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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 June 30, 2020
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For transition period from to
Commission File Number: 001-39186
ARCUTIS BIOTHERAPEUTICS, INC.
(Exact name of registrant as specified in its charter)
Delaware
(State or Other Jurisdiction of Incorporation or Organization)
81-2974255
(I.R.S. Employer Identification Number)
2945 Townsgate Road Suite 110
Westlake Village, California
(Address of Principal Executive Offices)
91361
(Zip Code)
(805) 418-5006
(Registrant's telephone number, including area code)

Not Applicable
(Former name, former address and former fiscal year, if changed since last report)

Securities registered pursuant to Section 12(b) of the Act:
Title of each class Trading Symbol Name of each exchange on which registered
Common Stock, par value $0.0001 ARQT 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.
Large accelerated filer Accelerated filer
Non-accelerated filer Smaller reporting company
Emerging growth company
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
The number of shares of the registrant’s Common Stock outstanding as of August 1, 2020 was 38,189,287.

1

INDEX
Page
1
1
2
3
5
6



PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
ARCUTIS BIOTHERAPEUTICS, INC.
Condensed Balance Sheets
(In thousands, except share and par value)
June 30, December 31,
2020 2019
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 171,546    $ 63,336   
Marketable securities 52,429    37,929   
Prepaid expenses and other current assets 4,060    5,209   
Total current assets 228,035    106,474   
Property, plant, and equipment, net 228    227   
Operating lease right-of-use asset 3,629    264   
Other assets 78    47   
Total assets $ 231,970    $ 107,012   
LIABILITIES, CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS’ EQUITY (DEFICIT)
Current liabilities:
Accounts payable $ 8,253    $ 1,405   
Accrued liabilities 10,948    3,654   
Operating lease liability 80    178   
Total current liabilities 19,281    5,237   
Operating lease liability, noncurrent 3,610    129   
Other long-term liabilities 156    184   
Total liabilities 23,047    5,550   
Commitments and contingencies (Note 6)
Convertible preferred stock, $0.0001 par value; no shares and 48,787,898 shares authorized at June 30, 2020 and December 31, 2019, respectively; no shares and 24,385,388 shares issued and outstanding at June 30, 2020 and December 31, 2019, respectively
—    166,491   
Stockholders’ equity (deficit):
Preferred stock, $0.0001 par value; 10,000,000 and no shares authorized at June 30, 2020 and December 31, 2019, respectively; no shares issued and outstanding at June 30, 2020 and December 31, 2019;
—    —   
Common stock, $0.0001 par value; 300,000,000 and 65,820,000 shares authorized at June 30, 2020 and December 31, 2019, respectively; 38,189,287 and 2,879,763 shares issued at June 30, 2020 and December 31, 2019, respectively; 37,690,058 and 2,120,853 shares outstanding at June 30, 2020 and December 31, 2019, respectively
  —   
Additional paid-in capital 338,617    1,244   
Accumulated other comprehensive income (loss) —    (1)  
Accumulated deficit (129,697)   (66,272)  
Total stockholders’ equity (deficit) 208,923    (65,029)  
Total liabilities, convertible preferred stock and stockholders’ equity (deficit) $ 231,970    $ 107,012   
The accompanying notes are an integral part of these unaudited condensed financial statements.
1

ARCUTIS BIOTHERAPEUTICS, INC.
Condensed Statements of Operations and Comprehensive Loss
(In thousands, except share and per share data)
(unaudited)
Three Months Ended June 30, Six Months Ended June 30,
2020 2019 2020 2019
Operating expenses:
Research and development
$ 30,009    $ 7,214    $ 55,191    $ 13,417   
General and administrative
5,618    1,324    9,087    2,073   
Total operating expenses
35,627    8,538    64,278    15,490   
Loss from operations
(35,627)   (8,538)   (64,278)   (15,490)  
Other income, net 215    248    853    542   
Net loss
$ (35,412)   $ (8,290)   $ (63,425)   $ (14,948)  
Other comprehensive income (loss):
Unrealized gain (loss) on marketable securities (19)        
Comprehensive loss $ (35,431)   $ (8,288)   $ (63,424)   $ (14,945)  
Per share information:
Net loss per share, basic and diluted
$ (0.94)   $ (4.69)   $ (2.05)   $ (8.79)  
Weighted-average shares used in computing net loss per share, basic and diluted 37,587,330    1,767,658    30,921,866    1,700,549   
The accompanying notes are an integral part of these unaudited condensed financial statements.
2


ARCUTIS BIOTHERAPEUTICS, INC.
Condensed Statements of Convertible Preferred Stock and Stockholders’ Equity (Deficit)
(In thousands, except share data)
(unaudited)
Convertible
Preferred Stock
Common Stock Additional
Paid-In
Capital
Accumulated Other Comprehensive Income (Loss) Accumulated
Deficit
Total Stockholders’ Equity (Deficit)
Shares Amount Shares Amount
Balance—December 31, 2018 16,262,425    $ 72,252    1,557,900    $ —    $ 289    $ —    $ (24,276)   $ (23,987)  
Vesting of founder shares subject to repurchase —    —    68,931    —    —    —    —    —   
Lapse of repurchase rights related to common stock issued pursuant to early exercises —    —    65,868    —    29    —    —    29   
Stock-based compensation expense —    —    —    —    76    —    —    76   
Unrealized gain on short term investments —    —    —    —    —      —     
Net Loss —    —    —    —    —    —    (6,658)   (6,658)  
Balance—March 31, 2019 16,262,425    $ 72,252    1,692,699    $ —    $ 394    $   $ (30,934)   $ (30,539)  
Vesting of founder shares subject to repurchase —    —    68,931    —    —    —    —    —   
Lapse of repurchase rights related to common stock issued pursuant to early exercises —    —    65,868    —    29    —    —    29   
Stock-based compensation expense —    —    —    —    139    —    —    139   
Unrealized gain on short term investments —    —    —    —    —      —     
Net Loss —    —    —    —    —    —    (8,290)   (8,290)  
Balance—June 30, 2019 16,262,425    $ 72,252    1,827,498    $ —    $ 562    $   $ (39,224)   $ (38,659)  
The accompanying notes are an integral part of these unaudited condensed financial statements
3

ARCUTIS BIOTHERAPEUTICS, INC.
Condensed Statements of Convertible Preferred Stock and Stockholders’ Equity (Deficit)
(In thousands, except share data)
(unaudited)
Convertible
Preferred Stock
Common Stock Additional
Paid-In
Capital
Accumulated Other Comprehensive Income (Loss) Accumulated
Deficit
Total Stockholders’ Equity (Deficit)
Shares Amount Shares Amount
Balance—December 31, 2019 24,385,388    $ 166,491    2,120,853    $ —    $ 1,244    $ (1)   $ (66,272)   $ (65,029)  
Conversion of preferred stock into common stock upon initial public offering (24,385,388)   (166,491)   24,385,388      166,489    —    —    166,491   
Issuance of shares of common stock, net of issuance costs of $16.0 million
—    —    10,781,250      167,240    —    —    167,241   
Issuance of common stock upon the exercise of stock options —    —    51,147    —    152    —    —    152   
Vesting of founder shares subject to repurchase —    —    68,931    —    —    —    —    —   
Lapse of repurchase rights related to common stock issued pursuant to early exercises —    —    64,428    —    30    —    —    30   
Stock-based compensation expense —    —    —    —    990    —    —    990   
Unrealized gain on short term investments —    —    —    —    —    20    —    20   
Net Loss —    —    —    —    —    —    (28,013)   (28,013)  
Balance—March 31, 2020 —    $ —    37,471,997    $   $ 336,145    $ 19    $ (94,285)   $ 241,882   
Issuance of common stock upon the exercise of stock options —    —    14,875    —    25    —    —    25   
Vesting of founder shares subject to repurchase —    —    68,932    —    —    —    —    —   
Lapse of repurchase rights related to common stock issued pursuant to early exercises —    —    114,392    —    111    —    —    111   
Shares issued pursuant to the employee stock purchase plan —    —    19,862    —    287    —    —    287   
Stock-based compensation expense —    —    —    —    2,049    —    —    2,049   
Unrealized gain on short term investments —    —    —    —    —    (19)   —    (19)  
Net Loss —    —    —    —    —    —    (35,412)   (35,412)  
Balance—June 30, 2020 —    $ —    37,690,058    $   $ 338,617    $ —    $ (129,697)   $ 208,923   
The accompanying notes are an integral part of these unaudited condensed financial statements.
4

ARCUTIS BIOTHERAPEUTICS, INC.
Condensed Statements of Cash Flows
(In thousands)
(unaudited)
Six Months Ended June 30,
2020 2019
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (63,425)   $ (14,948)  
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation 57    25   
Non-cash lease expense 65    55   
Net amortization/accretion on marketable securities (336)   (293)  
Stock-based compensation 3,039    215   
Changes in operating assets and liabilities:
Prepaid expenses and other current assets (629)   (1,576)  
Other assets —    (47)  
Accounts payable 6,910    225   
Accrued liabilities 7,595    1,029   
Operating lease liabilities (47)   (2)  
Net cash used in operating activities (46,771)   (15,317)  
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of marketable securities (62,763)   (22,897)  
Proceeds from maturities of marketable securities 48,600    11,700   
Purchases of property and equipment (58)   (225)  
Net cash used in investing activities (14,221)   (11,422)  
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock upon exercise of stock options 273    168   
Proceeds from initial public offering, net of issuance costs 168,642    —   
Proceeds from issuance of common stock for ESPP purchase 287    —   
Net cash provided by financing activities 169,202    168   
Net increase (decrease) in cash and cash equivalents 108,210    (26,571)  
Cash and cash equivalents at beginning of period 63,336    39,394   
Cash and cash equivalents at end of period $ 171,546    $ 12,823   
SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING INFORMATION:
Right-of-use asset obtained in exchange for lease liability $ 3,645    $ 391   
Reduction in right-of-use asset upon reassessment of lease term $ 139    $ —   
The accompanying notes are an integral part of these unaudited condensed financial statements.









5

ARCUTIS BIOTHERAPEUTICS, INC.
Notes to Condensed Financial Statements
(unaudited)


1. Organization and Description of Business
Arcutis Biotherapeutics, Inc., or the Company, is a late-stage biopharmaceutical company focused on developing and commercializing treatments for dermatological diseases with high unmet medical needs. The Company’s current portfolio is comprised of topical treatments with significant promise in addressing immune-mediated dermatological diseases and conditions, or immuno-dermatology. The Company’s strategy is to advance treatments that leverage validated biological targets in dermatology in order to deliver clinical profiles that address major shortcomings of existing therapies in its targeted indications. The Company believes this strategy uniquely positions it to rapidly advance its goal of bridging the treatment innovation gap in dermatology while maximizing its probability of technical success.
On January 17, 2020, the Company's board of directors approved a 1-for-2.0007 reverse stock split of the Company’s capital stock and the Company filed a certificate of amendment to its restated certificate of incorporation to effect the split. The par value and authorized shares of common stock and convertible preferred stock were not adjusted as a result of the reverse split. All share and per share information included in the accompanying financial statements has been adjusted to reflect this reverse stock split.
Initial Public Offering
On February 4, 2020, the Company closed an initial public offering (IPO), issuing and selling 10,781,250 shares of common stock at a public offering price of $17.00 per share, including 1,406,250 shares sold pursuant to the underwriters’ full exercise of their option to purchase additional shares. The aggregate net proceeds received by the Company from the offering were approximately $167.2 million, after deducting underwriting discounts, commissions and offering related transaction costs. Upon the closing of the IPO, all of the outstanding shares of convertible preferred stock automatically converted into shares of common stock. Subsequent to the closing of the IPO, there were no shares of convertible preferred stock outstanding. The financial statements as of June 30, 2020, including share and per share amounts, incorporate the effects of the IPO.

Liquidity
The Company has incurred significant losses and negative cash flows from operations since its inception and had an accumulated deficit of $129.7 million and $66.3 million as of June 30, 2020 and December 31, 2019, respectively. The Company had cash, cash equivalents and marketable securities of $224.0 million and $101.3 million as of June 30, 2020 and December 31, 2019, respectively. Prior to selling common stock in its IPO, the Company had historically financed its operations primarily through the sale of its convertible preferred stock. Management expects operating losses to continue for the foreseeable future.
The Company believes that its existing capital resources will be sufficient to meet the projected operating requirements for at least 12 months from the date of issuance of its financial statements. The Company will be required to raise additional capital to fund future operations. However, no assurance can be given as to whether additional needed financing will be available on terms acceptable to the Company, if at all. If sufficient funds on acceptable terms are not available when needed, the Company may be required to curtail planned activities to significantly reduce its operating expenses. Failure to manage discretionary spending or raise additional financing, as needed, may adversely impact the Company’s ability to achieve its intended business objectives and have an adverse effect on its results of operations and future prospects.
Coronavirus Outbreak
In March 2020, the World Health Organization declared a pandemic related to the global novel coronavirus disease 2019 (COVID-19) outbreak. As of August 11, 2020, the Company’s operations have not been significantly impacted by the COVID-19 pandemic. The Company is monitoring the potential impact COVID-19 may have on the clinical development of its product candidates, including potential delays or modifications to its ongoing and planned trials. However, the Company cannot at this time predict the specific extent, duration, or full impact that the COVID-19 outbreak will have on its financial condition and operations, including ongoing and planned clinical trials.
6

ARCUTIS BIOTHERAPEUTICS, INC.
Notes to Condensed Financial Statements
(unaudited)
2. Summary of Significant Accounting Policies
Basis of Presentation
The Company’s condensed financial statements have been prepared in accordance with United States generally accepted accounting principles, or U.S. GAAP.
Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the condensed financial statements and accompanying notes. On an ongoing basis, management evaluates such estimates and assumptions for continued reasonableness. In particular, management makes estimates with respect to accruals for research and development activities, fair value of common stock and convertible preferred stock (prior to the IPO completed in January 2020), stock-based compensation expense and income taxes. Appropriate adjustments, if any, to the estimates used are made prospectively based upon such periodic evaluation. Actual results could differ from those estimates.
Segments
To date, the Company has viewed its financial information on an aggregate basis for the purposes of evaluating financial performance and allocating the Company’s resources. Accordingly, the Company has determined that it operates in one segment.
Unaudited Interim Condensed Financial Statements
The interim condensed balance sheet as of June 30, 2020, the interim condensed statements of operations and comprehensive loss and the condensed changes in convertible preferred stock and stockholders’ equity (deficit) for the three and six months ended June 30, 2020 and 2019, and cash flows for the six months ended June 30, 2020 and 2019 are unaudited. These unaudited interim condensed financial statements have been prepared on the same basis as the Company’s audited annual financial statements and, in the opinion of management, reflect all adjustments (consisting only of normal recurring adjustments) that are necessary for a fair statement of the Company’s financial information. The financial data and the other financial information disclosed in these notes to the condensed financial statements related to the three- and six-month periods are also unaudited. The condensed results of operations for the three and six months ended June 30, 2020 are not necessarily indicative of the results to be expected for the year ending December 31, 2020 or for any other future annual or interim period. The condensed balance sheet as of December 31, 2019 included herein was derived from the audited financial statements as of that date. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with U.S. GAAP have been condensed or omitted. Therefore, these unaudited interim condensed financial statements should be read in conjunction with the Company’s audited financial statements included in its Annual Report on Form 10-K for the year ended December 31, 2019.
Cash and Cash Equivalents
The Company considers all highly liquid investments purchased with original maturities of three months or less from the purchase date to be cash equivalents. Cash equivalents consist primarily of money market funds, commercial paper, and government securities.
Marketable Securities
Marketable securities consist of investment grade short to intermediate-term fixed income investments that have been classified as available-for-sale and are carried at estimated fair value as determined based upon quoted market prices or pricing models for similar securities. Management determines the appropriate classification of its investments in fixed income securities at the time of purchase. Available-for-sale securities with original maturities beyond three months at the date of purchase are classified as current based on their availability for use in current operations.
Unrealized gains and losses are excluded from earnings and are reported as a component of other comprehensive loss. Realized gains and losses as well as credit losses, if any, on marketable securities are included in other income (expense), net. The Company evaluated the underlying credit quality and credit ratings of
7

ARCUTIS BIOTHERAPEUTICS, INC.
Notes to Condensed Financial Statements
(unaudited)
the issuers during the period. To date, no such credit losses have occurred or have been recorded. The cost of investments sold is based on the specific-identification method. As of June 30, 2020, there were no unrealized gains or losses on marketable securities, and as of December 31, 2019, there were unrealized losses on marketable securities of $1,000. Unrealized gains and losses on marketable securities are reported as a component of accumulated other comprehensive income (loss) on the balance sheets. There were no realized gains or losses on investments for the three and six months ended June 30, 2020 and 2019. Interest on marketable securities is included in Other income (expense), net.
Concentration of Credit Risk and Other Risks and Uncertainties
Financial instruments that potentially subject the Company to significant concentrations of credit risk consist primarily of cash, cash equivalents and marketable securities. The Company maintains deposits in federally insured financial institutions in excess of federally insured limits. The Company is exposed to credit risk in the event of a default by the financial institutions holding its cash to the extent recorded on the balance sheets.
Management believes the Company is not exposed to significant credit risk due to the financial position of the depository institutions in which those deposits are held.
Fair Value Measurement
The Company’s financial instruments, in addition to those presented in Note 3 Fair Value Measurements, include cash equivalents, accounts payable and accrued liabilities. The carrying amount of cash equivalents, accounts payable and accrued liabilities approximate their fair values due to their short maturities.
Assets and liabilities recorded at fair value on a recurring basis on the balance sheets are categorized based upon the level of judgment associated with the inputs used to measure their fair values. Fair value is defined as the exchange price that would be received for an asset or an exit price that would be paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. The authoritative guidance on fair value measurements establishes a three-tier fair value hierarchy for disclosure of fair value measurements as follows:
Level 1—Observable inputs such as unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date;
Level 2—Inputs (other than quoted prices included in Level 1) are either directly or indirectly observable for the asset or liability. These include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active;
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.
Leases

The Company determines if an arrangement is or contains a lease at inception. Right-of-use (ROU) assets represent the Company’s right to use an underlying asset for the lease term and lease liabilities represent the Company’s obligation to make lease payments arising from the lease. The classification of the Company’s leases as operating or finance leases along with the initial measurement and recognition of the associated ROU assets and lease liabilities is performed at the lease commencement date. The measurement of lease liabilities is based on the present value of future lease payments over the lease term. The Company uses its incremental borrowing rate, based on the information available at commencement date, to determine the present value of lease payments when its leases do not provide an implicit rate. The Company uses the implicit rate when readily determinable. The ROU asset is based on the measurement of the lease liability, includes any lease payments made prior to or on lease commencement and excludes lease incentives and initial direct costs incurred, as applicable. Lease expense for the Company’s operating leases is recognized on a straight-line basis over the lease term. The Company considers a lease term to be the non-cancelable period that it has the right to use the underlying asset, including any periods
8

ARCUTIS BIOTHERAPEUTICS, INC.
Notes to Condensed Financial Statements
(unaudited)
where it is reasonably assured the Company will exercise the option to extend the contract. Periods covered by an option to extend are included in the lease term if the lessor controls the exercise of that option.

The Company’s lease agreements includes lease and non-lease components and the Company has elected to not separate such components for all classes of assets. Further, the Company elected the short-term lease exception policy, permitting it to not apply the recognition requirements of this standard to leases with terms of 12 months or less (short-term leases) for all classes of assets.
Preclinical and Clinical Accruals and Costs
The Company records accrued liabilities for estimated costs of research and development activities conducted by third-party service providers, which include the conduct of preclinical studies, clinical trials and contract manufacturing activities. These costs are a significant component of the Company’s research and development expenses. The Company accrues for these costs based on factors such as estimates of the work completed and in accordance with agreements established with its third-party service providers under the service agreements. The Company makes significant judgments and estimates in determining the accrued liabilities balance in each reporting period. As actual costs become known, the Company adjusts its accrued liabilities. For the three and six months ended June 30, 2020 and 2019, the Company has not experienced any material differences between accrued costs and actual costs incurred.
Convertible Preferred Stock
Prior to its IPO, the Company classified its outstanding convertible preferred stock outside of stockholders’ equity (deficit) on its balance sheets as the requirements of triggering a deemed liquidation event, as defined within its amended and restated certificate of incorporation, were not entirely within the Company’s control. In the event of such a deemed liquidation event, the proceeds from the event were to be distributed in accordance with the liquidation preferences, provided that the holders of convertible preferred stock had not converted their shares into common stock. The Company recorded the issuance of convertible preferred stock at the issuance price less related issuance costs. The Company did not adjust the carrying values of the convertible preferred stock to the liquidation preferences of such shares because of the uncertainty as to whether or when a deemed liquidation event may have occurred. In connection with the IPO in February 2020, the Company’s outstanding shares of convertible preferred stock were automatically converted into 24,385,388 shares of common stock.
Research and Development
Research and development expenses include costs directly attributable to the conduct of research and development programs, including the cost of salaries, payroll taxes, employee benefits, license fees, stock-based compensation expense, materials, supplies, and the cost of services provided by outside contractors. All costs associated with research and development are expensed as incurred. Payments made prior to the receipt of goods or services to be used in research and development are capitalized until the goods are received or services are rendered. Such payments are evaluated for current or long-term classification based on when they will be realized.
The Company has entered into and may continue to enter into, license agreements to access and utilize certain technology. In each case, the Company evaluates if the license agreement results in the acquisition of an asset or a business. To date none of the Company’s license agreements have been considered an acquisition of a business. For asset acquisitions, the upfront payments to acquire such licenses, as well as any future milestone payments made before product approval that do not meet the definition of a derivative, are immediately recognized as research and development expense when paid or become payable, provided there is no alternative future use of the rights in other research and development projects.
Stock-Based Compensation
The Company accounts for share-based payments at fair value. The fair value of stock options is measured using the Black-Scholes option-pricing model. For share-based awards that vest subject to the satisfaction of a service requirement, the fair value measurement date for such awards is the date of grant and the expense is recognized on a straight-line basis, over the expected vesting period. For share-based awards that vest subject to a
9

ARCUTIS BIOTHERAPEUTICS, INC.
Notes to Condensed Financial Statements
(unaudited)
performance condition, the Company will recognize compensation cost for awards if and when the Company concludes that it is probable that the awards with a performance condition will be achieved on an accelerated attribution method. The Company accounts for forfeitures as they occur.
Income Taxes
Income taxes are accounted for using the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period of enactment. The Company records a valuation allowance to reduce deferred tax assets to an amount for which realization is more likely than not. Due to the Company’s historical operating performance and the recorded cumulative net losses in prior fiscal periods, the net deferred tax assets have been fully offset by a valuation allowance.

The Company recognizes the tax benefit from an uncertain tax position if it is more likely than not that the tax position will be sustained upon examination by the tax authorities, based on the merits of the position. The Company’s policy is to recognize interest and penalties related to the underpayment of income taxes as a component of income tax expense or benefit. To date, there have been no interest or penalties incurred in relation to the unrecognized tax benefits.

The United States Congress enacted the Families First Coronavirus Response Act (FFCR Act) on March 18, 2020 and the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) on March 27, 2020. The CARES Act is an emergency economic stimulus package that includes spending and tax breaks to strengthen the U.S. economy and fund a nationwide effort to curtail the effect of COVID-19. The FFCR Act and CARES Act include numerous tax-related provisions including modifications to the limitations on business interest expense and net operating losses (NOLs), as well as a payment delay of employer payroll taxes in 2020 after the date of enactment. On June 29, 2020, the California State Assembly Bill 85 (Trailer Bill) was enacted which suspends the use of California NOL deductions and certain tax credits, including research and development credits, for the 2020, 2021, and 2022 tax years. The Company does not expect the FFCR Act, CARES Act or Trailer Bill to have a material impact on the Company’s financial statements.

Variable Interest Entities
The Company reviews agreements it enters into with third-party entities, pursuant to which the Company may have a variable interest in the entity, in order to determine if the entity is a variable interest entity, or VIE. If the entity is a VIE, the Company assesses whether or not it is the primary beneficiary of that entity. In determining whether the Company is the primary beneficiary of an entity, the Company applies a qualitative approach that determines whether it has both (i) the power to direct the economically significant activities of the entity and (ii) the obligation to absorb losses of, or the right to receive benefits from, the entity that could potentially be significant to that entity. If the Company determines it is the primary beneficiary of a VIE, it consolidates that VIE into the Company’s financial statements. The Company’s determination about whether it should consolidate such VIEs is made continuously as changes to existing relationships or future transactions may result in a consolidation or deconsolidation event. The Company currently does not consolidate any VIEs.

Net Loss Per Share
Basic net loss per share is calculated by dividing the net loss by the weighted-average number of shares of common stock outstanding for the period, without consideration for potential dilutive shares of common stock. Diluted net loss per share is computed by dividing the net loss by the weighted-average number of common share equivalents outstanding for the period determined using the treasury-stock method. Since the Company was in a loss position for all periods presented, basic net loss per share is the same as diluted net loss per share since the effects of potentially dilutive securities are antidilutive. Shares of common stock subject to repurchase are excluded from the weighted-average shares.
10

ARCUTIS BIOTHERAPEUTICS, INC.
Notes to Condensed Financial Statements
(unaudited)
Emerging Growth Company Status
The Company is an emerging growth company, as defined in the Jumpstart Our Business Startups Act of 2012, or the JOBS Act. Under the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards issued subsequent to the enactment of the JOBS Act until such time as those standards apply to private companies. The Company has elected to use this extended transition period for complying with new or revised accounting standards that have different effective dates for public and private companies until the earlier of the date that it is (i) no longer an emerging growth company or (ii) affirmatively and irrevocably opt out of the extended transition period provided in the JOBS Act. As a result, these financial statements may not be comparable to companies that comply with the new or revised accounting pronouncements as of public company effective dates.
Recently Adopted Accounting Pronouncements
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, or ASU No. 2018-13, which removes, modifies, and adds various disclosure requirements on fair value measurements in Topic 820. ASU No. 2018-13 is effective for fiscal years and interim periods within those fiscal years beginning after December 15, 2019. The amendments on changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements, and the narrative description of measurement uncertainty should be applied prospectively for only the most recent interim or annual period presented in the initial fiscal year of adoption. All other amendments should be applied retrospectively to all periods presented upon their effective date. The Company early adopted this standard as of January 1, 2020, and it did not have a material impact on its condensed financial statements.
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, or ASU No. 2016-13. This update requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations now include forward-looking information in the determination of their credit loss estimates. Many of the previous loss estimation techniques are still permitted, although the inputs to those techniques have changed to reflect the full amount of expected credit losses. In addition, this update amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The Company early adopted this standard as of January 1, 2020, and it did not have a material impact on its condensed financial statements. There was no impact on the Company's condensed financial statements from credit losses for the three and six months ended June 30, 2020.
In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740), or ASU No. 2019-12, which amends the existing guidance relating to the accounting for income taxes. This standard is intended to simplify the accounting for income taxes by removing certain exceptions to the general principles of accounting for income taxes and to improve the consistent application of GAAP for other areas of accounting for income taxes by clarifying and amending existing guidance. The standard is effective for public business entities for fiscal years beginning after December 15, 2020, and interim periods therein. Early adoption is permitted. An entity that elects early adoption in an interim period should reflect any adjustments as of the beginning of the annual period that includes that interim period. Additionally, an entity that elects early adoption should adopt all the amendments in the same period. The Company early adopted this guidance as of January 1, 2020, and it did not have a material impact on its condensed financial statements.
3. Fair Value Measurements
The following table sets forth the Company’s financial instruments that were measured at fair value on a recurring basis by level within the fair value hierarchy (in thousands):
11

ARCUTIS BIOTHERAPEUTICS, INC.
Notes to Condensed Financial Statements
(unaudited)
June 30, 2020
Level 1 Level 2 Level 3 Total
Assets:
Money market funds(1)
$ 171,546    $ —    $ —    $ 171,546   
Commercial paper
—    52,429    —    52,429   
Total assets $ 171,546    $ 52,429    $ —    $ 223,975   

December 31, 2019
Level 1
Level 2
Level 3
Total
Assets:
Money market funds(1)
$ 43,558    $ —    $ —    $ 43,558   
Commercial paper —    44,689    —    44,689   
U.S. government securities 13,018    —    —    13,018   
Total assets
$ 56,576    $ 44,689    $ —    $ 101,265   
______________
(1)This balance includes cash requirements settled on a nightly basis.

Commercial paper, money market funds and government securities are valued taking into consideration valuations obtained from third-party pricing services. The pricing services utilize industry standard valuation models, including both income and market-based approaches, for which all significant inputs are observable, either directly or indirectly, to estimate fair value. These inputs include reported trades of and broker/dealer quotes on the same or similar securities, issuer credit spreads; benchmark securities; prepayment/default projections based on historical data; and other observable inputs. There were no transfers between Levels 1, 2 or 3 for any of the periods presented.
The following table summarizes the estimated value of the Company’s cash, cash equivalents and marketable securities and the gross unrealized holding gains and losses (in thousands):
June 30, 2020
Amortized
cost
Unrealized
gains
Unrealized
losses
Estimated
fair value
Cash and cash equivalents:
Money market funds(1) $ 171,546    $ —    $ —    $ 171,546   
Total cash and cash equivalents $ 171,546    $ —    $ —    $ 171,546   
Marketable securities:
Commercial paper $ 52,429    —    —    $ 52,429   
Total marketable securities $ 52,429    $ —    $ —    $ 52,429   
______________
(1)This balance includes cash requirements settled on a nightly basis.


12

ARCUTIS BIOTHERAPEUTICS, INC.
Notes to Condensed Financial Statements
(unaudited)
December 31, 2019
Amortized
cost
Unrealized
gains
Unrealized
losses
Estimated
fair value
Cash and cash equivalents:
Commercial paper $ 11,780    $ —    $ —    $ 11,780   
Money market funds(1) 43,558    —    —    43,558   
U.S. government securities 7,998    —    —    7,998   
Total cash and cash equivalents $ 63,336    $ —    $ —    $ 63,336   
Marketable securities:
Commercial paper $ 32,909    $ —    $ —    $ 32,909   
U.S. government securities 5,021    —    (1)   5,020   
Total marketable securities $ 37,930    $ —    $ (1)   $ 37,929   
______________
(1)This balance includes cash requirements settled on a nightly basis.

There were no realized gains or losses on investments for the three and six months ended June 30, 2020 and 2019. As of June 30, 2020 and December 31, 2019, unrealized losses on marketable securities were not material, and accordingly, no allowance for credit losses were recorded. As of June 30, 2020 and December 31, 2019, all securities have a maturity of one year or less and all securities with gross unrealized losses have been in continuous loss position for less than twelve months.
4. Balance Sheet Components
Prepaid Expenses and Other Current Assets
Prepaid expenses and other current assets consist of the following (in thousands):
June 30, December 31,
2020 2019
Prepaid insurance $ 1,634    $ 62   
Prepaid clinical trial costs 1,631    2,998   
Deferred financing costs —    1,747   
Other prepaid expenses and current assets 795    402   
Total prepaid expenses and other current assets $ 4,060    $ 5,209   
Accrued Liabilities
Accrued liabilities consist of the following (in thousands):
June 30, December 31,
2020 2019
Clinical trial accruals $ 8,504    $ 1,497   
Accrued compensation 1,694    1,379   
Early exercise liability, current
208    225   
Accrued expenses and other current liabilities
542    553   
Total accrued liabilities
$ 10,948    $ 3,654   

5. License Agreements
AstraZeneca License Agreement
In July 2018, the Company entered into an exclusive license agreement, or the AstraZeneca License Agreement, with AstraZeneca AB, or AstraZeneca, granting the Company a worldwide exclusive license, with the
13

ARCUTIS BIOTHERAPEUTICS, INC.
Notes to Condensed Financial Statements
(unaudited)
right to sublicense through multiple tiers, under certain AstraZeneca-controlled patent rights, know-how and regulatory documentation, to research, develop, manufacture, commercialize and otherwise exploit products containing roflumilast in topical forms, as well as delivery systems sold with or for the administration of roflumilast, or collectively, the AZ-Licensed Products, for all diagnostic, prophylactic and therapeutic uses for human dermatological indications, or the Dermatology Field. Under this agreement, the Company has sole responsibility for development, regulatory, and commercialization activities for the AZ-Licensed Products in the Dermatology Field, at its expense, and it shall use commercially reasonable efforts to develop, obtain and maintain regulatory approvals for, and commercialize the AZ-Licensed Products in the Dermatology Field in each of the United States, Italy, Spain, Germany, the United Kingdom, France, China, and Japan.
The Company paid AstraZeneca an upfront non-refundable cash payment of $1.0 million and issued 484,388 shares of Series B preferred stock, valued at $3.0 million on the date of the AstraZeneca License Agreement. The Company subsequently paid AstraZeneca the first milestone cash payment of $2.0 million upon the completion of a Phase 2b study of roflumilast cream in plaque psoriasis in August 2019 for the achievement of positive Phase 2 data for an AZ-Licensed Product, which was recorded in research and development expense. The Company has agreed to make additional cash payments to AstraZeneca of up to an aggregate of $12.5 million upon the achievement of specified regulatory approval milestones with respect to the AZ-Licensed Products and payments up to an additional aggregate amount of $15.0 million upon the achievement of certain aggregate worldwide net sales milestones. With respect to any AZ-Licensed Products the Company commercializes under the AstraZeneca License Agreement, it will pay AstraZeneca a low to high single-digit percentage royalty rate on the Company’s, its affiliates’ and its sublicensees’ net sales of such AZ-Licensed Products, subject to specified reductions, until, as determined on an AZ-Licensed Product-by-AZ-Licensed Product and country-by-country basis, the later of the date of the expiration of the last-to-expire AstraZeneca-licensed patent right containing a valid claim in such country and ten years from the first commercial sale of such AZ-Licensed Product in such country.
There were no payments made or due in connection with AZ-licensed Products for the three and six months ended June 30, 2020 and 2019.
Hengrui Exclusive Option and License Agreement
In January 2018, the Company entered into an exclusive option and license agreement, or the Hengrui License Agreement, with Jiangsu Hengrui Medicine Co., Ltd., or Hengrui, whereby Hengrui granted the Company an exclusive option to obtain certain exclusive rights to research, develop and commercialize products containing the compound designated by Hengrui as SHR0302, a JAK 1 inhibitor, in topical formulations for the treatment of skin diseases, disorders, and conditions in the United States, Japan, Canada and the European Union (including for clarity the United Kingdom). The Company made a $0.4 million upfront non-refundable cash payment to Hengrui upon execution of the Hengrui Option and License Agreement, which was recorded as research and development expense. In December 2019, the Company exercised its exclusive option under the agreement, for which it made a $1.5 million cash payment, which was recorded in research and development expense, and also contemporaneously amended the agreement to expand the territory to additionally include Canada. In addition, the Company has agreed to make cash payments of up to an aggregate of $20.5 million upon achievement of specified clinical development and regulatory approval milestones with respect to the licensed products and cash payments of up to an additional aggregate of $200 million in sales-based milestones based on certain aggregate annual net sales volumes with respect to a licensed product.
With respect to any products the Company commercializes under the Hengrui License Agreement, it will pay tiered royalties to Hengrui on net sales of each licensed product by the Company, or its affiliates, or its sublicensees, ranging from mid single-digit to sub-teen percentage rates based on tiered annual net sales bands subject to specified reductions. The Company is obligated to pay royalties until the later of (1) expiration of the last valid claim of the licensed patent rights covering such licensed product in such country and (2) expiration of regulatory exclusivity for the relevant licensed product in the relevant country, on a licensed product-by-licensed product and country-by-country basis. Additionally, the Company is obligated to pay Hengrui a specified percentage, ranging from the low-thirties to the sub-teens, of certain non-royalty sublicensing income it receives from sublicensees of its rights to the licensed products, such percentage decreasing as the development stage of the licensed products advance.
14

ARCUTIS BIOTHERAPEUTICS, INC.
Notes to Condensed Financial Statements
(unaudited)
There were no payments made or due in connection with Hengrui for the three and six months ended June 30, 2020 and 2019.
Hawkeye Collaboration Agreement
In June 2019, the Company entered into a collaboration agreement, or Hawkeye Agreement, with Hawkeye Therapeutics, Inc., or Hawkeye, a related party with common ownership, for the development of one or more new applications of roflumilast. The Hawkeye Agreement grants Hawkeye an exclusive license to certain intellectual property developed under the agreement as it relates to the applications.
Contemporaneously with the execution of the Hawkeye Agreement, the Company entered into a stock purchase agreement, purchasing 995,000 shares of Hawkeye’s common stock at $0.0001 per share, representing 19.9% of the outstanding common stock of Hawkeye. In the event that Hawkeye issues shares of Series A preferred stock with proceeds over $5.0 million, Hawkeye is required to issue to the Company a number of fully-paid fully-vested shares of common stock determined by dividing (i) $2,000,000 by (ii) an amount equal to the cash price per share for Series A preferred stock. Other than the potential issuance of this common stock, there are no upfront payments, milestones or royalties pursuant to the Hawkeye Agreement. The Company determined that Hawkeye is a variable interest entity for which consolidation is not required as it is not the primary beneficiary.
6. Commitments and Contingencies
Operating Lease
The Company leases a facility in Westlake Village, California under an operating lease that commenced in February 2019. This lease was amended in April 2020 in order to relocate to a new expanded space comprising 22,643 square feet. At the time of the amendment, the Company reassessed the lease term of the original space in accordance with the option to terminate if leasing additional space in the same property. In connection with the reduction of the lease term for the original space, the Company reduced the right-of-use asset and lease liability balance by $139,000.
The Company recognized the ROU asset and lease liability for the new space on May 1, 2020, which was determined to be the lease commencement date. The lease payments begin upon the earlier of Company occupying the space or 15 days after tenant improvements are complete, and terminate 91 months thereafter, with a renewal option for a term of five years. The Company will have a one-time option to cancel the lease after month 67. The renewal and one-time cancellation options have not been considered in the determination of the ROU asset or lease liability as the Company did not consider it reasonably certain it would exercise these options.
The lease is subject to fixed rate escalation increases with an initial base rent of $76,000 per month and includes rent free periods aggregating approximately 1 year. As a result, the Company recognizes rent expense on a straight-line basis for the full amount of the commitment including the minimum rent increases over the life of the lease and the free rent period. The amended lease agreement provides for a tenant improvement allowance up to $1.25 million. It also requires the Company to have an available letter of credit of $1.5 million upon occupying the space, which is allowed to be reduced throughout the lease period as rent obligations are met.
In association with commencement of this new lease, the Company recorded lease liabilities and off-setting ROU assets of $3.6 million on its condensed balance sheet as of June 30, 2020. Since the Company is reasonably certain to incur costs equal to or exceeding the tenant improvement allowance of $1.25 million, the allowance is treated as a lease incentive that is payable to the Company at the lease commencement date. Accordingly, the tenant improvement allowance is included in the measurement of the consideration in the contract at commencement, and is recognized as a reduction in the right-of-use asset and lease liability. Upon completion, the tenant improvements will be reclassified from the lease liability to fixed assets and depreciated over the term of the lease.

The minimum annual rental payments of the Company’s operating lease liability as of June 30, 2020 are as follows (in thousands):
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ARCUTIS BIOTHERAPEUTICS, INC.
Notes to Condensed Financial Statements
(unaudited)
Amounts
2020 (July through December) $ 81   
2021 172   
2022 803   
2023 967   
2024 997   
Thereafter 3,733   
Total minimum lease payments $ 6,753   
Less: Amounts representing interest (1,818)  
Less: Tenant improvement allowance (1,245)  
Present value of future minimum lease payments $ 3,690   
Current portion operating lease liability 80   
Operating lease liability, noncurrent 3,610   
Total operating lease liability $ 3,690   

Straight-line rent expense recognized for operating leases was $150,000 and $193,000 for the three and six months ended June 30, 2020, respectively, and $42,000 and $66,000 for the three and six months ended June 30, 2019, respectively. There were no significant variable lease payments, including non-lease components such as common area maintenance fees, recognized as rent expense for operating leases for the three and six months ended June 30, 2020 and 2019.

The following information represents supplemental disclosure for the statement of cash flows related to the Company’s operating lease (in thousands):
Six Months Ended June 30,
2020 2019
Cash flows from operating activities
Cash paid for amounts included in the measurement of lease liabilities $ 96    $ 47   

The following summarizes additional information related to the operating lease:
June 30, 2020
Weighted-average remaining lease term (in years) 7.8
Weighted-average discount rate 7.0  %
Indemnification
In the ordinary course of business, the Company enters into agreements that may include indemnification provisions. Pursuant to such agreements, the Company may indemnify, hold harmless and defend an indemnified party for losses suffered or incurred by the indemnified party. Some of the provisions will limit losses to those arising from third party actions. In some cases, the indemnification will continue after the termination of the agreement. The maximum potential amount of future payments the Company could be required to make under these provisions is not determinable. The Company has never incurred material costs to defend lawsuits or settle claims related to these indemnification provisions. The Company has also entered into indemnification agreements with its directors and officers that may require the Company to indemnify its directors and officers against liabilities that may arise by reason of their status or service as directors or officers to the fullest extent permitted by California corporate law. The Company currently has directors’ and officers’ insurance coverage that reduces its exposure and enables the Company to recover a portion of any future amounts paid. The Company believes the estimated fair value of these indemnification agreements in excess of applicable insurance coverage is minimal.
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ARCUTIS BIOTHERAPEUTICS, INC.
Notes to Condensed Financial Statements
(unaudited)
7. Convertible Preferred Stock and Stockholders’ Equity (Deficit)
Convertible preferred stock as of December 31, 2019 consisted of the following (in thousands, except share amounts):
Convertible Preferred Stock
Shares
Authorized
Shares
Issued and
Outstanding
Net
Carrying
Value
Liquidation
Preference
Series A
13,800,000    6,897,575    $ 14,340    $ 13,800   
Series B
18,736,270    9,364,850    57,912    58,000   
Series C 16,251,628    8,122,963    94,239    94,500   
Total 48,787,898    24,385,388    $ 166,491    $ 166,300   
In connection with the Company's IPO in February 2020, all of the Company’s outstanding shares of convertible preferred stock were automatically converted into 24,385,388 shares of common stock.
In October 2019, the Company issued 8,122,963 shares of Series C convertible preferred stock at a purchase price of $11.63 per share for total gross proceeds of $94.5 million, some of which were to related parties.
In September 2018, the Company issued 9,364,850 shares of Series B convertible preferred stock at a purchase price of $6.19 per share for total proceeds of $57.9 million, some of which were to related parties.
In April 2017, the Company entered into a Stock Purchase Agreement with investors, some of which were related parties, to issue 5,398,111 shares of Series A convertible preferred stock at $2.00 per share in three tranches. The first tranche, consisting of 3,590,845 shares for net proceeds of $7.1 million, was completed upon execution of the agreement. Additionally, the Company issued 149,946 shares of Series A convertible preferred stock as a result of the conversion of convertible promissory notes with an outstanding principal amount of $154,000 and the settlement of the derivative liability of $150,000.
The Series A investors were also granted freestanding rights to participate in additional tranches to raise a minimum of $3.3 million, upon election by the board of directors including at least one of the Series A directors, by purchasing 1,657,314 shares of Series A convertible preferred stock at $2.00 per share in two tranches, provided such election occurred prior to April 2019. The two tranches consisted of 828,654 shares and 828,660 shares, respectively. The Company concluded that the investors’ rights to purchase Series A convertible preferred shares met the definition of a freestanding financial instrument, as they were legally detachable and separately exercisable from the Series A convertible preferred stock, or the Series A Convertible Preferred Stock Liability. As the Series A Convertible Preferred Stock Liability was redeemable at the election of holders of the then-outstanding shares, it represented a liability to be accounted for at fair value and remeasured at each reporting period.
Changes in fair value were recognized as a gain or loss in other income (expense), net in the statements of operations. On the closing of the first tranche in April 2017, the Company recorded the initial fair value of the Series A Convertible Preferred Stock Liability of $219,000 for the second and the third tranche participating rights by reducing the carrying value of Series A convertible preferred stock.
In March 2018, the Company completed the second tranche closing and issued 3,156,784 shares of Series A convertible preferred stock to the investors at a purchase price of $2.00 per share for net proceeds of $6.3 million. The Series A Convertible Preferred Stock Liability was remeasured to fair value just prior to settlement and the carrying value of the liability of $891,000 was reclassified to Series A convertible preferred stock. Concurrently with the closing of the second tranche, the Company amended the Series A convertible preferred stock purchase agreement to merge the second and third tranches and increased the maximum number of shares to be issued in the second tranche to 3,156,784 shares.
Common Stock
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ARCUTIS BIOTHERAPEUTICS, INC.
Notes to Condensed Financial Statements
(unaudited)
The holders of the Company’s common stock have one vote for each share of common stock. Common stockholders are entitled to dividends when, as, and if declared by the board of directors. The holders have no preemptive or other subscription rights and there are no redemption or sinking fund provisions with respect to such shares. As of June 30, 2020, no dividends had been declared by the board of directors.
The Company reserved the following shares of common stock for issuance as follows:
June 30, December 31,
2020 2019
Convertible preferred stock outstanding —    24,385,388   
Options issued and outstanding 3,244,771    2,516,470   
Common stock awards available for grant under employee benefit plans 3,033,903    1,550,150   
Restricted stock units outstanding 130,060    —   
Total common stock reserved 6,408,734    28,452,008   
Authorized Share Capital
On February 4, 2020, the Company’s certificate of incorporation was amended and restated to provide for 300,000,000 authorized shares of common stock with a par value of $0.0001 per share and 10,000,000 authorized shares of preferred stock with a par value of $0.0001 per share. There were no shares of preferred stock outstanding as of June 30, 2020 and December 31, 2019.
8. Stock-Based Compensation
In January 2020, the Company’s board of directors approved the 2020 Equity Incentive Plan, or the 2020 Plan, which became effective January 30, 2020 in connection with the IPO. The 2020 Plan serves as the successor incentive award plan to the Company’s 2017 Equity Incentive Plan, or the 2017 Plan, and has 2,134,000 shares of common stock available 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 1,550,150 shares of common stock that were reserved for issuance pursuant to future awards under the 2017 Plan at the time the 2020 Plan became effective, plus shares represented by awards outstanding under the 2017 Plan that are forfeited or lapsed unexercised and which following the effective date of the 2020 Plan are not issued under the 2017 Plan. In addition, the 2020 Plan reserve will increase on January 1, 2021 and each subsequent anniversary through 2030, by an amount equal to the lesser of (a) four percent of the shares of stock outstanding (on an as converted basis) on the day immediately prior to the date of increase and (b) such smaller number of shares of stock as determined by our board of directors; provided, however, that no more than 11,000,000 shares of stock may be issued upon the exercise of incentive stock options. As of June 30, 2020, the Company had 2,702,765 shares available for future grant under the 2020 Plan.
The 2020 Plan provides for the Company to sell or issue common stock or restricted common stock, or to grant incentive stock options or nonqualified stock options for the purchase of common stock, to employees, members of the board of directors and consultants of the Company under terms and provisions established by the board of directors. Under the terms of the 2020 Plan, options may be granted at an exercise price not less than fair market value. The Company generally grants stock-based awards with service conditions. Options granted typically vest over a four-year period but may be granted with different vesting terms.
Following the Company’s IPO and in connection with the effectiveness of the Company’s 2020 Plan, the 2017 Plan terminated and no further awards will be granted under that plan. However, all outstanding awards under the 2017 Plan will continue to be governed by their existing terms.
Stock Option Activity
The following summarizes option activity (in thousands, except share amounts):
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ARCUTIS BIOTHERAPEUTICS, INC.
Notes to Condensed Financial Statements
(unaudited)
Number of
Options
Weighted-
Average
Exercise
Price
Remaining
Contractual
Term
(Years)
Aggregate
Intrinsic
Value
Balance—December 31, 2019 2,516,470    $ 3.47    9.44 $ 7,673   
Granted 851,325    $ 27.68   
Exercised (123,024)   $ 2.22   
Balance—June 30, 2020 3,244,771    $ 9.87    9.15 $ 66,436   
Exercisable—June 30, 2020 1,411,813    (1) $ 6.74    9.05 $ 33,176   
______________
(1)Options exercisable includes early exercisable options.
The aggregate intrinsic value is calculated as the difference between the exercise price of the options and the fair value of the Company’s common stock as of June 30, 2020. As of December 31, 2019, prior to the Company's IPO, the estimated fair value of the Company's common stock was determined by the board of directors.
The intrinsic value of options exercised for the six months ended June 30, 2020 was $1.9 million.
The total grant-date fair value of the options vested during the six months ended June 30, 2020 was $890,000. The weighted-average grant-date fair value of employee options granted during the six months ended June 30, 2020 was $18.71.
Restricted Stock Unit Activity
The following table summarizes information regarding our restricted stock units (RSUs):

Number of Units Weighted-Average
Grant Date Fair Value
Balance—December 31, 2019 —    $ —   
Granted 130,060    $ 27.61   
Vested —    $ —   
Forfeited —    $ —   
Unvested Balance—June 30, 2020 130,060    $ 27.61   
The grant date fair value of an RSU equals the closing price of our common stock on the grant date. RSUs generally vest equally over 4 years. There were no RSU grants prior to January 1, 2020.

Stock-Based Compensation Expense
Stock-based compensation expense recognized in our condensed statements of operations and comprehensive loss was as follows (in thousands):
Three Months Ended June 30, Six Months Ended June 30,
2020 2019 2020 2019
Research and development
$ 726    $ 57    $ 1,142    $ 88   
General and administrative
1,323    82    1,897    127   
Total stock-based compensation expense
$ 2,049    $ 139    $ 3,039    $ 215   
As of June 30, 2020, there was $18.9 million of total unrecognized compensation cost related to unvested options that are expected to vest, which is expected to be recognized over a weighted-average period of 3.4 years.
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ARCUTIS BIOTHERAPEUTICS, INC.
Notes to Condensed Financial Statements
(unaudited)
As of June 30, 2020, there was $3.3 million of total unrecognized compensation cost related to RSUs that is expected to vest, which is expected to be recognized over a weighted-average period of 3.7 years.
In determining the fair value of the stock options granted, the Company uses the Black-Scholes option-pricing model and assumptions discussed below. Each of these inputs is subjective and generally requires significant judgment.
Fair value of common stock— For options granted prior to IPO in the year ended December 31, 2019, given the absence of a public trading market, the Company’s board of directors with input from management considered numerous objective and subjective factors to determine the fair value of common stock. The factors included, but were not limited to: (i) third-party valuations of the Company’s common stock; (ii) the Company’s stage of development; (iii) the status of research and development efforts; (iv) the rights, preferences and privileges of the Company’s convertible preferred stock relative to those of the Company’s common stock; (v) the Company’s operating results and financial condition, including the Company’s levels of available capital resources; and (vi) equity market conditions affecting comparable public companies; (vii) general U.S. market conditions; and (viii) the lack of marketability of the Company’s common stock. For options granted after IPO, the Company uses its closing stock price as reported on Nasdaq on the grant date for the fair value of its stock.
Expected Term—The Company’s expected term represents the period that the Company’s stock-based awards are expected to be outstanding. The Company used the simplified method (based on the mid-point between the vesting date and the end of the contractual term) to determine the expected term.
Expected Volatility—Since the Company does not have sufficient trading history for its common stock, the expected volatility was estimated based on the average historical volatilities for comparable publicly traded pharmaceutical companies over a period equal to the expected term of the stock option grants. The comparable companies were chosen based on their similar size, stage in the life cycle and area of specialty. The Company will continue to apply this process until a sufficient amount of historical information regarding the volatility of its own stock price becomes available.
Risk-Free Interest Rate—The risk-free interest rate is based on the U.S. Treasury zero coupon issues in effect at the time of grant for periods corresponding with the expected term of option.
Dividend Yield—The Company has never paid dividends on its common stock and has no plans to pay dividends on its common stock. Therefore, the Company used an expected dividend yield of zero.
The fair value of stock option awards granted was estimated at the date of grant using a Black-Scholes option-pricing model with the following assumptions:
Six Months Ended
June 30, 2020
Year Ended
December 31, 2019
Expected term (in years)
5.5 – 6.2
5.1 – 6.6
Expected volatility
78.4 – 80.6%
68.6 – 72.5%
Risk-free interest rate
0.4 – 1.4%
1.6 – 2.6%
Dividend yield
—% —%
Early Exercise of Employee Options
The terms of the 2017 and 2020 Plans permit certain option holders to exercise options before their options are vested, subject to certain limitations. Upon early exercise, the awards become subject to a restricted stock agreement. The shares of restricted stock granted upon early exercise of the options are subject to the same vesting provisions in the original stock option awards. Shares issued as a result of early exercise that have not vested are subject to repurchase by the Company upon termination of the purchaser’s employment, at the price paid by the purchaser. While such shares have been issued, they are not considered outstanding for accounting purposes until they vest and are therefore excluded from shares used in determining loss per share until the repurchase right lapses and the shares are no longer subject to the repurchase feature. The liability is reclassified into common stock and additional paid-in capital as the shares vest and the repurchase right lapses. Accordingly,
20

ARCUTIS BIOTHERAPEUTICS, INC.
Notes to Condensed Financial Statements
(unaudited)
the Company has recorded the unvested portion of the exercise proceeds of $364,000 and $409,000 as a liability from the early exercise in the accompanying balance sheets as of June 30, 2020 and December 31, 2019, respectively. As of June 30, 2020 and December 31, 2019, there were $208,000 and $225,000 recorded in accrued liabilities, respectively, and $156,000 and $184,000 recorded in other long-term liabilities, respectively related to shares that were subject to repurchase.
Founder Awards
In August 2016, the Company issued 1,187,738 shares of restricted common stock to founders of which 1,102,903 shares vest under a service condition and 84,835 shares vest under a performance condition. The shares were issued under the terms of the respective restricted stock purchase agreements, or the Stock Purchase Agreement, and unvested shares were subject to repurchase by the Company at the original purchase price per share upon the holder’s termination of his relationship with the Company. The restricted shares were not considered outstanding for accounting purposes until they vest and are therefore excluded from shares used in determining loss per share until the repurchase right lapses and the shares are no longer subject to the repurchase feature. One-fourth of the 1,102,903 shares of restricted common stock were vested on the first-anniversary date and the remaining 827,177 shares will vest on a monthly basis thereafter. In July 2018, performance conditions prescribed by the Stock Purchase Agreement were met and 84,835 shares of the restricted common stock were fully vested. As of December 31, 2019, 1,049,875 shares subject to the award had vested, and an additional 137,863 shares vested during the six months ended June 30, 2020. As of June 30, 2020, all shares of restricted stock subject to the award had been vested.
2020 Employee Stock Purchase Plan
The Company adopted the 2020 Employee Stock Purchase Plan, or the ESPP, which became effective on January 30, 2020 in connection with the IPO. 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 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) 351,000 shares of common stock and (b) an annual increase on the first day of each year beginning in 2021 and ending in 2030, 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 5,265,000 shares of the Company’s common stock may be issued under the ESPP.
The Company commenced an offering period on January 31, 2020, which ended on May 31, 2020, and resulted in 19,862 shares of stock being issued under the ESPP during the six months ended June 30, 2020. Subsequently, the Company commenced another offering period on June 1, 2020, which will end on November 30, 2020. Stock-based compensation expense related to the ESPP was $94,000 and $161,000 for the three and six months ended June 30, 2020, respectively.
21

ARCUTIS BIOTHERAPEUTICS, INC.
Notes to Condensed Financial Statements
(unaudited)
9. Net Loss Per Share
The following outstanding potentially dilutive shares have been excluded from the calculation of diluted net loss per share for the periods presented due to their anti-dilutive effect:
As of June 30,
2020 2019
Convertible preferred stock on an as-converted basis —    16,262,425   
Stock options to purchase common stock 3,244,771    1,756,085   
Early exercised options subject to future vesting 499,235    612,395   
RSU's subject to future vesting 130,060    —   
ESPP shares subject to future issuance 5,933    —   
Restricted stock subject to future vesting —    275,726   
Total 3,879,999    18,906,631   

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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 together with our unaudited condensed financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q, and the audited financial statements and notes thereto as of and for the year ended December 31, 2019 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, 2019, which has been filed with the Securities and Exchange Commission. Some of the information contained in this discussion and analysis or set forth elsewhere in this Quarterly Report on Form 10-Q, including information with respect to our plans, objectives, expectations, projections and strategy for our business, includes forward-looking statements that involve risks and uncertainties. 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. As a result of many factors, including those factors identified below and those set forth in the “Risk Factors” section of this Quarterly Report on Form 10-Q, our actual results and the timing of selected events could differ materially from the forward-looking statements contained in the following discussion and analysis.
Overview
We are a late-stage biopharmaceutical company focused on developing and commercializing treatments for dermatological diseases with high unmet medical needs. Our current portfolio is comprised of topical treatments with significant potential to address immune-mediated dermatological diseases and conditions, or immuno-dermatology. Our strategy is to identify and develop treatments against validated biological targets in dermatology that deliver a differentiated clinical profile that addresses major shortcomings of existing therapies in our targeted indications. We believe this strategy uniquely positions us to rapidly progress towards our goal of bridging the treatment innovation gap in dermatology, while maximizing our probability of technical success and financial resources.
Our lead product candidate, topical roflumilast cream (ARQ-151), is in Phase 3 clinical trials in plaque psoriasis. Roflumilast cream is a topical cream formulation of roflumilast, a highly potent and selective phosphodiesterase type 4, or PDE4, inhibitor, which we are developing for the treatment of plaque psoriasis, including psoriasis in intertriginous regions such as the groin, axillae, and inframammary areas, as well as atopic dermatitis. In July 2018, we executed a worldwide licensing agreement with AstraZeneca AB, or AstraZeneca, for exclusive worldwide rights to all topical dermatological uses of roflumilast. We have successfully completed a Phase 2b study of roflumilast cream in plaque psoriasis, and, in August 2019, paid AstraZeneca the first milestone payment of $2.0 million that was earned upon the achievement of positive Phase 2 data for any AZ-Licensed Product (as defined in “—License Agreements—AstraZeneca License Agreement”). We have initiated three Phase 3 studies in plaque psoriasis, including two pivotal studies (DERMIS-1 and DERMIS-2) and an open label extension study (DERMIS-OLE), with topline data expected in the first half of 2021. The open label extension study has completed enrollment. We have also completed enrollment in a long-term safety study of roflumilast cream in plaque psoriasis patients, reported positive preliminary data for cohort 1, and expect to report topline data for the full study population from both cohorts 1 and 2 in the first quarter of 2021. We have also completed a Phase 2 proof of concept study of roflumilast cream in atopic dermatitis (AD) and plan to initiate a Phase 2b study in AD in the second half of 2020, with topline results expected in the second half of 2021. Additionally, we are developing ARQ-154, a topical foam formulation of roflumilast cream, and have completed enrollment in a Phase 2 proof of concept study in seborrheic dermatitis and a Phase 2b study in scalp psoriasis. We expect to report topline data from both of these studies in the fourth quarter of 2020.
Beyond this, we also initiated a Phase1/2b clinical study of ARQ-252, a potent and highly selective topical Janus kinase type 1, or JAK1, inhibitor for the treatment of chronic hand eczema. We have completed the Phase 1 portion of this clinical study and commenced the Phase 2b portion, and expect topline data in the second half of 2021. We also plan to initiate a clinical study of ARQ-252 in vitiligo in the second half of 2020. Additionally, we have formulation and preclinical efforts underway for ARQ-255, an alternative topical formulation of ARQ-252 designed to reach deeper into the skin in order to potentially treat alopecia areata. In January 2018, we executed an exclusive option and license agreement with Jiangsu Hengrui Medicine Co., Ltd. of China, or Hengrui, to the active pharmaceutical ingredient in ARQ-252 and ARQ-255 for all topical formulations for dermatological uses in the
23

United States, Canada, Europe and Japan. In December 2019, we exercised our exclusive option associated with this agreement, for which we made a $1.5 million cash payment, and also contemporaneously amended the agreement to expand the territory to additionally include Canada.
Since our inception in 2016, we have invested a significant portion of our efforts and financial resources in clinical development activities. We have not generated any revenue from product sales and, prior to our IPO completed in January 2020, have funded our operations primarily with $162.5 million in net cash proceeds from private placements of our convertible preferred stock. On February 4, 2020, we closed our IPO of 10,781,250 shares of common stock at an offering price of $17.00 per share, which included the exercise in full by the underwriters of their option to purchase up to 1,406,250 additional shares of common stock. Our net proceeds, after deducting underwriting discounts, commissions and offering related transaction costs, were $167.2 million.
We have incurred net losses in each year since inception, including net losses of $35.4 million and $63.4 million for the three and six months ended June 30, 2020, respectively, and $8.3 million and $14.9 million for the three and six months ended June 30, 2019, respectively. As of June 30, 2020, we had an accumulated deficit of $129.7 million and cash, cash equivalents and marketable securities of $224.0 million.
We expect to continue to incur losses for the foreseeable future and expect to incur increased expenses as we advance our product candidates through clinical trials and regulatory submissions. We do not expect to generate revenue from product sales unless, and until, we obtain regulatory approval or clearance from the Food and Drug Administration (FDA) or other foreign regulatory authorities for our product candidates. If we obtain regulatory approval or clearance for our product candidates, we expect to incur significant commercialization expenses related to product sales, marketing, manufacturing and distribution. In addition, we expect that our expenses will increase substantially as we continue preclinical studies and clinical trials for, and research and development of, our product candidates and maintain, expand and protect our intellectual property portfolio. As a result, we will need substantial additional funding to support our operating activities. Adequate funding may not be available to us on acceptable terms, or at all. We currently anticipate that we will seek to fund our operations through equity or debt financings or other sources, such as future potential collaboration agreements. Our failure to obtain sufficient funds on acceptable terms as and when needed could have a material adverse effect on our business, results of operations and financial condition. See “—Liquidity, Capital Resources and Requirements” below and Note 1 to the unaudited condensed financial statements for additional information. Based on our current planned operations, we expect our current cash, cash equivalents, and marketable securities will be sufficient to fund our operations through 2021.
We rely on third parties in the conduct of our preclinical studies and clinical trials and for manufacturing and supply of our product candidates. We have no internal manufacturing capabilities, and we will continue to rely on third parties, many of whom are single-source suppliers, for our preclinical and clinical trial materials, as well as the commercial supply of our products. In addition, we do not yet have a sales organization or commercial infrastructure. Accordingly, we expect to incur significant expenses to develop a sales organization or commercial infrastructure in advance of generating any product sales.
COVID-19 Update
In March 2020, the World Health Organization declared a pandemic related to the global novel coronavirus disease 2019 (COVID-19) outbreak. COVID-19 has placed strains on the providers of healthcare services, including the sites where we conduct our clinical trials. These strains have resulted in some clinical sites slowing or halting enrollment in clinical trials and restricting the on-site monitoring of clinical trials. We follow FDA guidance on clinical trial conduct during the COVID-19 pandemic, including the remote monitoring of clinical data. We are monitoring the potential impact COVID-19 may have on the clinical development of our product candidates, including potential delays or modifications to ongoing and planned trials. Thus far, we have seen limited impact on our clinical trials including some disruptions in screening, enrollment and monitoring, however at this time, we do not expect delays to previously disclosed clinical timelines, including those for roflumilast cream, roflumilast foam and ARQ-252. We cannot, at this time, predict the specific extent, duration, or full impact that the COVID-19 outbreak will have on our ongoing and planned clinical trials and other business operations.
There have been no disruptions in our supply chain of drug manufacturers necessary to conduct our clinical trials and, given our drug inventories, we believe that we will be able to supply the drug needs of our ongoing clinical studies.
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In alignment with public health guidance designed to slow the spread of COVID-19, we implemented a remote work plan for all employees as of mid-March 2020. We may need to undertake additional actions that could impact our operations as required by applicable laws or regulations, or which we determine to be in the best interests of our employees.
License Agreements
AstraZeneca License Agreement
In July 2018, we entered into an exclusive license agreement, or the AstraZeneca License Agreement, with AstraZeneca, granting us a worldwide exclusive license, with the right to sublicense through multiple tiers, under certain AstraZeneca-controlled patent rights, know-how and regulatory documentation, to research, develop, manufacture, commercialize and otherwise exploit products containing roflumilast in topical forms, as well as delivery systems sold with or for the administration of roflumilast, or collectively, the AZ-Licensed Products, for all diagnostic, prophylactic and therapeutic uses for human dermatological indications, or the Dermatology Field. Under this agreement, we have sole responsibility for development, regulatory, and commercialization activities for the AZ-Licensed Products in the Dermatology Field, at our expense, and we shall use commercially reasonable efforts to develop, obtain and maintain regulatory approvals for, and commercialize the AZ-Licensed Products in the Dermatology Field in each of the United States, Italy, Spain, Germany, the United Kingdom, France, China, and Japan.
We paid AstraZeneca an upfront non-refundable cash payment of $1.0 million and issued 484,388 shares of our Series B Preferred stock, valued at $3.0 million on the date of the AstraZeneca License Agreement. We subsequently paid AstraZeneca the first milestone cash payment of $2.0 million upon the completion of a Phase 2b study of roflumilast cream in plaque psoriasis in August 2019 for the achievement of positive Phase 2 data for an AZ-Licensed Product. We have agreed to make additional cash payments to AstraZeneca of up to an aggregate of $12.5 million upon the achievement of specific regulatory approval milestones with respect to the AZ-Licensed Products and payments up to an additional aggregate amount of $15.0 million upon the achievement of certain aggregate worldwide net sales milestones. With respect to any AZ-Licensed Products we commercialize under the AstraZeneca License Agreement, we will pay AstraZeneca a low to high single-digit percentage royalty rate on our, our affiliates’ and our sublicensees’ net sales of such AZ-Licensed Products, until, as determined on an AZ-Licensed Product-by-AZ-Licensed Product and country-by-country basis, the later of the date of the expiration of the last-to-expire AstraZeneca-licensed patent right containing a valid claim in such country and ten years from the first commercial sale of such AZ-Licensed Product in such country. See Note 5 to the unaudited condensed financial statements for additional information.
Hengrui Exclusive Option and License Agreement
In January 2018, we entered into an exclusive option and license agreement, or Hengrui License Agreement, with Hengrui, whereby Hengrui granted us an exclusive option to obtain certain exclusive rights to research, develop and commercialize products containing the compound designated by Hengrui as SHR0302, a JAK 1 inhibitor, in topical formulations for the treatment of skin diseases, disorders, and conditions in the United States, Canada, Japan, and the European Union (including for clarity the United Kingdom). We made a $0.4 million upfront non-refundable cash payment to Hengrui upon execution of the Hengrui Option and License Agreement. In December 2019, we exercised our exclusive option under the agreement, for which we made a $1.5 million cash payment, and also contemporaneously amended the agreement to expand the territory to additionally include Canada. In addition, we have agreed to make cash payments of up to an aggregate of $20.5 million upon our achievement of specified clinical development and regulatory approval milestones with respect to the licensed products and cash payments of up to an additional aggregate of $200.0 million in sales-based milestones based on achieving certain aggregate annual net sales volumes with respect to a licensed product. With respect to any products we commercialize under the Hengrui License Agreement, we will pay tiered royalties to Hengrui on net sales of each licensed product by us, or our affiliates, or our sublicensees, ranging from mid single-digit to sub-teen percentage rates based on tiered annual net sales bands subject to specified reductions. We are obligated to pay royalties until the later of (1) expiration of the last valid claim of the licensed patent rights covering such licensed product in such country and (2) the expiration of regulatory exclusivity for the relevant licensed product in the relevant country, on a licensed product-by-licensed product and country-by-country basis. Additionally, we are obligated to pay Hengrui a specified percentage, ranging from the low-thirties to the sub-teens, of certain non-royalty sublicensing income we receive from sublicensees of our rights to the licensed products, such percentage
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decreasing as the development stage of the licensed products advance. See Note 5 to the unaudited condensed financial statements for additional information.
Hawkeye Collaboration Agreement
In June 2019, we entered into a collaboration agreement, or the Hawkeye Agreement, with Hawkeye Therapeutics, Inc., or Hawkeye, a related party with common ownership, to collaborate on the research and development of one or more new applications of roflumilast. The Hawkeye Agreement grants Hawkeye an exclusive license to certain intellectual property developed under the agreement as it relates to the applications.
Contemporaneously with the execution of the Hawkeye Agreement, we entered into a stock purchase agreement, purchasing 995,000 shares of Hawkeye’s common stock at $0.0001 per share, representing 19.9% of the outstanding common stock of Hawkeye. See Note 5 to the unaudited condensed financial statements for additional information.
Components of Our Results of Operations
Operating Expenses
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, preclinical 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.
We expect to continue to incur substantial research and development expenses in the future as we develop our product candidates. In particular, we expect to incur substantial research and development expenses for the Phase 3 trials (DERMIS-1, DERMIS-2, and DERMIS-OLE) of roflumilast cream for plaque psoriasis, the preclinical studies and clinical trials for the continued development of roflumilast cream for atopic dermatitis, roflumilast foam for seborrheic dermatitis and scalp psoriasis, ARQ-252 for hand eczema and vitiligo, and ARQ-255 for alopecia areata.
We have entered, and may continue to enter, into license agreements to access and utilize certain molecules for the treatment of dermatological diseases and disorders. We evaluate if the license agreement is an acquisition of an asset or a business. To date, none of our license agreements have been considered to be an acquisition of a business. For asset acquisitions, the upfront payments to acquire such licenses, as well as any future milestone payments made before product approval, are immediately recognized as research and development expense when due, provided there is no alternative future use of the rights in other research and development projects.
The successful development of our product candidates is highly uncertain. At this time, we cannot reasonably estimate the nature, timing or costs required to complete the remaining development of roflumilast cream, roflumilast foam, ARQ-252 and ARQ-255 or any future product candidates. This is due to the numerous risks and uncertainties associated with the development of product candidates. See “Risk Factors” for a discussion of the risks and uncertainties associated with the development of our 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, insurance, and professional services fees for auditing, tax and general legal services. We expect our general and administrative expenses to continue to increase
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in the future as we expand our operating activities and prepare for potential commercialization of our product candidates, increase our headcount and support our operations as a public company, including increased expenses related to legal, accounting, insurance, regulatory and tax-related services associated with maintaining compliance with exchange listing and Securities and Exchange Commission requirements, directors and officers liability insurance premiums and investor relations activities.
Other Income (Expense), Net
Other income (expense), net primarily consists of interest income earned on our cash, cash equivalents, and marketable securities.
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Results of Operations
Comparison of the Three Months Ended June 30, 2020 and 2019
The following table sets forth our results of operations for the periods indicated:
Three Months Ended June 30, Change
2020 2019 $ %
(unaudited)
(in thousands)
Operating expenses:
Research and development
$ 30,009    $ 7,214    $ 22,795    316  %
General and administrative
5,618    1,324    4,294    324  %
Total operating expenses
$ 35,627    $ 8,538    $ 27,089    317  %
Loss from operations
(35,627)   (8,538)   (27,089)   317  %
Other income, net
215    248    (33)   (13) %
Net loss $ (35,412)   $ (8,290)   $ (27,122)   327  %
Research and Development Expenses
Three Months Ended June 30, Change
2020 2019 $ %
(unaudited)
(in thousands)
Direct Costs:
Preclinical and clinical
$ 22,691    $ 4,416    $ 18,275    414  %
Manufacturing
2,803    1,427    1,376    96  %
Indirect Costs:
Compensation and personnel-related 3,109    1,049    2,060    196  %
Other 1,406    322    1,084    337  %
Total research and development expense $ 30,009    $ 7,214    $ 22,795    316  %
Research and development expenses increased by $22.8 million, or 316%, for the three months ended June 30, 2020 compared to the three months ended June 30, 2019. The increase was due to an increase in clinical trial costs of $18.3 million, an increase in compensation and personnel-related expenses of $2.1 million, an increase in manufacturing costs of $1.4 million, and an increase of $1.1 million in other costs, including regulatory, research and clinical consulting costs. The increases in clinical trial and manufacturing costs relate to new and ongoing studies of roflumilast cream, including three Phase 3 studies of roflumilast cream for plaque psoriasis and a Phase 1 pediatric study of roflumilast cream for atopic dermatitis. Additionally, in the current year, there were costs related to the initiation of the Phase 2b study of roflumilast foam for scalp psoriasis, a Phase 2 Proof of Concept clinical trial of roflumilast foam for seborrheic dermatitis, and a Phase 1/2b study of ARQ-252 in hand eczema. The increase in compensation and personnel-related expenses, which includes stock compensation, was primarily due to an increase in headcount.
General and Administrative Expenses
General and administrative expenses increased by $4.3 million, or 324%, for the three months ended June 30, 2020 compared to the three months ended June 30, 2019. The increase was primarily due to an increase in compensation and personnel-related expenses of $2.0 million, an increase in professional services of $1.4 million, and an increase in insurance costs of $0.7 million. The increase in compensation and personnel-related expenses,
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which includes stock compensation, was due to an increase in headcount. The increases in professional services and insurance costs were mainly due to the costs associated with being a public company.
Other Income, Net
Other income, net decreased by $33,000, or 13%, for the three months ended June 30, 2020 compared to the three months ended June 30, 2019 . The decrease was due to a decrease in the yield on our investment portfolio, partially offset by higher balances.
Comparison of the Six Months Ended June 30, 2020 and 2019
The following table sets forth our results of operations for the periods indicated:
Six Months Ended June 30, Change
2020 2019 $ %
(unaudited)
(in thousands)
Operating expenses:
Research and development
$ 55,191    $ 13,417    $ 41,774    311  %
General and administrative
9,087    2,073    7,014    338  %
Total operating expenses
$ 64,278    $ 15,490    $ 48,788    315  %
Loss from operations
(64,278)   (15,490)   (48,788)   315  %
Other income, net
853    542    311    57  %
Net loss $ (63,425)   $ (14,948)   $ (48,477)   324  %
Research and Development Expenses
Six Months Ended June 30, Change
2020 2019 $ %
(unaudited)
(in thousands)
Direct Costs:
Preclinical and clinical
$ 41,427    $ 8,743    $ 32,684    374  %
Manufacturing
6,057    2,119    3,938    186  %
Indirect Costs:

Compensation and personnel-related 5,376    1,871    3,505    187  %
Other 2,331    684    1,647    241  %
Total research and development expense $ 55,191    $ 13,417    $ 41,774    311  %
Research and development expenses increased by $41.8 million, or 311%, for the six months ended June 30, 2020 compared to the six months ended June 30, 2019. The increase was due to an increase in clinical trial costs of $32.7 million, an increase in manufacturing costs of $3.9 million, an increase in compensation and personnel-related expenses of $3.5 million, and an increase of $1.6 million in other costs, including regulatory, research and clinical consulting costs. The increases in clinical trial and manufacturing costs relate to new and ongoing studies of roflumilast cream, including three Phase 3 studies of roflumilast cream for plaque psoriasis and a Phase 1 pediatric study of roflumilast cream for atopic dermatitis. Additionally, in the current year, there were costs related to the initiation of the Phase 2b study of roflumilast foam for scalp psoriasis, a Phase 2 Proof of Concept clinical trial of roflumilast foam for seborrheic dermatitis, and the Phase 1/2b study of ARQ-252 in hand eczema. The increase in compensation and personnel-related expenses, which includes stock compensation, was primarily due to an increase in headcount.
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General and Administrative Expenses
General and administrative expenses increased by $7.0 million, or 338%, for the six months ended June 30, 2020 compared to the six months ended June 30, 2019. The increase was primarily due to an increase in compensation and personnel-related expenses of $3.4 million, an increase in professional services of $2.1 million, and an increase in insurance costs of $1.2 million. The increase in compensation and personnel-related expenses, which includes stock compensation, was due to an increase in headcount. The increases in professional services and insurance costs were mainly due to the costs associated with being a public company.
Other Income, Net
Other income, net increased by $0.3 million, or 57%, for the six months ended June 30, 2020 compared to the six months ended June 30, 2019. The increase was primarily due to higher balances in our investment portfolio, partially offset by a decrease in their yield.
Liquidity, Capital Resources and Requirements
Sources of Liquidity
We have incurred operating losses since our inception and have an accumulated deficit as a result of ongoing efforts to develop our product candidates, including conducting preclinical and clinical trials and providing general and administrative support for these operations. As of June 30, 2020, we had cash, cash equivalents and marketable securities of $224.0 million, and an accumulated deficit of $129.7 million. We anticipate that operating losses and net cash used in operating activities will increase over the next several years as we further develop roflumilast cream, roflumilast foam, ARQ-252 and ARQ-255, move into later and more costly stages of product development, develop new product candidates, hire personnel and prepare for regulatory submissions and the commercialization of our product candidates.
We have historically financed our operations primarily through private placements of preferred stock as well as our IPO completed in January 2020, and will continue to be dependent upon equity, debt financing, collaborations or other forms of capital at least until we are able to generate positive cash flows from our operations.
Cash Flows
The following table sets forth our cash flows for the periods indicated:
Six Months Ended June 30,
2020 2019
(in thousands)
Cash used in operating activities $ (46,771)   $ (15,317)  
Cash used in investing activities (14,221)   (11,422)  
Cash provided by financing activities 169,202    168   
Net increase (decrease) in cash and cash equivalents $ 108,210    $ (26,571)  
Net Cash Used in Operating Activities
During the six months ended June 30, 2020, net cash used in operating activities was $46.8 million, which consisted of a net loss of $63.4 million, offset by a change in net operating assets and liabilities of $13.8 million and net non-cash charges of $2.8 million. The change in net operating assets and liabilities was due to an increase of $14.5 million in accounts payable and accrued liabilities due to our operating expense growth and timing of payments, partially offset by an increase of $0.6 million in prepaid expenses and other current assets. The net non-cash charges were primarily related to stock-based compensation expense of $3.0 million.
During the six months ended June 30, 2019, net cash used in operating activities was $15.3 million and consisted primarily of a net loss of $14.9 million and a change in net operating assets and liabilities of $0.4 million. The change in net operating assets and liabilities was primarily due to an increase of $1.6 million in prepaid
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expenses and other assets, partially offset by an increase in accounts payable and accrued liabilities of $1.3 million due to our operating expense growth and timing of payments.
Net Cash Used in Investing Activities
During the six months ended June 30, 2020, net cash used in investing activities was $14.2 million, which was comprised primarily of purchases of marketable securities of $62.8 million, partially offset by proceeds from the maturities of marketable securities of $48.6 million.
During the six months ended June 30, 2019, net cash used in investing activities was $11.4 million, which was comprised primarily of purchases of marketable securities of $22.9 million, partially offset by proceeds from maturities of marketable securities of $11.7 million.
Net Cash Provided by Financing Activities
During the six months ended June 30, 2020, net cash provided by financing activities was $169.2 million, which was comprised primarily of the net cash proceeds received from the IPO of $168.6 million.
During the six months ended June 30, 2019, net cash provided by financing activities was $0.2 million, which was comprised of the cash proceeds received from the issuance of common stock upon exercise of stock options.
Funding Requirements
We have historically incurred significant losses and negative cash flows from operations since our inception and had an accumulated deficit of $129.7 million as of June 30, 2020. We had cash, cash equivalents and marketable securities of $224.0 million as of June 30, 2020. Based on our current planned operations, we expect that our current cash, cash equivalents and marketable securities will be sufficient to fund our operations through 2021. Our ability to continue as a going concern is dependent upon our ability to successfully secure sources of financing and ultimately achieve profitable operations.
We will need to raise substantial additional capital to fund our operations through the sale of our equity securities, incurring debt, entering into licensing or collaboration agreements with partners, grants or other sources of financing. There can be no assurance that sufficient funds will be available to us at all or on attractive terms when needed from these sources. If we are unable to obtain additional funding from these or other sources when needed it may be necessary to significantly reduce our current rate of spending through reductions in staff and delaying, scaling back, or stopping certain research and development programs. Insufficient liquidity may also require us to relinquish rights to product candidates at an earlier stage of development or on less favorable terms than we would otherwise choose.
We have based our projections of operating capital requirements on assumptions that may prove to be incorrect and we may use all our available capital resources sooner than we expect. Because of the numerous risks and uncertainties associated with research, development and commercialization of pharmaceutical products, we are unable to estimate the exact amount of our operating capital requirements. Our future funding requirements will depend on many factors, including, but not limited to:
the scope, progress, results and costs of researching and developing our lead product candidates or any future product candidates, and conducting preclinical studies and clinical trials, in particular our currently ongoing Phase 3 studies (DERMIS-1, DERMIS-2, and DERMIS-OLE) of roflumilast cream in plaque psoriasis, our planned Phase 2b study of roflumilast cream in atopic dermatitis, our currently ongoing Phase 2 proof of concept study of roflumilast foam in seborrheic dermatitis, our currently ongoing Phase 2b study of roflumilast foam in scalp psoriasis, our currently ongoing Phase 1/2b study of ARQ-252 in hand eczema, our planned Phase 2a study of ARQ-252 in vitiligo and our formulation and preclinical efforts for ARQ-255 for alopecia areata.
suspensions or delays in the enrollment or changes to the number of patients we decide to enroll in our ongoing clinical trials as a result of the COVID-19 pandemic;
the timing of, and the costs involved in, obtaining regulatory approvals for our lead product candidate or our other product candidates;
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the number and characteristics of any additional product candidates we develop or acquire;
the cost of manufacturing our lead product candidates or any future product candidates and any products we successfully commercialize, including costs associated with building out our supply chain;
the cost of commercialization activities if our lead product candidates or any future product candidates are approved for sale, including marketing, sales and distribution costs;
the cost of building a sales force in anticipation of product commercialization;
our ability to establish and maintain strategic collaborations, licensing or other arrangements and the financial terms of any such agreements that we may enter into;
the costs related to milestone payments to AstraZeneca or Hengrui, upon the achievement of predetermined milestones;
any product liability or other lawsuits related to our products;
the expenses needed to attract and retain skilled personnel;
the