UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)

☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2019

☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number: 001-38155

Sienna Biopharmaceuticals, Inc.

(Exact Name of Registrant as Specified in its Charter)


Delaware		27-3364627
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)

30699 Russell Ranch Road, Suite 140 Westlake Village, California		91362
(Address of Principal Executive Offices)		(Zip Code)

(818) 629-2256

(Registrant’s Telephone Number, Including Area Code)

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class

Trading

Symbol(s)

Name of Each Exchange

on Which Registered

Common Stock, par value $0.0001 per share

SNNA

The Nasdaq Global Select Market

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☒

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

As of November 7, 2019, there were 30,907,542 shares of the registrant’s common stock, par value $0.0001 per share, outstanding.

Sienna Biopharmaceuticals, Inc.

(Debtor-In-Possession)

Form 10-Q For The Quarter Ended September 30, 2019

Index


PART I	FINANCIAL INFORMATION	3
ITEM 1:	Financial Statements	3
	Condensed Consolidated Balance Sheets	3
	Condensed Consolidated Statements of Operations and Comprehensive Loss	4
	Condensed Consolidated Statements of Stockholders’ Equity	5
	Condensed Consolidated Statements of Cash Flows	7
	Notes to Unaudited Condensed Consolidated Financial Statements	8
ITEM 2:	Management’s Discussion and Analysis of Financial Condition and Result of Operations	29
ITEM 3:	Quantitative and Qualitative Disclosures about Market Risk	39
ITEM 4:	Controls and Procedures	40

PART II	OTHER INFORMATION	40

ITEM 1:	Legal Proceedings	40
ITEM 1A:	Risk Factors	41
ITEM 2:	Unregistered Sales of Equity Securities and Use of Proceeds	47
ITEM 3:	Defaults Upon Senior Securities	47
ITEM 4:	Mine Safety Disclosures	47
ITEM 5:	Other Information	48
ITEM 6:	Exhibits	48
Signatures		50

PART I. FINANCIAL INFORMATION

ITEM 1.

Financial Statements

Sienna Biopharmaceuticals, Inc.

(Debtor-In-Possession)

Condensed Consolidated Balance Sheets

(in thousands, except per share amounts)


	September 30,			December 31,
	2019			2018
	(unaudited)
Assets
Current assets:
Cash and cash equivalents	$	11,332		$	48,526
Restricted cash		213			181
Prepaid expenses and other current assets		8,186			1,705

Total current assets		19,731			50,412
Property and equipment, net		180			311
Operating lease right-of-use asset		81			—
In-process research and development		23,500			45,594
Goodwill		—			10,989

Total assets	$	43,492		$	107,306

Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	$	187		$	2,792
Accrued personnel costs		164			3,057
Other accrued expenses		941			5,000
Contingent consideration, current portion		—			13,500

Total current liabilities		1,292			24,349
Contingent consideration—net of current portion		—			15,700
Long-term debt, net		—			30,125
Deferred tax liability		5,358			10,503
Other long-term liabilities		—			48

Total liabilities not subject to compromise		6,650			80,725
Liabilities subject to compromise		13,741			—
Total liabilities		20,391			80,725
Commitments and contingencies (Note 9)
Stockholders’ equity:
Preferred stock, $0.0001 par value, 10,000 shares authorized, no shares issued and outstanding at September 30, 2019 and December 31, 2018, respectively		—			—
Common stock, $0.0001 par value, 300,000 shares authorized, 30,908 and 21,177 shares issued and 30,765 and 20,870 outstanding at September 30, 2019 and December 31, 2018, respectively		—			—
Additional paid-in capital		209,818			182,750
Accumulated other comprehensive income		1,303			3,199
Accumulated deficit		(188,020	)		(159,368	)

Total stockholders’ equity		23,101			26,581

Total liabilities and stockholders’ equity	$	43,492		$	107,306

See accompanying notes.

Sienna Biopharmaceuticals, Inc.

(Debtor-In-Possession)

Condensed Consolidated Statements of Operations and Comprehensive Loss

(in thousands, except per share amounts)

(unaudited)


	Three Months Ended September 30,						Nine Months Ended September 30,
	2019			2018			2019			2018
Operating expenses:
Research and development	$	3,820		$	12,146		$	15,997		$	40,819
General and administrative		5,021			5,138			12,110			14,310
(Gain) loss on remeasurement of contingent consideration		(33,500	)		(700	)		(29,200	)		1,600
Impairment of goodwill and in-process research and development		30,695			—			30,695			—

Total operating expenses		6,036			16,584			29,602			56,729

Loss from operations		(6,036	)		(16,584	)		(29,602	)		(56,729	)
Reorganization items		(2,003	)		—			(2,003	)		—
Other income (expense), net		(549	)		(210	)		(1,629	)		2,593

Net loss before income taxes		(8,588	)		(16,794	)		(33,234	)		(54,136	)
Income tax benefit		4,618			—			4,618			—

Net loss	$	(3,970	)	$	(16,794	)	$	(28,616	)	$	(54,136	)

Other comprehensive income (loss):
Cumulative translation adjustment		(1,469	)		(396	)		(1,896	)		(1,515	)

Comprehensive loss	$	(5,439	)	$	(17,190	)	$	(30,512	)	$	(55,651	)

Per share information:
Net loss, basic and diluted	$	(0.13	)	$	(0.82	)	$	(1.00	)	$	(2.66	)


Weighted average shares outstanding, basic and diluted		30,726			20,473			28,584			20,331

See accompanying notes.

Sienna Biopharmaceuticals, Inc.

(Debtor-In-Possession)

Condensed Consolidated Statements of Stockholders’ Equity

(in thousands)

(unaudited)


	Nine Months Ended September 30, 2019
	Common Stock					Additional Paid-in Capital			Accumulated Other Comprehensive Income (Loss)			Accumulated Deficit			Total
	Shares			Par Value		Additional Paid-in Capital			Accumulated Other Comprehensive Income (Loss)			Accumulated Deficit			Total
Balance at December 31, 2018		20,870		$	—	$	182,750		$	3,199		$	(159,368	)	$	26,581
Cumulative effect of adoption of ASU 2016-02		—			—		—			—			(36	)		(36	)
Vesting of early exercised shares		55			—		56			—			—			56
Stock-based compensation expense		—			—		1,533			—			—			1,533
Issuance of shares of common stock, net of issuance cost of $1,555 pursuant to the follow on offering		9,200			—		21,445			—			—			21,445
Issuance of warrants to purchase common stock		—			—		1,105			—			—			1,105
Repurchase of early exercised shares		(1	)		—		(3	)		—			—			(3	)
Foreign currency translation adjustments		—			—		—			(1,013	)		—			(1,013	)
Net loss		—			—		—			—			(16,382	)		(16,382	)

Balance at March 31, 2019		30,124		$	—	$	206,886		$	2,186		$	(175,786	)	$	33,286
Vesting of early exercised shares		54			—		52			—			—			52
Stock-based compensation expense		—			—		871			—			—			871
Issuance of shares of common stock, net of issuance cost of $159 pursuant to the ATM Offering Program		329			—		425			—			—			425
Shares issued pursuant to the employee stock purchase plan		27			—		27			—			—			27
Foreign currency translation adjustments		—			—		—			586			—			586
Net loss		—			—		—			—			(8,264	)		(8,264	)

Balance at June 30, 2019		30,534		$	—	$	208,261		$	2,772		$	(184,050	)	$	26,983
Vesting of early exercised shares		56			—		150			—			—			150
Stock-based compensation expense		—			—		1,407			—			—			1,407
Vesting of restricted stock units		175
Foreign currency translation adjustments		—			—		—			(1,469	)		—			(1,469	)
Net loss		—			—		—			—			(3,970	)		(3,970	)

Balance at September 30, 2019		30,765		$	—	$	209,818		$	1,303		$	(188,020	)	$	23,101

See accompanying notes

Sienna Biopharmaceuticals, Inc.

(Debtor-In-Possession)

Condensed Consolidated Statements of Stockholders’ Equity

(in thousands)

(unaudited)


	Nine Months Ended September 30, 2018
	Common Stock					Additional Paid-in Capital			Accumulated Other Comprehensive Income (Loss)			Accumulated Deficit			Total
	Shares			Par Value		Additional Paid-in Capital			Accumulated Other Comprehensive Income (Loss)			Accumulated Deficit			Total
Balance at December 31, 2017		20,194		$	—	$	171,726		$	5,370		$	(85,897	)	$	91,199
Vesting of early exercised shares		60			—		70			—			—			70
Stock-based compensation expense		—			—		901			—			—			901
Repurchase of early exercised shares		(8	)		—		(18	)		—			—			(18	)
Foreign currency translation adjustments		—			—		—			1,374			—			1,374
Net loss		—			—		—			—			(17,103	)		(17,103	)

Balance at March 31, 2018		20,246		$	—	$	172,679		$	6,744		$	(103,000	)	$	76,423
Vesting of early exercised shares		52			—		54			—			—			54
Stock-based compensation expense		—			—		995			—			—			995
Issuance of common stock in connection with exercise of stock options		37			—		407			—			—			407
Shares issued pursuant to the employee stock purchase plan		30			—		388			—			—			388
Foreign currency translation adjustments		—			—		—			(2,494	)		—			(2,494	)
Net loss		—			—		—			—			(20,239	)		(20,239	)

Balance at June 30, 2018		20,365		$	—	$	174,523		$	4,250		$	(123,239	)	$	55,534
Vesting of early exercised shares		51			—		53			—			—			53
Stock-based compensation expense		—			—		1,495			—			—			1,495
Issuance of shares of common stock, net of issuance cost of $0.6 million pursuant to the ATM Offering Program		340			—		5,037			—			—			5,037
Foreign currency translation adjustments		—			—		—			(395	)		—			(395	)
Net loss		—			—		—			—			(16,794	)		(16,794	)

Balance at September 30, 2018		20,756		$	—	$	181,108		$	3,855		$	(140,033	)	$	44,930

See accompanying notes

Sienna Biopharmaceuticals, Inc.

(Debtor-In-Possession)

Condensed Consolidated Statements of Cash Flows

(in thousands)

(unaudited)


	Nine Months Ended September 30,
	2019			2018
Operating activities
Net loss	$	(28,616	)	$	(54,136	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation		112			117
Amortization of debt discount and issuance costs		671			130
Stock-based compensation		3,810			3,391
Fair value adjustment of success payment liability		(3	)		(2,597	)
Fair value adjustment of contingent consideration		(29,200	)		1,600
Non-cash interest expense		270			330
Non-cash income tax benefit		(4,618	)		—
Loss on disposal of property and equipment		23			3
Impairment of in-process research and development		20,040			—
Impairment of goodwill		10,655			—
Impairment of operating lease – right-of-use asset		13			—
Write-off of prior debt issuance costs		325			—
Changes in assets and liabilities:
Prepaid expenses and other current assets		(6,486	)		(210	)
Accounts payable and other accrued liabilities		(6,026	)		5,278

Net cash used in operating activities		(39,030	)		(46,094	)
Investing activities
Investment in property and equipment		(4	)		(33	)

Net cash used in investing activities		(4	)		(33	)
Financing activities
Proceeds from issuance of common stock, net of issuance costs, early exercise liability and repurchase of unvested early exercise stock options		21,867			5,426
Net proceeds from issuance of long-term debt (payment of debt financing costs)		(16	)		29,853
Repayment of long-term debt		(20,000	)		—
Proceeds from issuance of common stock upon ESPP purchase		27			388

Net cash provided by financing activities		1,878			35,667

Effect of exchange rate changes on cash		(6	)		(32	)
Net decrease in cash, cash equivalents and restricted cash		(37,162	)		(10,492	)
Cash, cash equivalents and restricted cash at beginning of period		48,707			74,648

Cash, cash equivalents and restricted cash at end of period	$	11,545		$	64,156

Supplemental Disclosure of Cash Flow Information:
Right-of-use asset obtained in exchange for lease liability	$	175		$	—
Warrants issued	$	1,105		$	—

See accompanying notes.

Sienna Biopharmaceuticals, Inc.

(Debtor-In-Possession)

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2019

1. Organization and Description of Business

In these notes to the unaudited condensed consolidated financial statements, the “Company,” “Sienna,” “we,” “us,’” and “our” refers to Sienna Biopharmaceuticals, Inc. (formerly Sienna Labs, Inc.) and its subsidiaries on a consolidated basis.

Sienna Biopharmaceuticals, Inc., was incorporated on July 27, 2010, under the laws of the State of Delaware and is headquartered in Westlake Village, California. The Company is a clinical-stage biopharmaceutical company focused on bringing unconventional scientific innovations to patients whose lives remain burdened by their disease.

Recent Developments and Chapter 11 Proceeding

On August 5, 2019, the Company announced that it had retained Cowen and Company, LLC (“Cowen”) as an independent financial advisor to assist in exploring financial and strategic alternatives designed to maximize shareholder value.

On September 13, 2019, the Company implemented a second corporate restructuring resulting in a reduction in force to reduce operational costs and preserve capital. The restructuring resulted in an immediate elimination of 7 positions. The Company incurred a one-time employee benefits and severance charge of approximately $1.1 million in the third quarter of 2019, in connection with the restructuring.

On September 16, 2019 (the “Petition Date”), the Company (the “Debtor”) filed a voluntary petition in the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”) seeking relief under Chapter 11 of Title 11 of the United States Code (the “Bankruptcy Code”). The case is being administered under the caption “In re: SIENNA BIOPHARMACEUTICALS, INC.” (the “Chapter 11 Proceeding”). The Company intends 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. The Company’s foreign subsidiaries (the “Non-Filing Entities”) did not file for Chapter 11 in the United States or for reorganization or insolvency proceedings in the foreign jurisdictions.

Pursuant to Section 362 of the Bankruptcy Code, the filing of the Chapter 11 Proceeding automatically stayed most actions against the Debtor, including actions to collect indebtedness incurred prior to the Petition Date or to exercise control over the Debtor’s property. Subject to certain exceptions under the Bankruptcy Code, the filing of the Debtor’s Chapter 11 petition also automatically stayed the filing of other actions against or on behalf of the Debtor or its property to recover on, collect or secure a claim arising prior to the Petition Date or to exercise control over property of the Debtor’s bankruptcy estates, unless the Bankruptcy Court modifies or lifts the automatic stay as to any such claim.

On the Petition Date, the Debtor filed a number of motions with the Bankruptcy Court generally designed to stabilize the Company’s operations and facilitate the transition into Chapter 11, which the Bankruptcy Court approved on an interim basis. Certain of these motions seek authority from the Bankruptcy Court for the Debtor to make payments upon, or otherwise honor, certain obligations that arose prior to the Petition Date, including obligations related to employee wages, salaries and benefits, and taxes. The Bankruptcy Court granted substantially all of the relief requested in these motions on a final basis at a hearing held on October 15, 2019.

For the duration of the Chapter 11 Proceeding, the Company’s operations and its ability to develop and execute its business plan are subject to risks and uncertainties associated with the Chapter 11 Proceeding. As a result of these risks and uncertainties, the Company’s assets, liabilities, officers and/or directors could be significantly different following the outcome of the Chapter 11 Proceeding, and the description of its operations, properties and capital plans included in these consolidated financial statements may not accurately reflect its operations, properties and capital plans following the Chapter 11 Proceeding.

As previously disclosed, on August 9, 2019, the Company received a notification from The Nasdaq Stock Market (“Nasdaq”) that for the previous 30 consecutive business days, the closing bid price of the Company’s common stock was below $1.00 per share, which is the minimum required closing bid price for continued listing on the Nasdaq Global Select Market pursuant to Listing Rule 5450(a)(1). On September 17, 2019, the Company received a letter (the “Nasdaq Letter”) from the staff of the Nasdaq Listing Qualifications Department (the “Staff”) notifying the Company that, as a result of the Chapter 11 Proceeding and in accordance with Nasdaq Listing Rules 5101, 5110(b) and IM-5101-1, the Staff had provided notification to the Company that the Company’s common stock (the “Common Stock”) would be delisted from Nasdaq unless the Company requested an appeal of the Staff’s determination by September 24, 2019. The Company subsequently appealed the Staff’s determination and a hearing was held in front of a Nasdaq Hearing Panel (the “Panel”) on October 17, 2019. As of November 11, 2019, the Panel had not rendered a decision and the Company’s common stock continues to trade on the Nasdaq.

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.

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.

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.

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.

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:

•

ASU No. 2018-10, Codification Improvements to Topic 842, Leases, which amends certain narrow aspects of the guidance issued in ASU 2016-02; and

•

ASU No. 2018-11, Leases (Topic 842): Targeted Improvements, which allows for a transition approach to initially apply ASU 2016-02 at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption as well as an additional practical expedient for lessors to not separate non-lease components from the associated lease component.

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.

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”.

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):


	Estimated Useful Life (in years)		September 30, 2019			December 31, 2018
Lab equipment		5	$	218		$	307
Computer hardware		3		111			142
Capital lease equipment		3		—			46
Furniture and fixtures		5		87			87
Software		3		9			9
Leasehold improvements				105			105

Total				530			696
Less accumulated depreciation				(350	)		(385	)

Property and equipment, net			$	180		$	311

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.

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):


	September 30, 2019
	Level 1		Level 2		Level 3
Assets:
Cash equivalents	$	11,332	$	—	$	—

Total	$	11,332	$	—	$	—

Liabilities:
Contingent consideration	$	—	$	—	$	—

Total	$	—	$	—	$	—


	December 31, 2018
	Level 1		Level 2		Level 3
Assets:
Cash equivalents	$	48,526	$	—	$	—

Total	$	48,526	$	—	$	—

Liabilities:
Contingent consideration	$	—	$	—	$	29,200

Total	$	—	$	—	$	29,200

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


	Contingent Consideration
Balance at December 31, 2018	$	29,200
Change in fair value due to remeasurement		(29,200	)

Balance at September 30, 2019	$	—

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.

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.

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):


	September 30, 2019
2019	$	10,000

Total principal payments		10,000
Final fee due at maturity in 2019		650

Total principal and final fee payments	$	10,650

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

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):


	Nine Months Ended September 30, 2019
Cash paid for amounts included in the measurement of operating lease liabilities	$	322
Right-of-use assets obtained in exchange for lease liabilities – operating leases	$	175

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


2019 (remaining three months)	$	109
2020		74
Total operating lease payments		183
Less: imputed interest		(4	)

Total operating lease liabilities	$	179

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.

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.

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):


	September 30, 2019
Common stock awards outstanding		2,403
Restricted stock units outstanding		919
Common stock awards available for grant under employee benefit plans		1,161
Common stock warrants outstanding		536

Total shares of common stock reserved for future issuance		5,019

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.

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.


	Nine Months Ended September 30, 2019	Year Ended December 31, 2018
Expected stock price volatility	69.91–78.63%	65.40–74.21%
Expected dividend yield	— %	— %
Expected term (in years)	1.3–5.6	5.0–6.1
Risk-free interest rate	1.52%–2.52%	2.55–3.06%

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.

Stock Options

The table below summarizes the stock option activity for the nine months ended September 30, 2019:


	Number of Shares (in thousands)			Weighted Average Exercise Price Per Share		Aggregate Intrinsic Value (in thousands)
Outstanding at December 31, 2018		2,263		$	12.42	$	—
Granted		1,155			1.08
Exercised		—			—		—
Cancelled		(995	)		10.10
Expired		(20	)		16.90

Outstanding at September 30, 2019		2,403		$	1.89	$	—

Exercisable at September 30, 2019		1,740		$	5.38	$	—

Restricted Stock Units (RSUs)

The table below summarizes the RSU activity for the nine months ended September 30, 2019:


	Number of RSUs (in thousands)			Weighted Average Grant Date Fair Value
Unvested at December 31, 2018		—		$	—
Granted		1,356			1.68
Vested		(175	)		2.32
Cancelled		(262	)		2.00

Unvested balance at September 30, 2019		919		$	1.47

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):


	Three months ended September 30,				Nine months ended September 30,
	2019		2018		2019		2018
Research and development	$	261	$	368	$	1,103	$	1,099
General and administrative		1,146		1,127		2,707		2,292

	$	1,407	$	1,495	$	3,810	$	3,391

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.

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.

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):


	Three Months Ended		Nine Months Ended
	September 30,		September 30,
	2019		2019
Write-off of debt issuance costs on debt subject to compromise	$	1,625	$	1,625
Professional fees		378		378

Reorganization items	$	2,003	$	2,003

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):


	September 30, 2019
Accounts payable	$	1,640
Accrued personnel costs		280
Other accrued expenses		1,718
SVB loan agreement		10,103

Total liabilities subject to compromise	$	13,741

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.

Debtor’s Condensed Balance Sheet

(in thousands)


	September 30, 2019
	(unaudited)
Assets
Current assets:
Cash and cash equivalents	$	10,933
Restricted cash		213
Prepaid expenses and other current assets		8,151

Total current assets		19,297
Property and equipment, net		178
Operating lease right-of-use asset		81
Investment in subsidiary		43,766

Total assets	$	63,322

Liabilities
Current liabilities:
Accounts payable	$	140
Accrued personnel costs		164
Other accrued expenses		416

Total current liabilities		720

Total liabilities not subject to compromise		720
Liabilities subject to compromise		13,741
Total liabilities		14,461
Total stockholders’ equity		48,861

Total liabilities and stockholders’ equity	$	63,322

Debtor’s Condensed Statements of Operations and Comprehensive Loss

(in thousands)


	Three Months Ended			Nine Months Ended
	September 30, 2019			September 30, 2019
Operating expenses:
Research and development	$	3,196		$	14,758
General and administrative		4,692			11,659
Gain on remeasurement of contingent consideration		(33,500	)		(29,200	)
Impairment of in-process research and development		8,494			8,494

Total operating expenses		(17,118	)		5,711

Income (loss) from operations		17,118			(5,711	)
Reorganization items		(2,003	)		(2,003	)
Other income (expense), net		(681	)		(1,762	)

Net income (loss) before income taxes		14,434			(9,476	)
Income tax benefit		1,986			1,986

Net income (loss)	$	16,420		$	(7,490	)

Debtor’s Condensed Statement of Cash Flows

(in thousands)


	Nine Months Ended September 30, 2019
Operating activities
Net loss	$	(7,490	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation		112
Amortization of debt discount and issuance costs		671
Stock-based compensation		3,810
Fair value adjustment of success payment liability		(3	)
Fair value adjustment of contingent consideration		(29,200	)
Non-cash interest expense		270
Non-cash income tax benefit		(1,986	)
Loss on disposal of property and equipment		23
Impairment of in-process research and development		8,494
Impairment of operating lease – right-of-use asset		13
Write-off of prior debt issuance costs		325
Changes in assets and liabilities:
Prepaid expenses and other current assets		(6,685	)
Accounts payable and other accrued liabilities		(5,897	)

Net cash used in operating activities		(37,543	)
Investing activities
Investment in property and equipment		(4	)
Investment in subsidiary		(1,785	)

Net cash used in investing activities		(1,789	)
Financing activities
Proceeds from issuance of common stock, net of issuance costs, early exercise liability and repurchase of unvested early exercise stock options		21,867
Payment of debt financing costs		(16	)
Repayment of long-term debt		(20,000	)
Proceeds from issuance of common stock upon ESPP purchase		27

Net cash provided by financing activities		1,878

Net decrease in cash, cash equivalents and restricted cash		(37,454	)
Cash, cash equivalents and restricted cash at beginning of period		48,600

Cash, cash equivalents and restricted cash at end of period	$	11,146

Supplemental Disclosure of Cash Flow Information:
Right-of-use asset obtained in exchange for lease liability	$	175
Warrants issued	$	1,105

ITEM 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements and related notes included in this Quarterly Report on Form 10-Q, and the audited consolidated financial statements and notes thereto as of and for the year ended December 31, 2018 and the related Management’s Discussion and Analysis of Financial Condition and Results of Operations, both of which are contained in our Annual Report on Form 10-K for the year ended December 31, 2018, which has been filed with the Securities and Exchange Commission, or SEC.

This report and other documents we file with the SEC contain forward-looking statements that are based on current expectations, estimates, forecasts and projections about us, our future performance, our business, our beliefs and our management’s assumptions. In addition, we or others on our behalf may make forward-looking statements in press releases or written statements or in our communications and discussions with investors and analysts in the normal course of business through meetings, webcasts, phone calls and conference calls. These statements are often identified by the use of words such as “may,” “will,” “expect,” “believe,” “anticipate,” “intend,” “could,” “should,” “estimate,” or “continue,” and similar expressions or variations. Such forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in the section titled “Risk Factors,” set forth in Part II, Item 1A of this Quarterly Report on Form 10-Q. The forward-looking statements in this Quarterly Report on Form 10-Q represent our views as of the date of this Quarterly Report on Form 10-Q. We anticipate that subsequent events and developments will cause our views to change. However, while we may elect to update these forward-looking statements at some point in the future, we have no current intention of doing so except to the extent required by applicable law. You should, therefore, not rely on these forward-looking statements as representing our views as of any date subsequent to the date of this Quarterly Report on Form 10-Q.

Overview

We are a clinical-stage biopharmaceutical company focused on bringing unconventional scientific innovations to patients whose lives remain burdened by their disease. Our lead candidate from this platform, 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 (itch). Our second product candidate, SNA-125, is a dual Janus kinase 3 (JAK3)/TrkA inhibitor for the treatment of atopic dermatitis, psoriasis and the associated pruritus. Additionally, SNA-001, a silver photoparticle technology derived from our Topical Photoparticle Therapy^™ platform completed pivotal clinical trials in early 2019. In October 2019, we announced that we had filed a Premarket Notification 510(k) submission with the U.S. Food and Drug Administration (“FDA”) for SNA-001 as a topical pre-treatment to standard laser devices to remove unwanted light hair, and that we received acknowledgement from FDA that the submission had been accepted.

Since our inception in 2010, we have invested a significant portion of our efforts and financial resources in research and development activities. We have not generated any revenue from product sales and, to date, have funded our operations primarily through private and public equity issuances, debt offerings and term loans. We have incurred net losses in each year since inception, including net losses of $4.0 million and $28.6 million for the three and nine months ended September 30, 2019, and $16.8 million and $54.1 million for the three and nine months ended September 30, 2018, respectively. As of September 30, 2019, we had an accumulated deficit of $188.0 million.

Recent Developments and Chapter 11 Proceeding

On August 5, 2019, we announced that we had retained Cowen and Company, LLC (“Cowen”) as an independent financial advisor to assist in exploring financial and strategic alternatives designed to maximize shareholder value. In September 2019, we implemented a second corporate restructuring resulting in a reduction in force to reduce operational costs and preserve capital. The restructuring resulted in an immediate elimination of 7 positions. We incurred a one-time employee benefits and severance charge of approximately $1.1 million in the third quarter of 2019, in connection with the restructuring. As of November 11, 2019, we have 13 full-time employees.

On September 16, 2019, we filed a voluntary petition in the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”) seeking relief under Chapter 11 of Title 11 of the United States Code (the “Bankruptcy Code”). The case is being administered under the caption “In re: SIENNA BIOPHARMACEUTICALS, INC.” (the “Chapter 11 Proceeding”). We intend to continue to manage and operate our 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. Our foreign subsidiaries did not file for Chapter 11 in the United States or for reorganization or insolvency proceedings in the foreign jurisdictions. For more information regarding the Chapter 11 Proceeding, please see Part II, Item 1 “Legal Proceedings”.

For the duration of the Chapter 11 Proceeding, our operations and ability to develop and execute our business plan are subject to the risks and uncertainties associated with the Chapter 11 process. As a result of these risks and uncertainties, the amount and composition of our assets, liabilities, officers and/or directors could be significantly different following the outcome of the Chapter 11 Proceeding, and the description of our operations, properties and liquidity and capital resources included in this quarterly report may not accurately reflect our operations, properties and liquidity and capital resources following the Chapter 11 process.

The accompanying interim unaudited condensed consolidated financial statements have been prepared assuming that we will continue as a going concern and contemplate continuity of operations, realization of assets and satisfaction of liabilities and commitments in the normal course of business. Our ability to continue as a going concern is contingent upon our ability to continue to manage and operate our 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 restructuring plan, among other factors. The filing of the Chapter 11 Proceeding constituted an Event of Default with respect to our 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. As a result, our financial condition and the risks and uncertainties surrounding our Chapter 11 Proceeding raise substantial doubt as to our ability to continue as a going concern.

SVB Loan Agreement

We are 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”). 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 our use of cash collateral to fund our operations during the Chapter 11 Proceeding, we 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 of the unaudited condensed consolidated financial statements, “SVB Loan Agreement”.

Sale Process

We are pursuing a variety of strategic transactions, including potentially a sale of all or substantially all of our assets. In connection with the Chapter 11 Proceeding, on October 22, 2019, we filed a motion seeking authority from the Bankruptcy Court to sell up to substantially all of our 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 we are unable to find a viable strategic partner or are otherwise unable to consummate a strategic transaction, or confirm a Chapter 11 plan of reorganization or liquidation, we could be forced to liquidate under Chapter 7 of the Bankruptcy Code.

Components of Our Results of Operations

Revenue

We have not generated any revenue from the sale of our products, and we do not expect to generate any revenue unless and until we obtain regulatory clearance or approval of, and commercialize, our product candidates, or enter into an out-license agreement or collaboration for any of our product candidates.

Research and Development Expenses

Since our inception, we have focused significant resources on our research and development activities, including conducting preclinical studies and clinical trials, manufacturing development efforts and activities related to regulatory filings for our product candidates. 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 our 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 (including salaries, payroll taxes, benefits, stock-based compensation and travel) for employees contributing to research and development activities are classified as research and development costs. We allocate direct external costs to our product candidates; internal costs are not allocated to specific product candidates.

General and Administrative Expenses

Our general and administrative expenses consist primarily of salaries and related costs, including payroll taxes, benefits, stock-based compensation and travel. Other general and administrative expenses include legal costs of pursuing patent protection of our intellectual property, professional services fees for auditing, tax, marketing and general legal services, insurance premiums, and the changes in the fair value of our contingent consideration liability.

Reorganization items

Reorganization items include expenses (including professional fees), realized gains and losses, and provisions for losses resulting from reorganization and restructuring of the business directly associated with the reorganization proceedings.

Income taxes

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.

Critical Accounting Policies and Use of Estimates

Our management’s discussion and analysis of financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States, or GAAP. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported expenses during the reporting periods. These items are monitored and analyzed by us for changes in facts and circumstances, and material changes in these estimates could occur in the future. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Changes in estimates are reflected in reported results for the period in which they become known. Actual results may differ materially from these estimates under different assumptions or conditions.

While our significant accounting policies are more fully described in the notes to our unaudited condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the year ended December 31, 2018, we believe that the following accounting policies are critical to the process of making significant judgments and estimates in the preparation of our consolidated financial statements and understanding and evaluating our reported financial results.

Clinical Trial Accruals

As part of the process of preparing our consolidated financial statements, we are required to estimate expenses resulting from our 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 under such contracts. Our objective is to reflect the appropriate trial expenses in our consolidated financial statements by matching those expenses with the period in which services and efforts are expended. We account for these expenses according to the progress of the trial as measured by patient progression and the timing of various aspects of the trial. We determine 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, we adjust the rate of clinical expense recognition if actual results differ from our estimates. We

make estimates of accrued expenses as of each balance sheet date in our consolidated financial statements based on the facts and circumstances known at that time. Although we do not expect our estimates to be materially different from amounts actually incurred, our 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 us reporting amounts that are too high or too low for any particular period. Through September 30, 2019, there have been no material adjustments to our prior period estimates of accrued expenses for clinical trials. Our clinical trial accrual is dependent in part upon the timely and accurate reporting of contract research organizations and other third-party vendors.

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 in-process research and development, (“IPR&D”), are treated as indefinite lived intangible assets and are not amortized until completion of the associated research and development efforts, typically upon regulatory approval. At that time, we will determine the useful life of the asset and begin amortization. Intangible assets are reviewed for impairment at least annually or whenever events or changes in circumstances indicate that the carrying amount may not be recoverable and upon establishment of technological feasibility or regulatory approval.

Determining fair value for purposes of an impairment analysis requires us to make significant estimates and assumptions regarding the amount and timing of costs to complete the project and the amount, timing and probability of achieving revenues from the completed product, similar to how the acquisition date fair value of the project was determined. There are often major risks and uncertainties associated with IPR&D projects as we are required to obtain regulatory approvals in order to be able to market these products. Such approvals require completing clinical trials that demonstrate a product candidate is safe and effective. Consequently, the eventual realized value of the acquired IPR&D project may vary from its fair value at the date of acquisition, and IPR&D impairment charges may occur in future periods which could have a material adverse effect on our results of operations.

As discussed in Note 5, “Identifiable Intangible Assets and Goodwill”, we performed an impairment test of our 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, we 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. There were no impairments of intangible assets for the year ended December 31, 2018.

The use of different assumptions, estimates or judgments in our intangible asset impairment testing process, such as the estimated future revenues and expenses, time and resources needed to complete development, probabilities of obtaining market approval and the risk-adjusted weighted-average cost of capital used to discount such cash flows, could significantly increase or decrease the estimated fair value of an asset, and therefore, impact the related impairment charge. At September 30, 2019, the above-noted impairment would have changed had the impairment test been conducted assuming: (1) a 1% increase in the discount rate used to discount the aggregate estimated cash flows of our assets to their net present value in determining their estimated fair values (without any change in the aggregate estimated cash flows of our intangibles); or (2) a 10% decrease in the cumulative probability of obtaining market approval would have resulted in potential incremental impairment of between approximately $3 million and $2 million under any of those scenarios individually and up to approximately $5 million under any combination of those scenarios.

We believe our estimations of future cash flows used for assessing impairment of long-lived assets and the impairment charges recorded during 2019 are based on reasonable assumptions given the facts and circumstances as of the related dates of the assessments. However, further indefinite-lived intangible asset impairment charges may be recognized in future periods to the extent changes in facts or circumstances occur, including deterioration in the macroeconomic environment, industry, deterioration in our performance or our future projections, including as a result of the Chapter 11 Proceeding or, if actual results are not consistent with our estimates and assumptions used in our impairment assessments, or if there are changes in our plans for one or more indefinite-lived intangible assets or our business, including the going-concern sale process and other disposition processes pursuant to the Chapter 11 Proceeding. We will continue to monitor for such changes in facts or circumstances, as well as changes to key assumptions such as the projected revenues and expenses, probabilities of obtaining market approval and assumed risk-adjusted weighted-average cost of capital. Changes in such facts or circumstances or to these key assumptions could result in revisions of management’s estimates of the fair value of the indefinite-lived intangible assets or reporting unit and could result in impairment charges in the future, which could be material to our results of operations.

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. We evaluate 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 for the difference between the fair value and its carrying amounts. The recent decline in our market capitalization was determined to be a triggering event for potential goodwill impairment and accordingly, we performed the goodwill impairment analysis.

In determining the fair value utilized in the goodwill impairment assessment, we considered qualitative factors such as changes in strategy, cash flows, the regulatory environment, overall market conditions, as well as the market capitalization of our publicly traded common stock. We operate as a single reporting unit and estimate the fair value of our single reporting unit using our 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 our common stock. As a result of the impairment assessment, we recorded an impairment charge to write off the entire balance of the goodwill of $10.7 million during the three months ended September 30, 2019. 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.

Stock-Based Compensation

We measure 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. 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. We estimate the fair value of restricted stock unit awards based on the closing price of our common stock on the date of issuance.

We calculate the fair value measurement of stock options using the Black-Scholes valuation model. 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.


	Nine Months Ended September 30, 2019	Year Ended December 31, 2018
Expected stock price volatility	69.91–78.63%	65.40–74.21%
Expected dividend yield	— %	— %
Expected term (in years)	1.3–5.6	5.0–6.1
Risk-free interest rate	1.52–2.52%	2.55–3.06%

Due to limited historical data, we estimate stock price volatility based on a combined weighted average of our historical average volatility and that of a selected peer group of comparable publicly traded companies over the expected life of the award. We have never paid, and do 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, there is sufficient information to utilize four years as an expected term. For awards without an early exercise provision, there is not sufficient history of stock option exercises to estimate the expected term and, thus, we calculate the 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 our common stock on the Nasdaq Global Select Market, or Nasdaq, the fair value of the common stock utilized in the fair value estimation of award arrangements has been determined by our board of directors, utilizing contemporaneous third-party valuations. Following the listing of our common stock on Nasdaq, we use the closing stock price as reported on Nasdaq on the grant date for the fair value of its stock.

We recorded noncash stock-based compensation expense for employee and nonemployee stock option grants and the ESPP for the three and nine months ended September 30, 2019 and 2018, as follows:


	Three months ended September 30,				Nine months ended September 30,
	2019		2018		2019		2018
Research and development	$	261	$	368	$	1,103	$	1,099
General and administrative		1,146		1,127		2,707		2,292

	$	1,407	$	1,495	$	3,810	$	3,391

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, we recognize compensation cost on a straight-line basis over the service period for the entire award.

Prior to its termination in connection with the effectiveness of our 2017 Incentive Award Plan, our 2010 Equity Incentive Plan allowed us to grant to employees the right to exercise stock options in exchange for cash before the requisite services are provided (e.g., before the award is vested under its original terms); however, such arrangements permit us 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 were issued and outstanding, respectively. At September 30, 2019 the closing market price of the stock was significantly lower than the exercise price of these options, and we determined we would not exercise our right to repurchase these shares. For accounting purposes, we wrote off the remaining early exercise liability at September 30, 2019. We 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. These shares are excluded from basic net loss per share until the repurchase right lapses and the shares are no longer subject to the repurchase feature.

On August 1, 2019, in order to retain and incentivize current employees, our 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 our 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 balance of the incremental expense together with the unamortized expense remaining on any unvested options will be amortized over the remaining vesting periods.

Contingent Consideration

In December 2016, we entered into a Share Purchase Agreement (the “Purchase Agreement”) to acquire the entire issued share capital of Creabilis. Upon closing of the transaction, we obtained our proprietary technology platform and related product candidates, including SNA-120 and SNA-125. As part of the terms of the agreement, we agreed to make certain 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 our commencement of the first Phase 3 clinical trial of SNA-120, we will become obligated to issue $18.0 million in shares of our common stock, less certain offsets if applicable, to the former Creabilis shareholders. In addition, under the Purchase Agreement, we are 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 cash royalties of less than 1% of the amount by which annual net sales exceed each threshold in the year such threshold is achieved. Where milestone payments are required to be paid in stock, the number of shares will be determined based on the volume weighted average price of the common stock as reported on Nasdaq, for the preceding 20-day trading period.

The agreement to pay the future milestones and potential one-time royalties resulted in the recognition of contingent consideration, 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. The fair value of the contingent consideration is determined using preliminary cash flow projections, which are 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. We believe that upon the discharge of claims and interests under a confirmed Chapter 11 plan of reorganization of the Company, the buyer or reorganized Company would emerge from any such transaction free and clear of all contingent payment obligations under the Purchase Agreement. As of 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 by applying the income approach, using several significant unobservable inputs for projected cash flows and a discount rate commensurate with our cost of capital and expectation of the revenue growth for products based on their life cycle stage.

Net Operating Loss and Research and Development Carryforwards

As of December 31, 2018, we had deferred tax assets of $45.4 million and deferred tax liabilities of approximately $10.5 million. The deferred tax assets have been offset by a valuation allowance due to uncertainties surrounding our ability to realize these tax benefits. The deferred tax assets are primarily composed of amortization related to capitalized R&D and net operating loss (NOL) carryforwards. As of December 31, 2018, we had federal and state NOL carryforwards of $60.0 million and foreign NOL carryforwards of $41.3 million available to potentially offset future taxable income. As of December 31, 2018, we also had federal research and development tax credit carryforwards of approximately $2.9 million available to potentially offset future federal income taxes. The federal and state NOL carryforwards and research and development tax credit carryforwards expire at various dates between 2031 and 2038. In general, if we experience a greater than 50 percentage point aggregate change in ownership of certain significant stockholders over a three-year period, or a Section 382 ownership change, utilization of our pre-change NOL or research and development tax credit carryforwards are subject to an annual limitation under Section 382 of the Internal Revenue Code of 1986, as amended. Such limitations may result in expiration of a portion of the NOL or research and development credit carryforwards before utilization and may be substantial. We have not conducted an assessment to determine whether there may have been a Section 382 ownership change. If we have experienced a Section 382 ownership change or if we experience a Section 382 ownership change as a result of future changes in our stock ownership, some of which changes are outside of our control, the tax benefits related to the NOL or research and development tax credit carryforwards may be limited or lost.

Results of Operations

Comparison of the Three Months Ended September 30, 2019 and 2018

The following table sets forth our results of operations for the periods indicated:


	(unaudited) Three Months Ended September 30,						Change
	2019			2018			$			%
	(in thousands, except percentages)
Operating expenses:
Research and development	$	3,820		$	12,146		$	(8,326	)		(69	%)
General and administrative		5,021			5,138			(117	)		(2	)
Gain on remeasurement of contingent consideration		(33,500	)		(700	)		(32,800	)		4,686
Impairment of goodwill and in-process research and development		30,695			—			30,695			—

Total operating expenses		6,036			16,584			(10,548	)		(64	)

Loss from operations		(6,036	)		(16,584	)		10,548			(64	)
Reorganization items		(2,003	)		—			(2,003	)		—
Other income (expense), net		(549	)		(210	)		(339	)		161

Net loss before income taxes		(8,588	)		(16,794	)		8,206			(49	%)
Income tax benefit		4,618			—			4,618			—

Net loss	$	(3,970	)	$	(16,794	)	$	12,824			(76	%)

Research and development expenses

Research and development expenses were $3.8 million for the three months ended September 30, 2019, compared to $12.1 million for the three months ended September 30, 2018. The decrease of $8.3 million was primarily due to lower clinical and non-clinical costs of $5.8 million, mainly related to SNA-120 of $3.2 million, SNA-001 of $1.6 million, and SNA-125 of $1.0 million, as a result of winding down the clinical studies. Additionally, there was a decrease of $1.3 million for employee salaries and other compensation costs in connection with reductions in personnel and lower expenses for travel, meals and other outside services partially offset by severance and retention payments. There was also continued decreased spending on manufacturing costs across all product candidates of $0.9 million and early stage research of $0.3 million.

General and administrative expenses

General and administrative expenses were $5.0 million for the three months ended September 30, 2019, compared to $5.1 million for the three months ended September 30, 2018. The decrease of $0.1 million was primarily a result of lower headcount and efforts to reduce costs, offset by increases in costs related to severance and employee retention, and costs incurred for professional fees prior to the Chapter 11 Proceeding.

Contingent consideration

The fair value adjustment of the contingent consideration resulted in income of $33.5 million for the three months ended September 30, 2019, compared to $0.7 million for the three months ended September 30, 2018. The increase in income of $32.8 million was a result of the decrease in likelihood of payment of the contingent claims as a result of the Chapter 11 Proceeding, and the determination that the fair value of the contingent consideration at September 30, 2019 was $0.

Goodwill and in-process research and development impairment

Impairment charges of $30.7 million for the three months ended September 30, 2019 consisted of a $10.7 charge for goodwill impairment and a $20.0 million charge for the impairment of in-process research and development.

Reorganization items

Reorganization items were $2.0 million for the three months ended September 30, 2019. These expenses relate to the Chapter 11 Proceeding and include $1.6 million related to the write-off of debt issuance costs and debt discount and $0.4 million for legal and accounting fees.

Other income (expense), net

Other income (expense), net was a net expense of $0.5 and $0.2 million for three months ended September 30, 2019 and 2018, respectively. Other income (expense), net primarily consists of the interest expense on the SVB Loan Agreement, offset by the interest income earned on our cash balances.

Income tax benefit

Income tax benefit for the three months ended September 30, 2019 was $4.6 million and was the result of the reversal of deferred taxes related to the acquisition of in-process research and development assets and corresponding impairment charges recorded during the period.

Comparison of the Nine Months Ended September 30, 2019 and 2018

The following table sets forth our results of operations for the periods indicated:


	(unaudited) Nine Months Ended September 30,						Change
	2019			2018			$			%
	(in thousands, except percentages)
Operating expenses:
Research and development	$	15,997		$	40,819		$	(24,822	)		(61	%)
General and administrative		12,110			14,310			(2,200	)		(15	)
(Gain) loss on remeasurement of contingent consideration		(29,200	)		1,600			(30,800	)		(1,925	)
Impairment of goodwill and in-process research and development		30,695			—			30,695			—

Total operating expenses		29,602			56,729			(27,127	)		(48	)

Loss from operations		(29,602	)		(56,729	)		27,127			(48	)
Reorganization items		(2,003	)		—			(2,003	)		—
Other income (expense), net		(1,629	)		2,593			(4,222	)		(163	)

Net loss before income taxes		(33,234	)		(54,136	)		20,902			(39	%)
Income tax benefit		4,618			—			4,618			—

Net loss	$	(28,616	)	$	(54,136	)	$	25,520			(47	%)

Research and development expenses

Research and development expenses were $16.0 million for the nine months ended September 30, 2019, compared to $40.8 million for the nine months ended September 30, 2018. The decrease of $24.8 million in research and development expenses was primarily due to lower clinical and non-clinical costs of $18.1 million, primarily consisting of $9.4 million for SNA-120, $5.6

million for SNA-001 and $3.1 million for SNA-125. Additionally, there was decreased spending on manufacturing costs across all products of $2.8 million, and decreased spending on early stage research of $1.8 million. The remaining decrease in expense of $2.1 million related to lower personnel and related costs of $1.5 million with the remainder related to lower outside spending as a result of efforts to reduce costs.

General and administrative expenses

General and administrative expenses were 12.1 million for the nine months ended September 30, 2019, compared to $14.3 million for the nine months ended September 30, 2018. The decrease of $2.2 million in general and administrative expenses was primarily due to lower headcount and efforts to reduce costs, offset by increases in costs related to severance and employee retention, and costs incurred for professional fees prior to the Chapter 11 Proceeding.

Contingent consideration

The fair value adjustment of the contingent consideration resulted in income of $29.2 million for the nine months ended September 30, 2019, compared to an expense of $1.6 million for the nine months ended September 30, 2018. The increase in income of $30.8 million was a result of the decrease in likelihood of payment of the contingent claims as a result of the Chapter 11 Proceeding, and the determination that the fair value of the contingent consideration at September 30, 2019 was $0.

Goodwill and in-process research and development impairment

Impairment charges of $30.7 million for the nine months ended September 30, 2019 consisted of a $10.7 charge for goodwill impairment and a $20.0 million charge for the impairment of in-process research and development.

Reorganization items

Reorganization items were $2.0 million for the nine months ended September 30, 2019. These expenses relate to the Chapter 11 Proceeding and include $1.6 million related to the write-off of debt issuance costs and debt discount and $0.4 million for legal and accounting fees.

Other income (expense), net

Other income (expense), net was a net expense of $1.6 million and a net income of $2.6 million for the nine months ended September 30, 2019 and 2018, respectively. The net expense of $1.6 million for the nine months ended September 30, 2019 was primarily due to $2.5 million of interest expense incurred in connection with the SVB Loan Agreement, offset by $0.8 million of interest earned on our cash balances.

The other net income of $2.6 million for the nine months ended September 30, 2018 was primarily due to the $2.6 million gain recognized on the decrease in success payment liability and interest earned on our cash balances.

Income tax benefit

Income tax benefit for the nine months ended September 30, 2019 was $4.6 million and was the result of the reversal of deferred taxes related to the acquisition of in-process research and development assets and corresponding impairment charges recorded during the period.

Liquidity, Capital Resources and Requirements

We have incurred operating losses and have an accumulated deficit as a result of efforts to develop our product candidates, including conducting nonclinical and clinical trials and providing general and administrative support for these operations. We had an accumulated deficit of $188.0 million and $159.4 million as of September 30, 2019 and December 31, 2018, respectively. We had net losses of $4.0 million and $28.6 million for the three and nine months ended September 30, 2019, and $16.8 million and $54.1 million for the three and nine months ended September 30, 2018, respectively. We had net cash used in operating activities of $39.0 million and $46.1 million for the nine months ended September 30, 2019 and 2018, respectively. These conditions raise substantial doubt about our ability to continue as a going concern. We do not currently have any sources of capital beyond our current cash balance.

On January 2, 2019, we implemented a corporate restructuring to focus resources on our lead product candidate, SNA-120 for psoriasis and the associated pruritus, resulting in a reduction in force to reduce operational costs and preserve capital. The restructuring resulted in an elimination of a significant number of positions. At March 31, 2019, we had completed the activities associated with the restructuring plan and all related payments had been made.

On September 13, 2019, we implemented a second corporate restructuring resulting in a reduction in force to reduce operational costs and preserve capital. The restructuring resulted in an immediate elimination of 7 positions. We incurred a one-time employee benefits and severance charge of approximately $1.1 million in the third quarter of 2019, in connection with the restructuring.

Our 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. For additional discussion concerning the SVB Loan Agreement and use of cash collateral, see Note 8 of the unaudited condensed consolidated financial statements, “SVB Loan Agreement”.

Cash Flows Comparison of the Nine Months Ended September 30, 2019 and 2018

The following table sets forth our cash flows for periods indicated:


	(unaudited) (in thousands) Nine Months Ended September 30,
	2019			2018
Net cash provided by (used in)
Operating activities	$	(39,030	)	$	(46,094	)
Investing activities		(4	)		(33	)
Financing activities		1,878			35,667
Effect of exchange rate changes on cash		(6	)		(32	)

Net decrease in cash, cash equivalents and restricted cash	$	(37,162	)	$	(10,492	)

Net Cash Used in Operating Activities

During the nine months ended September 30, 2019, net cash used in operating activities was $39.0 million and consisted primarily of a net loss of $28.6 million and a decrease in the fair value of the contingent consideration of $29.2 million offset by the impairment of goodwill of $10.7 million and the impairment of our acquired in-process research and development assets of $20.0 million. In addition, accounts payable and other accrued liabilities decreased by $6.0 million primarily related to the wind down of SNA-001 and SNA-120 clinical trials and the general decrease in expenses as result of the restructuring and related efforts to reduce spending. In addition, prepaid expenses and other current assets increased by $6.5 million, primarily as a result of the payments for directors and officers insurance policies. This was offset by non-cash items, including an income tax benefit of $4.6 million, stock-based compensation expense of $3.8 million, the write-off of debt issuance costs and debt discount of $0.3 million, and amortization of debt discounts and issuance costs of $0.7 million.

During the nine months ended September 30, 2018, net cash used in operating activities was $46.1 million and consisted primarily of a net loss of $54.1 million and a decrease in the fair value of the success payment liability of $2.6 million, offset by the increase in the fair value of the contingent consideration of $1.6 million, and the non-cash stock-based compensation expense of $3.4 million. In addition, there was a $5.3 million favorable change in accounts payable and other accrued liabilities due to our overall growth and increased research and development spending.

Net Cash Used in Investing Activities

During the nine months ended September 30, 2019 and 2018, net cash used in investing activities was $4,000 and $33,000, respectively, and represented purchases of property and equipment.

Net Cash Provided by Financing Activities

During the nine months ended September 30, 2019, net cash provided by financing activities was $1.9 million, which consisted primarily of the net proceeds received from the follow on offering completed in February 2019 of $21.4 million and the net proceeds received from the ATM Offering Program of $0.4 million offset by the pay down of the SVB Loan Agreement of $20.0 million.

During the nine months ended September 30, 2018, net cash provided by financing activities was $35.7 million primarily from the $30.0 million received from the SVB Loan Agreement offset by debt issuance costs of $0.1 million. There was an additional $5.6 million received from our ATM Offering Program offset by commissions and other offering costs of $0.6 million.

Contractual Obligations and Contingent Liabilities

There have been no material changes to our contractual obligations and commitments compared to the disclosures in our Annual Report on Form 10-K for the year ended December 31, 2018, except as noted below:

On September 16, 2019, prior to filing the Chapter 11 Proceeding, and as a condition to the Silicon Valley Bank’s (“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. 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. The filing of the Chapter 11 Proceeding is an “Event of Default” under the SVB Loan Agreement. Immediately upon the occurrence and during the continuance of an Event of Default, the term loan shall bear interest at a rate per annum which is 3.00% above the rate that is otherwise applicable.

Indemnification

In the normal course of business, we enter into contracts and agreements that contain a variety of representations and warranties and provide for general indemnifications. Our exposure under these agreements is unknown because it involves claims that may be made against us in the future but have not yet been made. To date, we have not paid any claims or been required to defend any action related to our indemnification obligations. However, we may record charges in the future as a result of these indemnification obligations.

In accordance with our certificate of incorporation and bylaws, we have indemnification obligations to our officers and directors for specified events or occurrences, subject to some limits, while they are serving at our request in such capacities. There have been no claims to date, and we have director and officer insurance that may enable us to recover a portion of any amounts paid for future potential claims.

Off-Balance Sheet Arrangements

We did not have during the periods presented, and we do not currently have, any off-balance sheet arrangements, as defined under SEC rules.

ITEM 3.

Quantitative and Qualitative Disclosures About Market Risk.

There have been no material changes in the source and effects of our market risk compared to the disclosures in our Annual Report on Form 10-K for the year ended December 31, 2018.

Interest Rate Risk

As of September 30, 2019, the outstanding principal amount of the term loans under the SVB Loan Agreement was $10.0 million. The interest payments under our term loans may be subject to interest rate risk and our interest expense could increase if market interest rates increase. The interest on the term loans accrue at a per annum rate of the greater of (i) the Wall Street Journal prime rate plus 2.50% and (ii) 7.25%. Immediately upon the occurrence of an Event of Default, the term loan shall bear interest at a 3.00% above the rate that is otherwise applicable thereto. Increases in these published rates would increase our interest payments under the term loans. The rate at September 30, 2019 was 10.5%. A hypothetical 1% change in interest rates would not have a material impact on our results of operations, given the short term nature of the loan.

Cash, Cash Equivalents and Restricted Cash

As of September 30, 2019, we had cash and cash equivalents of $11.3 million and restricted cash of $0.2 million, which consist of bank deposits and cash invested in U.S. Treasury money market funds. As of December 31, 2018, we had cash and cash equivalents of $48.5 million and restricted cash of $0.2 million, which consist of bank deposits and cash invested in U.S. Treasury money market funds. Currently, a portion of our investments may be subject to interest rate risk and could fall in value if market interest rates increase. We do not enter into investments for trading or speculative purposes and have not used any derivative financial instruments to manage our interest rate risk exposure. A hypothetical 1% change in interest rates during any of the periods presented would not have a material impact on our consolidated financial statements, and we do not expect interest rate fluctuations to have a material impact on our results of operations. Our ability to use cash is subject to applicable orders of the Bankruptcy Court, including the Bankruptcy Court’s orders concerning use of cash collateral.

Foreign Currency Exchange Risk

The majority of our transactions occur in U.S. dollars. Our foreign subsidiaries operate with the euro and British pound as its functional currencies. The fluctuation in the value of the U.S. dollar against the euro and British pound affect the reported amounts of expenses, assets and liabilities. If we expand our international operations, our exposure to exchange rate fluctuations will increase. At September 30, 2019 and December 31, 2018, we had cash balances denominated in euros of $0.4 million and $0.1 million, respectively. We currently do not hedge any foreign currency exposure. A hypothetical 10% change in foreign exchange rates during any of the periods presented would not have had a material impact on our consolidated financial statements.

ITEM 4.

Controls and Procedures

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports under the Securities Exchange Act of 1934, as amended, or the Exchange Act, and the rules and regulations thereunder, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, or persons performing similar functions, as appropriate, to allow for timely decisions regarding required or necessary disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable, not absolute, assurance of achieving the desired control objectives, and we are required to apply judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of September 30, 2019, our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

Changes in Internal Control over Financial Reporting

Management determined that, as of September 30, 2019, there were no changes in our internal control over financial reporting that occurred during the fiscal quarter then ended that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Inherent Limitations on Effectiveness of Controls and Procedures

In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply judgment in evaluating the benefits of possible controls and procedures relative to their costs.

PART II. OTHER INFORMATION

ITEM 1.

Legal Proceedings

During the third quarter of 2019, the Company filed a voluntary petition in the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”), as described below. We are also party to ongoing legal proceedings with respect to certain of our intellectual property rights relating to SNA-001, as described below. In addition, we are, and may from time to time continue to be, involved in various legal proceedings of a character normally incident to the ordinary course of our business.

Chapter 11 Proceeding

On September 16, 2019 (the “Petition Date”), the Company filed a voluntary petition in the Bankruptcy Court seeking relief under Chapter 11 of Title 11 of the United States Code (the “Bankruptcy Code”). The case is being administered under the caption “In re: SIENNA BIOPHARMACEUTICALS, INC.” (the “Chapter 11 Proceeding”). The Company intends 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.

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”). The filing of the Chapter 11 Proceeding is an “Event of Default” under the Loan Agreement. The occurrence of an Event of Default in connection with a voluntary bankruptcy proceeding under the 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 the Petition Date, the Company filed multiple motions seeking various forms of relief from the Bankruptcy Court to facilitate a smooth transition into chapter 11. The Bankruptcy Court granted substantially all of the relief requested in these motions on a final basis at a hearing held on October 15, 2019 and entered various orders authorizing the Debtor to, among other things:

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continue the use of its cash management system, bank accounts, and business forms;

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continue paying employee wages and benefits;

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continue insurance programs;

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establish procedures for utility companies to request adequate assurance of payment and to prohibit utility companies from altering or discontinuing service;

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establish notice and hearing procedures for trading in equity securities in the Company;

•

pay certain prepetition taxes and fees; and

•

use SVB’s cash collateral on a postpetition basis and establishing milestones in connection therewith.

On September 27, 2019, the United States Trustee for Region 3 appointed a statutory committee of unsecured creditors (the “Creditors’ Committee”) in the Chapter 11 Proceeding. The members of the Creditors’ Committee are (a) Therapeutics, Inc., (b) Johnson Matthey, Inc., and (c) MedPharm Ltd. No trustee or examiner has been appointed in the Chapter 11 Proceeding.

On October 17, 2019, the Company filed its periodic report on the value, operations, and profitability, for the six months ended June 30, 2019, of a certain non-debtor entity in which the Company holds a substantial or controlling interest as required by Rule 2015.3 of the Federal Rules of Bankruptcy Procedure. On October 23, 2019, the Company filed its schedules of assets and liabilities and statements of financial affairs. The Bankruptcy Court has established November 27, 2019 at 5:00 p.m. (Prevailing Eastern Time) as the final date and time for persons or entities to file proofs of claim in 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 seeking approval of procedures in connection therewith (the “Bidding Procedures and Sale Motion”). The Bankruptcy Court scheduled hearings on the Bidding Procedures and Sale Motion for November 12, 2019 at 10:30 a.m. (Prevailing Eastern Time) in connection with the approval of the bidding procedures and on December 10, 2019 in connection with the approval of any sale.

All pleadings filed in the Chapter 11 Proceeding are maintained on the case docket, which can be accessed through the website maintained by the Bankruptcy Court (https://www.deb.uscourts.gov), or an unofficial version of the case docket along with other case information is available at https://dm.epiq11.com/case/Sienna.

Interference Proceeding

On October 8, 2015, Patent Interference No. 106,037 was declared by the Patent Trial and Appeal Board, or the PTAB, between our U.S. Patent No. 8,821,941, which is directed to treating hair follicles with plasmonic particles, and U.S. Patent Application No. 13/789,575, which lists Massachusetts General Hospital, or GHC, as assignee. On August 9, 2016, the PTAB entered judgment against GHC. On October 3, 2016, GHC filed an appeal of the interference judgment with the U.S. Court of Appeals for the Federal Circuit, or Court of Appeals, in matter No. 17-1012, which names GHC and Sebacia, Inc., or Sebacia, as real parties in interest. The parties filed their respective appellate briefs with the Court of Appeals in the first quarter of 2017. On November 6, 2017, the Court of Appeals heard oral arguments in this matter. On May 4, 2018, the Court of Appeals entered its decision which affirmed the PTAB’s ruling that GHC’s original claims 65-67 are unpatentable and vacated and remanded the PTAB’s denial of GHC’s motion to add a new claim. On November 20, 2018, the PTAB denied GHC’s motion to add a new claim and entered judgement against GHC. On January 18, 2019, GHC filed an appeal of the interference judgment with the U.S. Court of Appeals for the Federal Circuit. On April 22, 2019, GHC filed its opening appellate brief. On July 3, 2019, Sienna filed its responsive brief. On August 15, 2019, GHC filed its reply brief.

For further information regarding risks regarding these proceedings and patent rights held by third parties, please see “Item 1A. Risk Factors—Risks Related to Our Intellectual Property.”

ITEM 1A.

Risk Factors

Our operations and financial results are subject to various risks and uncertainties, including those described below, which could adversely affect our business, financial condition, results of operations, cash flows, and the trading price of our common stock. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business operations. You should carefully consider the risks described below and the other information in this Quarterly Report on Form 10-Q, including our unaudited condensed consolidated financial statements and the related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Risks Related to Our Chapter 11 Petition and Reorganization Process

As a result of the filing of our voluntary petition in U.S. Bankruptcy Court, we are subject to the risks and uncertainties associated with bankruptcy proceedings, and operating under Chapter 11 may restrict our ability to pursue strategic and operational initiatives.

On September 16, 2019, we filed a voluntary petition in the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”) seeking relief under Chapter 11 of Title 11 of the United States Code (the “Bankruptcy Code”). Additionally, on October 16, 2019, the Bankruptcy Court entered the Final Order (I) Authorizing Postpetition Use of Cash Collateral, (II) Granting Adequate Protection, and (III) Granting Related Relief [Docket No. 127] (the “Cash Collateral Order”), which provides, among other things, certain milestone deadlines relating to a sale process, including with respect to (i) filing a sale motion establishing bid procedures with the Bankruptcy Court, (ii) receipt of bids, (iii) obtaining Bankruptcy Court approval of a sale transaction, and (iv) closing a sale transaction.

For the duration of the proceedings under Chapter 11 (the “Chapter 11 Proceeding”), our operations and our ability to execute our business strategy will be subject to the risks and uncertainties associated with bankruptcy. These risks include:

•

our ability to obtain Bankruptcy Court approval with respect to motions filed in the Chapter 11 Proceeding from time to time;

•

our ability to comply with and operate under any cash management orders entered by the Bankruptcy Court from time to time;

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our ability to comply with the Cash Collateral Order;

•

our ability to consummate a strategic transaction, including a sale of all or substantially all of our assets;

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our ability to fund and execute our business plan; and

•

our ability to continue as a going concern.

These risks and uncertainties could affect our business and operations in various ways. For example, negative events or publicity associated with the Chapter 11 Proceeding could adversely affect our relationships with our vendors and employees. In particular, critical vendors may determine not to do business with us due to our Chapter 11 filing and we may not be successful in securing alternative vendors, or we may not be able to retain employees critical to the consummation of a strategic transaction. Our employees face considerable distraction and uncertainty during this process and we have and may continue to experience increased levels of employee attrition. The failure to retain members of our management team and other key personnel could impair our ability to a strategic transaction, thereby having a material adverse effect on the value of our common stock.

Also, transactions outside the ordinary course of business are subject to the prior approval of the Bankruptcy Court and compliance with the Cash Collateral Order, which may limit our ability to take certain actions. Because of the risks and uncertainties associated with the Chapter 11 Proceeding, we cannot predict or quantify the ultimate impact that events occurring during the Chapter 11 Proceeding may have on our business, financial condition and results of operations, and there is no certainty as to our ability to continue as a going concern.

There is no assurance that we will be able to consummate a strategic transaction.

In connection with our Chapter 11 process, we are actively pursuing a variety of strategic transactions. We are devoting significant time and resources to identifying and evaluating a strategic transaction; however, there can be no assurance that such activities will result in any agreements or transactions. Further, even if we enter into a binding agreement, there is no guarantee that the transactions will be consummated due to regulatory or other obstacles, and even if executed and consummated, such strategic or financial alternatives may not enhance stockholder value or our financial position.

If we are not able to consummate a strategic transaction, or are unable to confirm a Chapter 11 plan of reorganization or liquidation, we could be required to liquidate under Chapter 7 of the Bankruptcy Code.

We are pursuing a variety of strategic transactions for the Company, including potentially a sale of all or substantially all of our assets. If we are unable to find a viable strategic partner or are we otherwise unable not able to consummate a strategic transaction, or confirm a Chapter 11 plan of reorganization or liquidation, we could be forced to liquidate under Chapter 7 of the Bankruptcy Code.

Upon a showing of cause, the Bankruptcy Court may convert our Chapter 11 case to a case under Chapter 7 of the Bankruptcy Code. In such event, a Chapter 7 trustee would be appointed or elected to liquidate our assets for distribution in accordance with the priorities established by the Bankruptcy Code. We believe that liquidation under Chapter 7 would result in significantly smaller distributions being made to our creditors than those provided for in a Chapter 11 sale because of the likelihood that the assets would have to be sold or otherwise disposed of in a more distressed fashion over a shorter period of time rather than in a controlled manner, additional administrative expenses involved in the appointment of a Chapter 7 trustee, and additional expenses and claims.

We are not in compliance with the continued listing requirements of Nasdaq and may be subject to delisting.

On September 17, 2019, we received a letter (the “Nasdaq Letter”) from the staff of the Nasdaq Listing Qualifications Department (the “Staff”) notifying us that, as a result of the Chapter 11 Proceeding and in accordance with Nasdaq Listing Rules 5101, 5110(b) and IM-5101-1, the Staff has provided notification to the Company that the Company’s common stock

would be delisted from Nasdaq. We have appealed this determination and a hearing was conducted in front of a Nasdaq Hearing Panel (the “Panel”) on October 17, 2019 and, as of November 11, 2019, we are awaiting the outcome of the appeal process. If Nasdaq determines not to grant our appeal, our common stock will be removed from listing and registration with Nasdaq. Following a delisting from Nasdaq, our common stock would initially be traded over the counter in the OTC Pink Market, but this may not always be the case. The delisting by Nasdaq could result in significantly lower trading volumes and reduced liquidity for investors seeking to buy or sell shares of our common stock. Accordingly, we urge extreme caution with respect to existing and future investments in our equity or other securities.

Trading in our common stock while the Chapter 11 Proceeding is ongoing is highly speculative and poses substantial risks.

If a sale of our assets is consummated or a plan of reorganization is approved in the Chapter 11 Proceeding, it is likely that our existing common stock may be extinguished, and existing equity holders may not receive consideration in respect of their existing equity interests. Further, a delisting of our common stock by Nasdaq could result in significantly lower trading volumes and reduced liquidity for investors seeking to buy or sell shares of our common stock. Accordingly, we urge extreme caution with respect to existing and future investments in our common stock.

If we pursue a Chapter 11 plan of reorganization, our post-bankruptcy capital structure is yet to be determined, and any changes to our capital structure may have a material adverse effect on existing security holders.

If we pursue a Chapter 11 plan of reorganization, our post-bankruptcy capital structure will be set pursuant to a plan that requires Bankruptcy Court approval. Any reorganization of our capital structure may include new debt or equity securities. There can be no assurance that any new debt or equity securities will maintain their value at the time of issuance. If existing debt or equity holders are adversely affected by a reorganization, it may adversely affect our ability to issue new debt or equity in the future.

We may be subject to claims that will not be discharged in our Chapter 11 Proceeding, which could have a material adverse effect on our financial condition and results of operations.

The Bankruptcy Code provides that the confirmation of a Chapter 11 plan of reorganization discharges a debtor from substantially all debts arising prior to confirmation. With few exceptions, all claims that arose prior to confirmation of the plan of reorganization (i) would be subject to compromise and/or treatment under the plan of reorganization and (ii) would be discharged in accordance with the Bankruptcy Code and the terms of the plan of reorganization. Any claims not ultimately discharged through a Chapter 11 plan of reorganization could be asserted against the reorganized entities and may have an adverse effect on our financial condition and results of operations on a post-reorganization basis.

Operating in bankruptcy for a long period of time may harm our business.

A long period of operations under Bankruptcy Court protection could have a material adverse effect on our business, financial condition, results of operations, and liquidity. So long as the Chapter 11 Proceeding continues, management will be required to spend a significant amount of time and effort dealing with the reorganization. A prolonged period of operating under Bankruptcy Court protection also may make it more difficult to retain management and other key personnel necessary to the success of our business. In addition, the longer the Chapter 11 Proceeding continues, the more likely it is that vendors and employees will lose confidence in our ability to reorganize our business successfully.

We incur significant costs as a result of operating as a public company, and our management devotes substantial time to new compliance initiatives. We may fail to comply with the rules that apply to public companies, including Section 404 of the Sarbanes-Oxley Act of 2002, which could result in sanctions or other penalties that would harm our business.

We incur significant legal, accounting and other expenses as a public company, including costs resulting from public company reporting obligations under the Securities Exchange Act of 1934, as amended, and regulations regarding corporate governance practices. The listing requirements of the Nasdaq Global Select Market and the rules of the Securities and Exchange Commission, or SEC, require that we satisfy certain corporate governance requirements relating to director independence, filing annual and interim reports, stockholder meetings, approvals and voting, soliciting proxies, conflicts of interest and a code of conduct. Our management and other personnel devote a substantial amount of time to ensure that we comply with all of these requirements. Moreover, the reporting requirements, rules and regulations will continue to increase our legal and financial compliance costs and make some activities more time-consuming and costly. Any changes we make to comply with these obligations may not be sufficient to allow us to satisfy our obligations as a public company on a timely basis, or at all. These reporting requirements, rules and regulations, coupled with the increase in potential litigation exposure associated with being a public company, could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors or board committees or to serve as executive officers, or to obtain certain types of insurance, including directors’ and officers’ insurance, on acceptable terms.

We are subject to Section 404 of The Sarbanes-Oxley Act of 2002, or Section 404, and the related rules of the SEC, which generally require our management and independent registered public accounting firm to report on the effectiveness of our internal control over financial reporting. Beginning with our most recent Annual Report on Form 10-K, Section 404 requires that we file with the SEC an annual management assessment of the effectiveness of our internal control over financial reporting. However, for so long as we remain an emerging growth company as defined in the JOBS Act, we intend to take advantage of certain exemptions from various reporting requirements that are applicable to public companies that are not emerging growth companies, including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404. Once we are no longer an emerging growth company or, if prior to such date, we opt to no longer take advantage of the applicable exemption, we will be required to include an opinion from our independent registered public accounting firm on the effectiveness of our internal controls over financial reporting. We will remain an emerging growth company until the earlier of (1) the last day of the fiscal year (a) following August 1, 2022, the fifth anniversary of the completion of our IPO, (b) in which we have total annual gross revenue of at least $1.07 billion, or (c) in which we are deemed to be a large accelerated filer, which means the market value of our common stock that is held by non-affiliates exceeds $700.0 million as of the prior June 30th, and (2) the date on which we have issued more than $1.0 billion in non-convertible debt during the prior three-year period.

During the course of our review and testing of our internal control over financial reporting, we may identify deficiencies and be unable to remediate them before we must provide the required reports. Furthermore, if we have a material weakness in our internal controls over financial reporting, we may not detect errors on a timely basis and our financial statements may be materially misstated. We or our independent registered public accounting firm may not be able to conclude on an ongoing basis that we have effective internal control over financial reporting, which could harm our operating results, cause investors to lose confidence in our reported financial information and cause the trading price of our stock to fall. In addition, as a public company we are required to file accurate and timely quarterly and annual reports with the SEC under the Securities Exchange Act of 1934, as amended. In order to report our results of operations and financial statements on an accurate and timely basis, we will depend, in part, on CROs to provide timely and accurate notice of their costs to us. Any failure to report our financial results on an accurate and timely basis could result in sanctions, lawsuits, delisting of our shares from the Nasdaq Global Select Market or other adverse consequences that would materially harm our business.

Our stock price may be volatile and you may not be able to resell shares of our common stock at or above the price you paid.

The trading price of our common stock could be highly volatile and could be subject to wide fluctuations in response to various factors, some of which are beyond our control. These factors include those discussed in this “Risk Factors” section and others such as:

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results from, and any delays in or suspension of, our clinical trials for our lead product candidates, or any other future clinical development programs, including as a result of unforeseen safety events or side effects;

•

announcements of regulatory approval or disapproval of our current or any future product candidates;

•

failure or discontinuation of any of our research and development programs;

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announcements of capital raising events or activities;

•

announcements relating to future licensing, collaboration or development agreements;

•

delays in the commercialization of our current or any future product candidates;

•

acquisitions and sales of new products, technologies or businesses;

•

manufacturing and supply issues related to our product candidates for clinical trials or future product candidates for commercialization;

•

results or announcements (if any) from, or any delays in, our exploration of financial or strategic alternatives for the Company focusing on maximizing stockholder value and the timing and nature of any strategic transactions that we undertake (if any);

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quarterly variations in our results of operations or those of our future competitors;

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changes in earnings estimates or recommendations by securities analysts;

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announcements by us or our competitors of new products, significant contracts, commercial relationships, acquisitions or capital commitments;

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developments with respect to intellectual property rights;

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our commencement of, or involvement in, litigation;

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changes in financial estimates or guidance, including our ability to meet our future revenue and operating profit or loss estimates or guidance;

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any major changes in our board of directors or management;

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new legislation in the United States, or governmental announcements of proposed legislation, relating to the sale or pricing of pharmaceuticals;

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FDA or other U.S. or foreign regulatory actions affecting us or our industry;

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product liability claims or other litigation or public concern about the safety of our product candidates;

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market conditions in the pharmaceutical, biopharmaceutical and biotechnology sectors;

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ability to meet Nasdaq minimum listing requirements; and

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general economic conditions in the United States and abroad.

In addition, the stock markets in general, and the markets for pharmaceutical, biopharmaceutical, medical device and biotechnology stocks in particular, have experienced extreme volatility that may have been unrelated to the operating performance of the issuer. These broad market fluctuations may adversely affect the trading price or liquidity of our common stock. In the past, when the market price of a stock has been volatile, holders of that stock have sometimes instituted securities class action litigation against the issuer. If any of our stockholders were to bring such a lawsuit against us, we could incur substantial costs defending the lawsuit and the attention of our management would be diverted from the operation of our business.

An active market for our common stock may not be maintained.

Prior to our IPO in July 2017, there had been no public market for shares of our common stock. Our stock only recently began trading on the Nasdaq Global Select Market, but we can provide no assurance that we will be able to maintain an active trading market on the Nasdaq Global Select Market or any other exchange in the future. If an active market for our common stock does not develop or is not maintained, it may be difficult for our stockholders to sell shares without depressing the market price for the shares or at all. An inactive market may also impair our ability to raise capital by selling shares and may impair our ability to acquire other businesses, applications or technologies using our shares as consideration.

If securities or industry analysts do not publish research or reports about our business, or if they issue an adverse or misleading opinion regarding our stock, our stock price and trading volume could decline.

The trading market for our common stock is influenced by the research and reports that industry or securities analysts publish about us or our business. We currently have very limited research coverage by securities and industry analysts. If no additional securities or industry analysts commence coverage of us, the trading price or trading volume for our stock could be negatively impacted. If any of the analysts who cover us issue an adverse or misleading opinion regarding us, our business model, our intellectual property or our stock performance, or if our clinical trials and operating results fail to meet the expectations of analysts, our stock price would likely decline. If one or more of these analysts cease coverage of us or fail to publish reports on us regularly, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline.

Our principal stockholders and management own a significant percentage of our stock and will be able to exert significant control over matters subject to stockholder approval.

Based on the number of shares outstanding as of September 30, 2019, our executive officers, directors, holders of 5% or more of our capital stock and their respective affiliates beneficially owned approximately 42.73% of our voting stock. These stockholders will have the ability to influence us through this ownership position. These stockholders may be able to determine all matters requiring stockholder approval. For example, these stockholders may be able to control elections of directors, amendments of our organizational documents, or approval of any merger, sale of assets, or other major corporate transaction. This may prevent or discourage unsolicited acquisition proposals or offers for our common stock that you may feel are in your best interest as one of our stockholders.

Our ability to use our net operating loss carryforwards and certain other tax attributes may be limited.

We have incurred substantial losses during our history and do not expect to become profitable in the near future, and we may never achieve profitability. To the extent that we continue to generate taxable losses, unused losses will carry forward to offset future taxable income, if any, until such unused losses expire. Under Sections 382 and 383 of the Internal Revenue Code of 1986, as amended, 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, or NOLs, and other pre-change tax attributes (such as research and development tax credits) to offset its

post-change income or taxes may be limited. We may have experienced ownership changes in the past and may experience ownership changes in the future and/or subsequent shifts in our stock ownership (some of which shifts are outside our control). As a result, if we earn net taxable income, our ability to use our pre-change NOLs to offset such taxable income could be subject to limitations. Similar provisions of state tax law may also apply. As a result, even if we attain profitability, we may be unable to use a material portion of our NOLs and other tax attributes.

Provisions in our charter documents and under Delaware law could discourage a takeover that stockholders may consider favorable and may lead to entrenchment of management.

Our amended and restated certificate of incorporation and amended and restated bylaws contain provisions that could delay or prevent changes in control or changes in our management without the consent of our board of directors. These provisions will include the following:

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a classified board of directors with three-year staggered terms, which may delay the ability of stockholders to change the membership of a majority of our board of directors;

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no cumulative voting in the election of directors, which limits the ability of minority stockholders to elect director candidates;

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the exclusive right of our board of directors to elect a director to fill a vacancy created by the expansion of the board of directors or the resignation, death or removal of a director, which prevents stockholders from being able to fill vacancies on our board of directors;

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the ability of our board of directors to authorize the issuance of shares of preferred stock and to determine the price and other terms of those shares, including preferences and voting rights, without stockholder approval, which could be used to significantly dilute the ownership of a hostile acquiror;

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the ability of our board of directors to alter our bylaws without obtaining stockholder approval;

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the required approval of at least 66 2/3% of the shares entitled to vote at an election of directors to adopt, amend or repeal our bylaws or repeal the provisions of our amended and restated certificate of incorporation regarding the election and removal of directors;

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a prohibition on stockholder action by written consent, which forces stockholder action to be taken at an annual or special meeting of our stockholders;

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the requirement that a special meeting of stockholders may be called only by the chief executive officer or the president or the board of directors, which may delay the ability of our stockholders to force consideration of a proposal or to take action, including the removal of directors; and

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advance notice procedures that stockholders must comply with in order to nominate candidates to our board of directors or to propose matters to be acted upon at a stockholders’ meeting, which may discourage or deter a potential acquiror from conducting a solicitation of proxies to elect the acquiror’s own slate of directors or otherwise attempting to obtain control of us.

In addition, these provisions would apply even if we were to receive an offer that some stockholders may consider beneficial.

We are also subject to the anti-takeover provisions contained in Section 203 of the Delaware General Corporation Law. Under Section 203, a corporation may not, in general, engage in a business combination with any holder of 15% or more of its capital stock unless the holder has held the stock for three years or, among other exceptions, the board of directors has approved the transaction.

Claims for indemnification by our directors and officers may reduce our available funds to satisfy successful third-party claims against us and may reduce the amount of money available to us.

Our amended and restated certificate of incorporation and amended and restated bylaws provide that we will indemnify our directors and officers, in each case to the fullest extent permitted by Delaware law.

In addition, as permitted by Section 145 of the Delaware General Corporation Law, our amended and restated bylaws and the indemnification agreements that we have entered into with our directors and officers provide that:

•

We will indemnify our directors and officers for serving us in those capacities or for serving other business enterprises at our request, to the fullest extent permitted by Delaware law. Delaware law provides that a corporation may indemnify such person if such person acted in good faith and in a manner such person reasonably believed to be in or not opposed to the best interests of the registrant and, with respect to any criminal proceeding, had no reasonable cause to believe such person’s conduct was unlawful.

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We may, in our discretion, indemnify employees and agents in those circumstances where indemnification is permitted by applicable law.

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We are required to advance expenses, as incurred, to our directors and officers in connection with defending a proceeding, except that such directors or officers shall undertake to repay such advances if it is ultimately determined that such person is not entitled to indemnification.

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We will not be obligated pursuant to our amended and restated bylaws to indemnify a person with respect to proceedings initiated by that person against us or our other indemnitees, except with respect to proceedings authorized by our board of directors or brought to enforce a right to indemnification.

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The rights conferred in our amended and restated bylaws are not exclusive, and we are authorized to enter into indemnification agreements with our directors, officers, employees and agents and to obtain insurance to indemnify such persons.

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We may not retroactively amend our amended and restated bylaw provisions to reduce our indemnification obligations to directors, officers, employees and agents.

Our certificate of incorporation provides that the Court of Chancery of the State of Delaware will be the exclusive forum for substantially all disputes between us and our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers or employees.

Our amended and restated certificate of incorporation provides that the Court of Chancery of the State of Delaware is the exclusive forum for any derivative action or proceeding brought on our behalf, any action asserting a breach of fiduciary duty, any action asserting a claim against us arising pursuant to the Delaware General Corporation Law, our certificate of incorporation or our bylaws, any action to interpret, apply, enforce, or determine the validity of our certificate of incorporation or bylaws, or any action asserting a claim against us that is governed by the internal affairs doctrine. The choice of forum provision may limit a stockholder’s ability to bring a claim in a judicial forum that it finds favorable for disputes with us or our directors, officers or other employees, which may discourage such lawsuits against us and our directors, officers and other employees. Alternatively, if a court were to find the choice of forum provision contained in our certificate of incorporation to be inapplicable or unenforceable in an action, we may incur additional costs associated with resolving such action in other jurisdictions, which could adversely affect our business and financial condition.

ITEM 2.

Unregistered Sales of Equity Securities and Use of Proceeds

Covenants in our loan and security agreement with Silicon Valley Bank limit our ability to pay dividends (or make other distributions) without Silicon Valley Bank’s consent. For additional information refer to Note 8, “ SVB Loan Agreement” in the notes to our unaudited condensed consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q.

Unregistered Sales of Equity Securities

Information relating to the issuance of warrants to purchase shares of our common stock in January 2019 was included in our Current Report on Form 8-K (File No. 001-38155) filed with the U.S. Securities and Exchange Commission, or SEC, on January 30, 2019, and is accordingly omitted. No other equity securities of the Company that were not registered under the Securities Act were sold during the nine months ended September 30, 2019.

Use of Proceeds

Not applicable.

Issuer Purchases of Equity Securities

None.

ITEM 3.

Defaults Upon Senior Securities

None.

ITEM 4.

Mine Safety Disclosures

Not applicable.

ITEM 5.

Other Information

None.

ITEM 6.

EXHIBITS


Exhibit Number		Incorporated by Reference			Filed
Exhibit Number	Exhibit Description	Form	Date	Number	Herewith

3.1	Amended and Restated Certificate of Incorporation, as amended.	8-K	8-1-2017	3.1

3.2	Amended and Restated Bylaws.	8-K	8-1-2017	3.2

4.1	Reference is made to exhibits 3.1 through 3.2.

4.2	Form of Common Stock Certificate.	S-1/A	7-17-2017	4.2

10.1#	Management Retention Plan Letter by and between Sienna Biopharmaceuticals, Inc. and Frederick C. Beddingfield III, dated as of September 11, 2019.				X

10.2#	Management Retention Plan Letter by and between Sienna Biopharmaceuticals, Inc. and Alexander Azoy, dated as of September 11, 2019.				X

10.3#	Management Retention Plan Letter by and between Sienna Biopharmaceuticals, Inc. and Paul Lizzul, dated as of September 11, 2019.				X

10.4#	Management Retention Plan Letter by and between Sienna Biopharmaceuticals, Inc. and Timothy K. Andrews, dated as of September 11, 2019.				X

10.5#	Key Employee Incentive Bonus Plan Letter by and between Sienna Biopharmaceuticals, Inc. and Frederick C. Beddingfield III, dated as of September 11, 2019.				X

10.6#	Key Employee Incentive Bonus Plan Letter by and between Sienna Biopharmaceuticals, Inc. and Alexander Azoy, dated as of September 11, 2019.				X

10.7#	Key Employee Incentive Bonus Plan Letter by and between Sienna Biopharmaceuticals, Inc. and Paul Lizzul, dated as of September 11, 2019.				X

10.8#	Key Employee Incentive Bonus Plan Letter by and between Sienna Biopharmaceuticals, Inc. and Timothy K. Andrews, dated as of September 11, 2019.				X

10.9#	Key Employee Retention Plan				X

10.10#	Separation and General Release Agreement by and between Sienna Biopharmaceuticals, Inc. and Diane Stroehmann, dated as of August 1, 2019

31.1	Certification of Chief Executive Officer of Sienna Biopharmaceuticals, Inc., as required by Rule 13a-14(a) or Rule 15d-14(a) under the Securities Exchange Act of 1934, as amended.				X


Exhibit Number		Incorporated by Reference			Filed
Exhibit Number	Exhibit Description	Form	Date	Number	Herewith

31.2	Certification of Chief Financial Officer of Sienna Biopharmaceuticals, Inc., as required by Rule 13a-14(a) or Rule 15d-14(a) under the Securities Exchange Act of 1934, as amended.				X

32.1*	Certification by the Chief Executive Officer and Chief Financial Officer, as required by Rule 13a-14(b) or Rule 15d-14(b) under the Securities Exchange Act of 1934, as amended, and Section 1350 of Chapter 36 of Title 18 of the United States Code (18 U.S.C. §1350).				X

101.INS	XBRL Instance Document				X

101.SCH	XBRL Taxonomy Extension Schema Document				X

101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document				X

101.DEF	XBRL Taxonomy Extension Definition Linkbase Document				X

101.LAB	XBRL Taxonomy Extension Labels Linkbase Document				X

101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document				X

#	Indicates management contract or compensatory plan.

The certification attached as Exhibit 32.1 that accompanies this Quarterly Report on Form 10-Q is not deemed filed with the SEC and is not to be incorporated by reference into any filing of Sienna Biopharmaceuticals, Inc. under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date of this Form 10-Q, irrespective of any general incorporation language contained in such filing.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this Quarterly Report to be signed on its behalf by the undersigned, thereunto duly authorized.


	Sienna Biopharmaceuticals, Inc.

Date: November 12, 2019	By:	/s/ Alexander Azoy
		Alexander Azoy Chief Financial Officer (Principal Financial Officer)

Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller reporting company

Emerging growth company

Sienna Biopharmaceuticals, Inc. 10-Q