upon regulatory approval. At that time, the Company will determine the useful life of the asset and begin amortization. Indefinite lived intangible assets are reviewed for impairment at least annually or if indicators of potential impairment exist. To the extent such assets are foreign denominated, they are subject to translation.

Goodwill represents the excess of the purchase price over the estimated fair value of the identifiable assets acquired and liabilities assumed in a business combination. The Company evaluates goodwill for impairment annually and upon the occurrence of triggering events or substantive changes in circumstances that could indicate a potential impairment. An impairment loss is recognized when the fair value of the reporting unit to which the goodwill relates is below its carrying value.

Research and Development Costs

Research and development costs are expensed as incurred. These costs include direct program expenses, which are payments made to third parties that specifically relate to the Company’s research and development, such as payments to clinical research organizations, clinical investigators, manufacturing of clinical material, pre-clinical testing and consultants. In addition, employee costs (salaries, payroll taxes, benefits, stock-based compensation and travel) for employees contributing to research and development activities are classified as research and development costs.

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Stock-Based Compensation

The Company measures employee and director stock-based compensation expense for all stock-based awards at the grant date based on the fair value measurement of the award. The expense is recorded on a straight-line basis over the requisite service period, which is generally the vesting period, for the entire award. Expense is adjusted for actual forfeitures of unvested awards as they occur. The Company calculates the fair value measurement of stock options using the Black-Scholes valuation model. Prior to the adoption of a new accounting pronouncement on January 1, 2019 related to share-based payments issued to non-employees for goods or services, stock options issued to non-employees were valued on their grant date and remeasured at the current fair value at the end of each reporting period until they vested. Under the new guidance, the measurement of equity-classified non-employee awards is fixed at the grant date, and no longer remeasured. The Company estimates the fair value of restricted stock unit awards based on the closing price of the Company’s common stock on the date of issuance. Proceeds from options exercised by employees prior to vesting pursuant to an early exercise provision, the related shares of which the Company has the option to repurchase prior to the vesting date should employment of the early exercise holder be terminated, are recognized as a liability until the shares vest.

Clinical Trial Accruals

As part of the process of preparing its consolidated financial statements, the Company is required to estimate its expenses resulting from its obligations under contracts with vendors and consultants and clinical site agreements in connection with conducting clinical trials. The financial terms of these contracts are subject to negotiations which vary from contract to contract and may result in payment flows that do not match the periods over which materials or services are provided to the Company under such contracts. The Company’s objective is to reflect the appropriate trial expenses in its consolidated financial statements by matching those expenses with the period in which services and efforts are expended. The Company accounts for these expenses according to the progress of the trial as measured by patient progression and the timing of various aspects of the trial. The Company determines accrual estimates through financial models taking into account discussion with applicable personnel and outside service providers as to the progress or state of consummation of trials, or the services completed. During the course of a clinical trial, the Company adjusts its rate of clinical expense recognition if actual results differ from its estimates. The Company makes estimates of its accrued expenses as of each balance sheet date in its consolidated financial statements based on the facts and circumstances known at that time. Although the Company does not expect its estimates to be materially different from amounts actually incurred, its understanding of the status and timing of services performed relative to the actual status and timing of services performed may vary and may result in the Company reporting amounts that are too high or too low for any particular period. Through September 30, 2019, there have been no material adjustments to the Company’s prior period estimates of accrued expenses for clinical trials. The Company’s clinical trial accrual is dependent in part upon the timely and accurate reporting of contract research organizations and other third-party vendors.

Other accrued expenses include accrued clinical trial costs of $0.6 million and $2.3 million as of September 30, 2019 and December 31, 2018, respectively. Prepaid clinical trial expenses were immaterial as of September 30, 2019 and December 31, 2018.

Basic and Diluted Net Loss Per Common Share

Basic net loss per common share is computed by dividing the net loss by the weighted average number of shares of common stock outstanding during the period, excluding the effects of converting warrants, stock options and unvested restricted stock outstanding. Diluted net loss per common share is computed by dividing the net loss by the sum of the weighted average number of shares of common stock outstanding during the period plus the potential dilutive effects of warrants, stock options and unvested restricted stock outstanding during the period calculated in accordance with the treasury stock method but are excluded if their impact is anti-dilutive. Because the impact of these items is anti-dilutive during periods of net loss, there was no difference between the weighted average number of shares used to calculate basic and diluted net loss per common share for the three and nine months ended September 30, 2019 and 2018. Shares excluded from the calculation were 3.5 million and 2.6 million at September 30, 2019 and 2018, respectively.

Income Taxes

The Company uses the asset and liability method of accounting for income taxes. Under this method, deferred taxes are recognized based on the differences between financial statement and income tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized. The Company has provided a full valuation allowance on its deferred tax assets. The provision for income taxes represents the current tax payable for the period and the change during the period in deferred tax assets and liabilities. The Company recognizes the effect of an income tax position only if, based on its merits, the position is more likely than not to be sustained on audit by the taxing authorities. Interest and penalties related to uncertain tax positions are recorded as income tax expense.

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Other Comprehensive Income (Loss)

Included in other comprehensive income (loss) for the three and nine months ended September 30, 2019 and 2018 are unrealized foreign currency translation losses of $1.4 million and $1.9 million, and $0.4 million and $1.5 million, respectively. This is the Company’s only component of other comprehensive income (loss) for the three and nine months ended September 30, 2019 and 2018.

Foreign currency translation

The net assets of international subsidiaries where the local currencies have been determined to be the functional currencies are translated into U.S. dollars using current exchange rates. These include the entities acquired as part of the Creabilis acquisition. As part of this transaction, the Company acquired entities in the United Kingdom, denominated in British pounds, and Italy and Luxembourg, denominated in euros. The U.S. dollar effects that arise from translating net assets of these subsidiaries at changing rates are recognized in other comprehensive income (loss) in the condensed consolidated balance sheet. The earnings or loss of these subsidiaries are translated into U.S. dollars using average exchange rates for the periods.

Recently Issued Accounting Standards

Accounting Pronouncements Adopted

In February 2016, the FASB issued ASU No. 2016-02, Leases (ASC 842), which requires lessees to recognize most leases on the balance sheet. Lessees and lessors are required to apply the new standard at the beginning of the earliest period presented in the financial statements in which they first apply the new guidance, using a modified retrospective approach to adoption. The primary effect of adoption is the requirement to record right-of-use assets and corresponding lease obligations for current operating leases. The requirements of this standard generally include a significant increase in required disclosures.

The FASB subsequently issued the following amendments to ASU 2016-02, which have the same effective date and transition date of January 1, 2019:

On January 1, 2019, the Company adopted ASC 842, which resulted in the recognition of right-of-use assets of approximately $0.8 million and related lease liabilities on the consolidated balance sheets of approximately $1.0 million related to its operating lease commitments, with no material impact to the opening balance of retained earnings. The Company adopted the new leasing standards using the modified retrospective transition approach, applying to leases existing as of, or entered into after, January 1, 2019. Prior periods were not adjusted. The new standard provides a number of optional practical expedients in transition. The Company has elected the package of practical expedients to not reassess prior conclusions about lease identification under the new standard, lease classification, and initial direct costs. The Company also elected the practical expedient allowing the use of hindsight in determining the lease term and assessing impairment of right-of-use assets based on all facts and circumstances through the effective date of the new standard. The new standard also provides practical expedients for ongoing lease accounting, including electing the recognition exemption for short-term leases for all leases that qualify. Under this exemption, the Company did not recognize right-of-use, assets or lease liabilities for those leases that qualify as a short-term lease (leases with lease terms of 12 months or less), which includes not recognizing right-of-use assets or lease liabilities for existing short-term leases in transition. The Company also elected the practical expedient to not separate lease and non-lease components for all leases.

In June 2018 the FASB issued ASU 2018-07, “Compensation —Stock Compensation (Topic 718) —Improvements to Nonemployee Share-Based Payment Accounting” (“ASU 2018-07”), which expands the scope of Topic 718, Compensation—Stock Compensation (which currently only includes share-based payments to employees) to include share-based payments issued to nonemployees for goods or services. Consequently, the accounting for share-based payments to nonemployees and employees will be substantially aligned. ASU 2018-07 supersedes Subtopic 505-50, Equity—Equity-Based Payments to Non-Employees. The amendments in ASU 2018-07 are effective for public companies for fiscal years beginning after December 15, 2018, including interim periods within that fiscal year. The Company adopted this standard on January 1, 2019 with no impact on the consolidated financial statements.

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In February 2018, the FASB issued ASU 2018-02, “Income Statement—Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income”, which provides the option to reclassify stranded tax effects within accumulated other comprehensive income to retained earnings in each period in which the effect of the change in the U.S. federal corporate income tax rate in the Tax Cuts and Jobs Act (or portion thereof) is recorded. The Company adopted this standard on January 1, 2019 with no impact on the consolidated financial statements.

Accounting Pronouncements Not Yet Adopted

In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement. This new standard modifies certain disclosure requirements on fair value measurements. This new standard will be effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. The Company does not expect the adoption of this new standard to have a significant impact on its disclosures.

4. Contingent Consideration

In December 2016, the Company entered into a Share Purchase Agreement (the “Purchase Agreement”) to acquire the entire issued share capital of Creabilis. Pursuant to the acquisition of Creabilis, the Company obtained SNA-120, SNA-125 and the related intellectual property. SNA-120 is a first-in-class inhibitor of Tropomyosin receptor kinase A (TrkA) for the treatment of psoriasis, as well as the associated pruritus. SNA-125 is a topical dual Janus kinase 3 (JAK3)/TrkA inhibitor being developed for the treatment of various inflammatory conditions, including atopic dermatitis, psoriasis and the associated pruritus.

Upon closing, Creabilis became a direct wholly-owned subsidiary. As part of the terms of the acquisition, the Company agreed to make contingent payments up to an aggregate of $58.0 million in a combination of cash and stock upon the achievement of certain development and approval milestones, of which $5.0 million has been previously satisfied. Pursuant to the Purchase Agreement, upon the Company’s commencement of the first Phase 3 clinical trial of SNA-120, the Company will become obligated to issue $18.0 million in shares of common stock, less certain offsets if applicable, to the former Creabilis shareholders. In addition, under the Purchase Agreement, the Company is obligated to make certain contingent payments up to an aggregate of $80.0 million in cash upon the achievement of certain annual net sales thresholds and one-time royalties of less than 1% of the amount by which annual net sales exceeds each threshold in the year such threshold is achieved.

The agreement to pay the future milestones and potential one-time royalties resulted in the recognition of a contingent consideration liability, which was recognized at the inception of the transaction. Other than these payments, subsequent changes to the estimated amounts of contingent consideration to be paid are recognized in the consolidated statement of operations in general and administrative expense. While operating as a debtor-in-possession, certain claims against the Company in existence before the Petition Date are stayed while the Company continues business operations as a debtor-in-possession. Additional claims may subsequently arise for contingencies and other disputed amounts. The satisfaction of liabilities and contingent claims following the Petition Date are subject to uncertainty and claims against the Company may be subject to disallowance or discharge under applicable provisions of the Bankruptcy Code. The fair value of the contingent consideration is determined using preliminary cash flow projections, based on estimated timing and probabilities around the achievement of certain development, approval and sales milestones, expected product sales and other assumptions. Given the uncertainties regarding the achievement of those milestones, cash flows and the likelihood of payment of the contingent claims as a result of, among other factors, the Company’s filing under Chapter 11, the fair value of the contingent consideration at September 30, 2019 was determined to be $0. At December 31, 2018 the fair value was $29.2 million. The fair value of the contingent consideration at year end was determined with assistance from a third-party valuation firm applying the income approach, using several significant unobservable inputs as discussed in Note 7, “Fair Value Measurements”. These inputs are considered Level 3 inputs under the fair value measurements and disclosure guidance.

5. Identifiable Intangible Assets and Goodwill

In-Process Research and Development

The Company’s identifiable intangible assets were in-process research and development related to SNA-120 and SNA-125, which were recorded at an initial value of $42.3 million as a result of the Company’s acquisition of Creabilis. The Company used the income approach to determine the fair value of the in-process research and development assets. This approach calculated fair value by estimating future cash flows attributable to the assets using several unobservable inputs, such as future revenues and expenses, time and resources needed to complete development and probabilities of obtaining market approval, and then discounting these cash flows to a present value using a risk-adjusted discount rate commensurate with the Company’s cost of capital and expectation of the revenue growth for products at their life cycle stage. These inputs are considered Level 3 inputs under the fair value measurements and disclosure guidance. See Note 7, “Fair Value Measurements”.

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Identifiable intangible assets are initially measured at their respective fair values and will not be amortized until commercialization. If commercialization occurs, intangible assets will be amortized over their estimated useful lives. In-process research and development assets were initially recognized at their fair value as determined on the date of acquisition of December 6, 2016 and are reviewed for impairment at least annually or whenever changes in circumstances indicate a potential impairment, or upon regulatory approval resulting in the reclassification to a finite-lived intangible asset. See Note 1, “Organization and Description of Business”. The filing under Chapter 11 was an indicator that there might be a deterioration of the underlying assumptions, such as the risk-adjusted discount rate, used to determine the fair value of the IPR&D. In accordance with accounting standards governing the impairment or disposal of indefinite lived intangible assets, the Company performed an impairment test of its in-process research and development assets due to events and changes in circumstances during the three-month period ended September 30, 2019, that indicated an impairment might have occurred. As a result of impairment testing, the Company recorded impairment charges of $20.0 million for the three and nine-months ended September 30, 2019, which were recorded in the condensed consolidated statement of operations. See Note 7, “Fair Value Measurements”.

No impairment was recognized as of December 31, 2018. Changes in value as a result of translation adjustments for foreign denominated identifiable intangible assets are included in other comprehensive income in the consolidated balance sheets.

Goodwill

The recent decline in the Company’s market capitalization was determined to be a triggering event for potential goodwill impairment and accordingly, the Company performed the goodwill impairment analysis for the third quarter ended September 30, 2019. In determining the fair value utilized in the goodwill impairment assessment, the Company considers qualitative factors such as changes in strategy, cash flows, the regulatory environment, overall market conditions, as well as the market capitalization of the Company’s publicly traded common stock. The Company operates as a single reporting unit and estimates the fair value of its single reporting unit using the Company’s market capitalization plus an estimated control premium. Market capitalization is determined by multiplying the shares outstanding on the assessment date by the market price of the Company’s common stock. As a result of the impairment assessment during the three months ended September 30, 2019, the Company recorded an impairment charge to write off the entire balance of the goodwill of $10.7 million. The impairment charge was recorded in the consolidated statement of operations and comprehensive loss. There was no impairment of goodwill for the year ended December 31, 2018.

6. Property and Equipment

Property and equipment consisted of the following as of September 30, 2019 and December 31, 2018 (in thousands):

Leasehold improvements are depreciated over the shorter of the lease term or the estimated useful life of the related asset. Depreciation expense was $35,000 and $0.1 million for the three and nine months ended September 30, 2019, and $39,000 and $0.1 million for the three and nine months ended September 30, 2018, respectively.

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7. Fair Value Measurements

The Company determines the fair value of financial and nonfinancial assets and liabilities using the fair value hierarchy, which describes three levels of inputs that may be used to measure fair value, as follows:

Level 1—Quoted prices in active markets for identical assets or liabilities;

Level 2—Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities, quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. These inputs either represent quoted prices for similar assets in active markets or have been derived from observable market data; and

Level 3—Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. These inputs reflect the Company’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities based on the best information available in the circumstances.

In certain cases where there is limited activity or less transparency around inputs to valuation, assets are classified as Level 3 within the valuation hierarchy.

The following tables set forth the fair value of the Company’s financial assets and liabilities measured at fair value on a recurring basis based on the three-tier fair value hierarchy as of September 30, 2019 and December 31, 2018 (in thousands):

The following table sets forth a summary of the changes in the fair value of the Company’s Level 3 financial liabilities (in thousands):

Cash equivalents

At September 30, 2019, the Company’s cash equivalents are comprised of U.S. Treasury money market funds whose value is based upon quoted market prices in active markets for identical assets or liabilities with no adjustments applied. Accordingly, these investments are classified as Level 1 of the fair value measurements and disclosure guidance.

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Intangible assets

In connection with the acquisition of Creabilis, the Company acquired intangible in-process research and development assets which were recorded at fair value based on significant unobservable (Level 3) inputs. The fair value of in-process research and development (“IPR&D”) assets was determined with assistance from an independent third-party valuation firm applying the income approach. This approach calculates fair value by estimating future cash flows attributable to the IPR&D assets using several significant unobservable inputs, including a risk adjusted discount rate commensurate with the perceived risk of the IPR&D assets of 20.5%, projected future revenues and expenses based on the cumulative probabilities of multiple scenarios with individual probabilities ranging from 0.1% to 22.5%, and estimates of the timing of the achievement of the various product development, regulatory approval and sales milestones. These intangible assets are not measured at fair value on a recurring basis but are subject to fair value measurement as part of the related impairment test.

As discussed in Note 5, “Identifiable Intangible Assets and Goodwill”, we performed an impairment test of our intangible assets during the three-month period ended September 30, 2019. The fair value of IPR&D assets was determined with assistance from an independent third-party valuation firm applying the income approach using several significant unobservable inputs, including a risk adjusted discount rate commensurate with the perceived risk of the IPR&D assets of 39.6%, projected future revenues and expenses based on the cumulative probabilities of successful achievement, ranging from 11% to 54%.

Warrants

In January 2019, in connection with the amendment to the SVB Loan Agreement, the Company issued warrants to purchase shares of the Company’s common stock. Based upon the characteristics and provisions of the warrants, they were classified as equity and recorded at their fair value as of the date of issuance. The estimated fair value of the warrants was calculated using the Black-Scholes option-pricing model, using a term of 10 years, an estimated volatility of 78.02%, a risk-free interest rate of 2.75% and an expected dividend yield of 0%. The warrants are not measured at fair value on a recurring basis.

Contingent consideration

In connection with the acquisition of Creabilis, the Company agreed to pay additional amounts based on the achievement of certain development, approval and sales milestones. The valuation of contingent consideration uses assumptions the Company believes would be made by a market participant. The Company assesses these estimates on an on-going basis as additional data impacting the assumptions is obtained. Contingent consideration may change significantly as development progresses and additional data is obtained, impacting the Company’s assumptions regarding probabilities of successful achievement of related milestones used to estimate the fair value of the liability and the timing in which they are expected to be achieved. In evaluating the fair value information, judgment is required to interpret the market data used to develop the estimates. The estimates of fair value may not be indicative of the amounts that could be realized in a current market exchange. Accordingly, the use of different market assumptions and/or different valuation techniques could result in materially different fair value estimates.

The fair value of the contingent consideration was determined with assistance from an independent third-party valuation firm applying the income approach. This approach calculated fair value by estimating future cash flows attributable to the related IPR&D assets using several significant unobservable inputs, including risk adjusted discount rates and estimates of the probabilities and timing of the achievement of the various product development, regulatory approval and sales milestones. Significant increases or decreases in any of the probabilities of success and other inputs, such as the timing of achievement of any of the milestones, would result in a significantly higher or lower fair value measurement, respectively. Changes in the fair values of the contingent consideration obligations are recorded in general and administrative expense in the condensed consolidated statement of operations.

The change in value during the three and nine months ended September 30, 2019 was a decrease of $33.5 million and $29.2 million, respectively. These changes were related to the uncertainties regarding the achievement of milestones, cash flows and the likelihood of payment of the contingent claims as a result of, among other factors, the Company’s filling under Chapter 11. The change in value during the three and nine months ended September 30, 2018 was a decrease of $0.7 million and an increase of $1.6 million, respectively. The changes were primarily related to the passage of time, changes in probabilities of success, and progress toward milestone dates as well as changes in external market factors.

There were no transfers of assets or liabilities between the fair value measurement levels during the nine months ended September 30, 2019 or the year ended December 31, 2018.

8. SVB Loan Agreement

On June 29, 2018 the Company entered into the Loan and Security Agreement with SVB. Under the SVB Loan and Security Agreement, SVB initially provided the Company with access to term loans in an aggregate principal amount of up to $40.0 million. The first credit extension, of a principal amount of $30.0 million, was funded on June 29, 2018, and is repayable in monthly installments until July 1, 2023, including an initial interest-only period through July 31, 2020. On January 28, 2019, the Company entered into an amendment to the loan and security agreement (as amended, the “SVB Loan Agreement”). Under the amended SVB Loan Agreement, the Company’s total access to term loans was $30.0 million. The outstanding principal balance may be prepaid in whole but not in part, subject to a prepayment fee ranging from 1.0% to 2.0% of any amount prepaid, depending upon when the prepayment occurs. The terms also included a final payment fee equal to 6.50% of the total term loans advanced, due upon the earliest of maturity, acceleration, prepayment or termination of the SVB Loan Agreement.

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On September 16, 2019, prior to filing the Chapter 11 Proceeding, and as a condition to SVB’s consent to the Company’s use of cash collateral to fund its operations during the Chapter 11 Proceeding, the Company made a payment to SVB in the amount of $21.3 million, which included $20.0 million of principal plus the 6.5% final payment fee of $1.3 million under the SVB Loan Agreement, and excluded the applicable prepayment fee which SVB agreed to waive. The final fee payment was being recognized over the life of the term loan through interest expense using the effective interest method, and to the extent it was unamortized, was recognized as interest expense in the condensed consolidated statement of operations. The remaining aggregate principal balance outstanding under the SVB Loan Agreement is $10.0 million.

Under the terms of the SVB Loan Agreement, the Company granted first priority liens and security interests in substantially all of the Company’s assets (excluding all of its intellectual property, which is subject to a negative pledge) and a pledge of the shares of one of its wholly-owned subsidiaries as collateral for the obligations thereunder. The SVB Loan Agreement also contains representations and warranties by the Company and SVB and indemnification provisions in favor of SVB and customary covenants (including limitations on other indebtedness, liens, acquisitions, and investments and dividends), and events of default (including payment defaults, breaches of covenants following any applicable cure period, a material impairment in the perfection or priority of SVB’s security interest in the collateral, and events relating to bankruptcy or insolvency).

As noted herein, the Company’s secured lender, SVB, has consented to the use of cash collateral in the Chapter 11 Proceeding in accordance with applicable orders of the Bankruptcy Court. Under the Bankruptcy Court’s orders authorizing use of SVB’s cash collateral, among other rights and protections, SVB has also been granted certain adequate protection super-priority claims and liens on substantially all of the Company’s assets, including the Company’s intellectual property. Further, the Bankruptcy Court’s orders authorizing use of cash collateral include various sale and Chapter 11 plan related milestones, which include, among other things, that in connection with a sale, a sale of all or substantially all assets must be approved on or before December 10, 2019 and such a transaction is required to close on or before December 13, 2019. These milestones may be modified with the consent of SVB or further order of the Bankruptcy Court, but failure to meet the applicable milestones (among other things) could result in termination of the Company’s ability to use cash collateral.

The filing of the Chapter 11 Proceeding is an “Event of Default” under the SVB Loan Agreement. The occurrence of an Event of Default in connection with a voluntary bankruptcy proceeding under the SVB Loan Agreement automatically triggers the unpaid principal amount of all outstanding loans, all interest accrued and unpaid thereon and certain fees to become immediately due and payable, and SVB may seek relief from the Bankruptcy Court in connection with its rights. Immediately upon the occurrence and during the continuance of an Event of Default, the SVB Loan Agreement provides that the term loan shall bear interest at a rate per annum which is 3.00% above the rate that is otherwise applicable.

As of September 30, 2019, the Company wrote off $1.6 million of prior debt issuance costs including the unamortized portion of debt discount related to warrants issued in connection with prior amendment to the SVB Loan Agreement. The write-offs are included within reorganization items in the condensed consolidated statements of operations. See Note 14 “Liabilities Subject to Compromise” for further details.

Interest expense relating to the term loan for the three and nine months ended September 30, 2019 was $0.9 million and $2.5 million, respectively. Interest expense relating to the term loan for the three and nine months ended September 30, 2018 was $0.7 million. Interest expense is calculated using the effective interest method, and was inclusive of non-cash amortization of capitalized loan costs for periods prior to the Chapter 11 filing. At September 30, 2019, the effective interest rate was 37.46%.

Future principal payments for the SVB loan agreement are as follows (in thousands):

9. Commitments and Contingencies

Operating Lease

In May 2016, the Company entered into a 40-month operating lease obligation for office space in Westlake Village, California (“Suite 140”), which commenced on October 10, 2016, and terminates on February 29, 2020. The lease contains a renewal option for an additional three-year term. At January 1, 2019, it was reasonably certain that the Company would exercise the renewal option on Suite 140. The Company recorded a $36,000 adjustment to the opening balance of accumulated deficit, upon adopting ASU 2016-02, to recognize the cumulative effect of the updated lease term on previously recorded straight-line rent expense.

In June 2017, the Company amended the lease agreement to include an additional 5,973 square feet (“Suite 215”) and an allowance for leasehold improvements of up to $0.1 million. In March 2019, the Company subleased Suite 215 and received an upfront payment of $0.1 million for rental income on the sublease. The lease and sublease terminate concurrently on February 29, 2020. The Company does not plan on exercising a renewal option for Suite 215.

On January 1, 2019, the Company adopted ASC 842, which resulted in the recognition of right-of-use (“ROU”) assets of approximately $0.8 million and related lease liabilities in the consolidated balance sheets of approximately $1.0 million related to its operating lease commitments. ROU assets represent the Company’s right to control an underlying asset for the lease term and lease

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liabilities represent the Company’s obligation to make lease payments arising from the lease. ROU assets and liabilities are recognized at the commencement date based on the present value of lease payments over the lease term. As most of its leases do not provide an implicit rate, the Company used its incremental borrowing rate based on the information available at the commencement date in determining the discount rate used to present value the lease payments.

In March 2019, in connection with the sublease of Suite 215, the Company evaluated the ROU asset for impairment. Because the lease payments for Suite 215 exceeded the sublease income over the remaining lease term, the Company recorded an impairment charge of $13,000 to write-down the ROU asset to the fair value of the sublease income over the remaining term.

When the Company commenced the Chapter 11 Proceeding on September 16, 2019, it concluded that it was no longer reasonably certain that it would exercise the three-year renewal option on Suite 140. At September 30, 2019, the Company remeasured the lease liability and related ROU asset, recording a reduction to each of $0.6 million to reflect the shortened lease term. The discount rate used to present value the lease payments was not material given the short term nature of the lease obligation and cash collateralized standby letters of credit in connection with the lease obligations.

As of September 30, 2019 the balance of the ROU asset was $0.1 million and the balance of the lease liability was $0.2 million, all of which is considered short-term and is included in other accrued expenses. Also included in other accrued expenses is a prepaid rent liability of $45,000 for the upfront payment received in connection with the sublease of Suite 215.

Total operating lease expense for the three and nine months ended September 30, 2019 was $0.1 million and $0.3 million, respectively. Total sublease income for the three and nine months ended September 30, 2019 was $27,000 and $63,000, respectively.

Supplemental cash flow information for the nine months ended September 30, 2019 related to operating leases is as follows (in thousands):

As of September 30, 2019, the maturities of the Company’s operating lease liabilities are as follows (in thousands):

As of September 30, 2019, the weighted average remaining lease term for the company’s operating leases was 0.4 years.

License and Supply Agreement

The Company has an amended and restated exclusive license agreement with nanoComposix, pursuant to which the Company owes minimum annual royalties of $50,000 or low single digit royalties on net sales of licensed products.

Success Payment Liability

In October 2015, the Company entered into a letter agreement with certain stockholders pursuant to which the Company agreed to make success payments to such stockholders. The agreement ends on its fifth anniversary in October 2020. Success payments are payable in cash or common stock at the Company’s sole discretion and will be owed in the event that the value of its common stock meets or exceeds certain specified share price thresholds on certain specified dates during the success payment period. Each success payment and the associated share price threshold is ascending from $10.0 million payable at a share price threshold of $53.71 per share to $35.0 million payable at $71.61 per share and with a maximum payment of $60.0 million at a share price threshold of $107.42 per share. Each success payment is inclusive of any preceding payments, if previously made, such that the success payments to stockholders will not exceed $60.0 million in the aggregate.

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Upon their issuance, the success payments did not require any future service to be provided by the recipients and as such, the success payments were accounted for under accounting guidance for derivatives and hedging. Accordingly, the Company recorded an initial liability at fair value and remeasured the liability each reporting period, with changes being recognized in the consolidated statement of operations in other income and expense. The fair value of the success payments liability was estimated based on a third-party valuation using a model which simulates the future movement of stock prices based on several key variables. As of September 30, 2019 and December 31, 2018, the success payment liability was immaterial. During the three and nine months ended September 30, 2018, the Company recorded other income of $0.2 million and $2.6 million, respectively, due to remeasurement of the liability.

Indemnifications

The Company has indemnification obligations to its directors and executive officers for specified events or occurrences, subject to certain limits, while the directors and executive officers are serving at the Company’s request in such capacities. There have been no claims to date and the Company did not accrue any liabilities related to these agreements as of September 30, 2019 and December 31, 2018.

Contingencies

From time to time, the Company may be subject to various litigation and related matters arising in the ordinary course of business, including those set forth in Part II, Item 1 “Legal Proceedings”. As of September 30, 2019, there are no matters where there is at least a reasonable possibility that a material loss has been or will be incurred.

10. Related Party Transactions

Venvest Biotech, LLC

Dr. Beddingfield, the Company’s President and Chief Executive Officer and a member of the Company’s board of directors, is an advisor to Venvest Biotech, LLC, or Venvest, and is considered a non-managing member of Venvest. Dr. Beddingfield has an economic interest in any gain associated with the shares of the Company’s capital stock purchased by Venvest in the Company’s Series A-3 and Series B Preferred Stock financings. On May 17, 2018, Dr. Beddingfield acquired 47,594 shares pursuant to a mandatory distribution from Venvest, resulting from the economic gain associated with those shares. Dr. Beddingfield has resigned from his advisory role, is no longer a member of Venvest, and has no management or voting rights in respect of Venvest.

Stock Purchase Rights

In January 2016, in connection with his commencement of employment with the Company, the Company’s board of directors granted Dr. Beddingfield, the Company’s President and Chief Executive Officer, the right to purchase 553,652 shares of the Company’s common stock for a purchase price of $2.35 per share, which the board of directors determined was the fair market value on the date of grant. With respect to 454,912 shares subject to the stock purchase right, 25% of the shares vest on the first anniversary of the grant, and 1/48th of the shares vest monthly thereafter, subject to Dr. Beddingfield continuing to provide services to the Company through each such vesting date. With respect to 49,370 shares subject to the stock purchase right, 50% of the shares vest on the first date the volume-weighted average trading price of the Company’s common stock equals or exceeds $71.03 per share, and 1/24th of the shares vest monthly thereafter, subject to Dr. Beddingfield continuing to provide services to the Company through each such vesting date. With respect to the remaining 49,370 shares subject to the stock purchase right, 50% of the shares vest upon achievement of a milestone related to clinical development, and 1/24th of the shares vest monthly thereafter, subject to Dr. Beddingfield continuing to provide services to the Company through each such vesting date. On December 3, 2018, 50% of these shares vested as a result of achieving the clinical development milestone relating to the top-line results from the Phase 2b study of SNA-120 for the treatment of itch and psoriasis. The Company determined that the stock purchase rights effectively represented an option and the fair value of the option was $1.3 million which is being amortized as compensation expense over the performance period of the award with $0.1 million and $0.3 million recognized as compensation expense for the three and nine months ended September 30, 2019, respectively and $0.2 million and $0.4 million recognized as compensation expense for the three and nine months ended September 30, 2018, respectively.

In May 2016, Dr. Beddingfield exercised his stock purchase rights in full and purchased restricted stock that vests on the same schedule as the stock purchase rights. As of December 31, 2018, 0.4 million shares subject to the award had vested, and an additional 91,468 shares vested during the nine months ended September 30, 2019.

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Success Payments

Todd Harris, a member of the Company’s board of directors, is a beneficiary of the Success Payments Agreement, as described in Note 9 “Commitments and Contingencies—Success Payment Liability” and will receive 25.22% of any related payouts.

11. Stockholders’ Equity

As of September 30, 2019, the authorized stock of the Company was 300.0 million shares of common stock, $0.0001 par value per share, and 10.0 million shares of preferred stock, $0.0001 par value per share.

Common Stock

Holders of common stock are entitled to one vote per share and, upon liquidation, dissolution, or winding up of the Company, are entitled to receive all assets available for distribution to stockholders. The holders have no preemptive or other subscription rights and there are no redemption or sinking fund provisions with respect to such shares.

Shares of common stock reserved for future issuance are as follows (in thousands):

Convertible Preferred Stock

As of September 30, 2019 and December 31, 2018, there was no convertible preferred stock outstanding.

ATM Offering Program

In August 2018, the Company entered into a sales agreement with Cowen pursuant to which the Company may sell from time to time, at its option, up to $75.0 million of the Company’s common stock through ATM Offering Program, under which Cowen will act as sales agent. The aggregate compensation payable to Cowen shall be 3% of the gross sales price of the common stock sold by Cowen pursuant to the Sales Agreement. During the year ended December 31, 2018, the Company issued 340,307 shares of its common stock through its ATM Offering Program and received net proceeds of approximately $5.0 million, after deducting commissions of $0.2 million and other offering expenses of $0.4 million. During the three months ended September 30, 2019, the Company did not issue any shares of its common stock under the ATM program. During the nine months ended September 30, 2019, the Company issued an additional 329,588 shares of its common stock and received net proceeds of approximately $0.4 million, after deducting commissions of $18,000 and other offering expenses of $0.1 million. Issuances through the ATM Offering Program have been suspended.

Stock Awards and Stock-Based Compensation

In July 2017, the Company’s board of directors approved the 2017 Incentive Award Plan, or the 2017 Plan, which became effective upon the completion of the Company’s initial public offering (“IPO”) on August 1, 2017. The 2017 Plan serves as the successor incentive award plan to the Company’s 2010 Equity Incentive Plan, or the 2010 Plan, and has 0.6 million shares of common stock available at September 30, 2019 for issuance pursuant to a variety of stock-based compensation awards, including stock options, stock appreciation rights, restricted stock awards, restricted stock unit awards and other stock-based awards, plus shares of common stock that were reserved for issuance pursuant to future awards under the 2010 Plan at the time the 2017 Plan became effective, plus shares represented by awards outstanding under the 2010 Plan that are forfeited or lapse unexercised and which following the effective date of the 2017 Plan are not issued under the 2010 Plan. In addition, the 2017 Plan reserve increased on January 1, 2018 and 2019 and will increase further on each subsequent anniversary through 2027, by an amount equal to the lesser of (a) four percent of the shares of stock outstanding (on an as converted basis) on the last day of the immediately preceding fiscal year and (b) such smaller number of shares of stock as determined by our board of directors; provided, however, that no more than 12.0 million shares of stock may be issued upon the exercise of incentive stock options.

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The terms of awards pursuant to the 2017 Plan are determined by the administrator of the 2017 Plan. The 2017 Plan is administered by the compensation committee of the Company’s board of directors unless the Company’s board of directors assumes authority for administration. In addition, the Company’s board of directors has delegated authority to grant awards to employees other than executive officers and certain senior executives of the Company to a committee consisting of the Company’s chief executive officer. Stock options granted pursuant to the 2017 Plan must have an exercise price of not less than the fair market value of the Company’s common stock on the date of grant, except that incentive stock options granted to an individual who owns (or is deemed to own) at least 10% of the total combined voting power of all classes of the Company’s capital stock (a “10% Holder”), must have an exercise price of at least 110% of the fair market value of a share of common stock on the date of grant. Stock options granted under the 2017 Plan generally expire ten years from the date of the grant, except that incentive stock options granted to a 10% Holder must not be exercisable after five years from the date of grant. The Company’s stock awards under the 2017 Plan vest based on terms in the stock award agreements and generally vest over four years.

Following the Company’s IPO and in connection with the effectiveness of the Company’s 2017 Plan, the 2010 Plan terminated and no further awards will be granted under that plan. However, all outstanding awards under the 2010 Plan will continue to be governed by their existing terms.

The fair value of each employee award granted during 2019 and 2018 was estimated on the grant date using the Black-Scholes option-pricing model. Prior to the adoption of a new accounting pronouncement on January 1, 2019 related to share-based payments issued to non-employees for goods or services, the fair value of each non-employee option granted was estimated on the grant date using the Black-Scholes option-pricing model and subsequently remeasured each reporting period. Under the new guidance, the measurement of equity-classified non-employee awards is fixed at the grant date, and no longer remeasured. The Company estimates the fair value of restricted stock unit awards based on the closing price of the Company’s common stock on the date of issuance.

In determining the fair value of stock options granted, the following weighted average assumptions were used in the Black-Scholes option-pricing model for awards granted for the nine months ended September 30, 2019 and the year ended December 31, 2018.

Due to limited historical data, the Company estimates stock price volatility based on a combined weighted average of the Company’s historical average volatility and that of a selected peer group of comparable publicly traded companies over the expected life of the award. The Company has never paid and does not expect to pay dividends in the foreseeable future. The expected term represents the average time that awards that vest are expected to be outstanding. For employee awards that have an early exercise provision, the Company has sufficient information to utilize four years as an expected term. For awards without an early exercise provision, the Company does not have sufficient history of stock option exercises to estimate the expected term and, thus, calculates expected term using the simplified method, based on the midpoint between the average vesting date and the contractual term. For all non-employees, the expected term is equivalent to the contractual term of 10 years. The risk-free interest rate is based on the United States Treasury yield curve for the expected life of the option. For awards issued prior to the listing of the Company’s common stock on Nasdaq, the fair value of the common stock utilized in the fair value estimation of award arrangements has been determined by the Company’s board of directors, utilizing contemporaneous third-party valuations. Following the listing of the common stock on Nasdaq, the Company uses its closing stock price as reported on Nasdaq on the grant date for the fair value of its stock. The Company has elected to record forfeitures as they occur and does not adjust its expense based on an estimated forfeiture rate.

Option Repricing

On August 1, 2019, in order to retain and incentivize current employees, the Company’s Board of Directors approved a repricing of 1,854,462 stock options held by then current employees granted prior to August 1, 2019. The options had exercise prices between $2.32 and $20.53 per share, which were reduced to $0.71, the closing price of the Company’s common stock as of August 6, 2019. There were no modifications to the vesting schedules of the previously issued options. The total incremental expense relating to the repricing was $0.5 million. The repricing of the options was treated as a modification for accounting purposes and the incremental compensation expense of $0.2 million for vested stock options calculated using the Black-Scholes option-pricing model was recorded in the consolidated statement of operations and comprehensive loss for the quarter ending September 30, 2019. The $0.3 million balance of the incremental expense together with the unamortized expense on any unvested options will be amortized over the remaining vesting periods.

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The Company did not grant any non-employee options to purchase shares of its common stock during the nine months ended September 30, 2019 and 2018.

Total compensation cost recorded in the condensed consolidated statements of operations and comprehensive loss, which includes non-cash stock-based compensation expense, restricted shares issued to non-employees subject to vesting and the value of stock options issued to non-employees for services and non-cash stock-based compensation expense relating to the ESPP are allocated as follows (in thousands):

As of September 30, 2019, there was $7.3 million of unrecognized compensation expense related to unvested employee stock award agreements, which is expected to be recognized over a weighted-average period of approximately 2.25 years. For stock option awards subject to graded vesting, the Company recognizes compensation cost on a straight-line basis over the service period for the entire award.

The weighted-average grant date fair value of all stock options granted during the nine months ended September 30, 2019 was $0.48. The weighted-average remaining contractual life of options outstanding at September 30, 2019 is 8.2 years. The total fair value of the shares vested during the nine months ended September 30, 2019 was $4.7 million. Additionally, stock-based compensation expense includes $37,000, $0.1 million, $3,000 and $0.3 million related to non-employee option grants during the three and nine months ended September 30, 2019 and 2018, respectively.

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Prior to its termination in connection with the effectiveness of the 2017 Plan, the 2010 Plan allowed the Company to grant to employees the right to exercise stock options in exchange for cash before the requisite service was provided (e.g., before the award is vested under its original terms); however, such arrangements permit the Company to subsequently repurchase such shares at the exercise price if the employee ceases to be a service provider. Such an exercise is not substantive for accounting purposes. Therefore, the payment received for the exercise price is recognized as an early exercise liability in the consolidated balance sheets and will be transferred to common stock and additional paid-in capital as such shares vest. As of September 30, 2019 and December 31, 2018, 142,638 and 307,504 unvested shares, respectively, were legally issued but are not considered outstanding for accounting purposes and are therefore excluded from basic and diluted net loss per share until the repurchase right lapses and the shares are no longer subject to the repurchase feature. At September 30, 2019 the closing market price of the stock was significantly lower than the exercise price of these options, and the Company determined it would not exercise its right to repurchase these shares. For accounting purposes, the Company wrote off the remaining early exercise liability at September 30, 2019. The Company recorded an early exercise liability as of December 31, 2018, of $0.3 million, of which $0.2 million is included in other accrued expenses, and $0.1 million is included in other long-term liabilities in the condensed consolidated balance sheets.

Warrants

In January 2019, in connection with the amendment to the SVB Loan Agreement, the Company issued warrants to purchase an aggregate of 535,714 shares of the Company’s common stock at an exercise price of $2.80 per share. Based upon the characteristics and provisions of the warrants, they were classified as equity and recorded at their fair value as of the date of issuance of $1.1 million to additional paid-in capital, with no further adjustments to their valuation. The offset was reflected as $1.1 million of a debt discount upon issuance. The estimated fair value of the warrants was calculated using the Black-Scholes option-pricing model, using assumptions that are based on the individual characteristics of the warrants on the valuation date, as well as assumptions for expected volatility, expected life, yield and risk-free interest rate.

2017 Employee Stock Purchase Plan

The Company adopted the 2017 Employee Stock Purchase Plan, or the ESPP, which became effective upon the completion of the IPO on August 1, 2017. The ESPP is designed to allow the Company’s eligible employees to purchase shares of the Company’s common stock, at semi-annual intervals, with their accumulated payroll deductions. Under the ESPP, participants are offered the option to purchase shares of the Company’s common stock at a discount during a series of successive offering periods. The option purchase price will be the lower of 85% of the closing trading price per share of the Company’s common stock on the first trading date of an offering period in which a participant is enrolled or 85% of the closing trading price per share on the purchase date, which will occur on the last trading day of each offering period. The Company began the first offering period on December 31, 2017. In light of the Chapter 11 Proceeding, the Company is no longer continuing the ESPP.

The ESPP is intended to qualify under Section 423 of the U.S. Internal Revenue Service Code of 1986, as amended. The maximum number of the Company’s common stock which will be authorized for sale under the ESPP is equal to the sum of (a) 198,883 shares of common stock and (b) an annual increase on the first day of each year beginning in 2018 and ending in 2027, equal to the lesser of (i) 1% of the shares of common stock outstanding (on an as converted basis) on the last day of the immediately preceding fiscal year and (ii) such number of shares of common stock as determined by the Company’s board of directors; provided, however, no more than 3.0 million shares of the Company’s common stock may be issued under the ESPP. The ESPP has 0.5 million shares of common stock reserved for future issuance pursuant to the plan.

The Company recognized $0.0 million and $0.1 million in compensation expense related to the ESPP for the three and nine months ended September 30, 2019, and $0.1 million and $0.2 million for the three and nine months ended September 30, 2018, respectively. As of December 31, 2018, 67,508 shares of common stock were issued under the ESPP, and an additional 26,886 shares were issued during the nine months ended September 30, 2019.

12. Income Taxes

There is no provision for income taxes for the three and nine months ended September 30, 2019, as the Company has incurred operating losses since inception.

The Company has evaluated the available evidence supporting the realization of its deferred tax assets, including the amount and timing of future taxable income, and has determined that it is more likely than not that its net deferred tax assets will not be realized in the United States and certain foreign jurisdictions. Due to uncertainties surrounding the realization of the deferred tax assets, the Company maintains a full valuation allowance against substantially all deferred tax assets. When the Company determines that it will be able to realize some portion or all of its deferred tax assets, an adjustment to its valuation allowance on its deferred tax assets would have the effect of increasing net income in the period such determination is made. The Company has recorded a deferred tax liability related the acquisition of in-process research and development assets in a non-taxable transaction.

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The first nine months of 2019 were positively impacted by the reversal of deferred taxes related to the impairment of acquired in-process research and development assets.

Utilization of the net operating loss and research credit carryforwards may be subject to substantial annual limitations due to ownership change limitations that may have occurred or that could occur in the future, as required by Sections 382 and 383 of the Code, as well as similar state provisions. Under Sections 382 and 383 of the Code, if a corporation undergoes an “ownership change,” generally defined as a greater than 50 percentage point change (by value) in its equity ownership by certain stockholders over a three-year period, the corporation’s ability to use its pre-change net operating loss carryforwards and other pre-change tax attributes (such as research and development tax credits) to offset its post-change income or taxes may be limited.

The Company has not completed a study to assess whether an ownership change has occurred. If the Company has experienced an ownership change, utilization of the net operating loss and research credit carryforwards would be subject to an annual limitation under Sections 382 and 383 of the Code. Any limitation may result in expiration of a portion of the net operating loss carryforwards before utilization. Due to the existence of the valuation allowance, future changes in the Company’s unrecognized tax benefits will not impact its effective tax rate. Any carryforwards that will expire prior to utilization as a result of such limitations will be removed from deferred tax assets with a corresponding reduction of the valuation allowance.

As of September 30, 2019, the Company does not have any accrued interest or penalties related to uncertain tax positions. The Company’s policy is to recognize interest and penalties related to uncertain tax positions in income tax expense. The Company is subject to U.S. federal tax authority and U.S. state tax authority examinations for all years with the net operating loss and credit carryforwards.

13. Reorganization items

In accordance with ASC 852, the statement of operations shall portray the results of operations of the reporting entity while it is in Chapter 11. Expenses (including professional fees), realized gains and losses, and provisions for losses resulting from reorganization of the business shall be reported separately as reorganization items. Reorganization items represent amounts incurred after the Petition Date as a direct result of the Chapter 11 Proceeding and consist of the following (in thousands):

14. Liabilities Subject to Compromise

Liabilities subject to compromise represent liabilities incurred prior to the Chapter 11 filing that are unsecured or under-secured. These liabilities are reported at the estimated allowed claim amount, but are subject to adjustment through the Chapter 11 bankruptcy process and therefore have at least a possibility of not being repaid at the full claim amount. Furthermore, as the bankruptcy process continues, circumstances may arise that may change the classification of these liabilities to liabilities not subject to compromise or vice versa. Generally, actions to enforce or otherwise effect payment of pre-petition liabilities are stayed. Where there is uncertainty about whether a secured claim will be paid or impaired pursuant to the Chapter 11 Proceeding, the Company has classified the entire amount of the claim as a liability subject to compromise.

Liabilities subject to compromise consist of the following (in thousands):

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15. Condensed Debtor-In-Possession Financial Information

The financial statements below represent the unaudited condensed financial statements of the Debtor, as of and for the nine months ended September 30, 2019, excluding the results of the Non-Filing Entities. Intercompany transactions among the Debtor and the Non-Filing Entities have not been eliminated in the Debtor’s financial statements.

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