Quarterly Report (10-q)
Date : 11/12/2019 @ 11:07AM
Source : Edgar (US Regulatory)
Stock : Sorrento Therapeutics Inc (SRNE)
Quote : 4.2  -0.06 (-1.41%) @ 4:59AM
Sorrento Therapeutics share price Chart
After Hours
Last Trade 		Last $ 4.29 ▲ 0.09 (2.14%)

Quarterly Report (10-q)

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2019
OR
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission file number 001-36150  
SORRENTO THERAPEUTICS, INC.
(Exact Name of Registrant as Specified in Its Charter)
 
Delaware   33-0344842
(State or Other Jurisdiction of
Incorporation or Organization) 		  (I.R.S. Employer
Identification Number)
4955 Directors Place
San Diego, California 92121
(Address of Principal Executive Offices)
(858) 203-4100
(Registrant’s Telephone Number, Including Area Code)
Securities Registered pursuant to Section 12(b) of the Act:
Title of each class: Trading Symbol (s) Name of each exchange on which registered:
Common Stock, $0.0001 par value SRNE The Nasdaq Stock Market LLC
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 file, 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 issuer’s common stock, par value $0.0001 per share, outstanding as of October 22, 2019 was 141,871,384.


Sorrento Therapeutics, Inc.
Form 10-Q for the Quarter Ended September 30, 2019
Table of Contents
 
1
3
4
5
7
9
35
44
45
 
47
47
48
53
54
56



PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements.
SORRENTO THERAPEUTICS, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except for share amounts; unaudited)
ASSETS September 30,
2019 		December 31,
2018
Current assets:    
Cash and cash equivalents $ 34,649    $ 158,738   
Restricted cash 9,592    9,592   
Marketable securities 94    297   
Accounts receivables, net 11,560    3,833   
Inventory 4,335    2,898   
Income tax receivable 216    526   
Prepaid expenses and other 7,122    3,680   
Total current assets 67,568    179,564   
Property and equipment, net 30,338    24,384   
Operating lease right-of-use assets 47,799    —   
Intangibles, net 64,299    66,283   
Goodwill 38,298    38,298   
Cost method investments 237,008    237,008   
Equity method investments 25,240    27,980   
Restricted cash 45,150    45,000   
Other, net 5,175    5,570   
Total assets $ 560,875    $ 624,087   
LIABILITIES AND STOCKHOLDERS’ EQUITY    
Current liabilities:    
Accounts payable $ 26,750    $ 13,817   
Accrued payroll and related benefits 14,665    10,236   
Accrued expenses 18,478    13,403   
Current portion of deferred revenue 3,613    2,703   
Acquisition consideration payable 11,312    11,312   
Current portion of derivative liabilities 9,000    —   
Current portion of debt 25,877    10,150   
Current portion of operating lease liabilities 3,018    —   
Total current liabilities 112,713    61,621   
Long-term debt, net of discount 234,370    223,136   
Deferred tax liabilities, net 8,634    9,416   
Deferred revenue 114,783    116,274   
Derivative liabilities 29,500    —   
Operating lease liabilities 53,378    —   
Deferred rent and other 828    6,140   
Total liabilities $ 554,206    $ 416,587   
Commitments and contingencies (See Note 13)
Equity:    
Sorrento Therapeutics, Inc. equity    
Preferred stock, $0.0001 par value; 100,000,000 shares authorized and no shares issued or outstanding
—    —   
1

Common stock, $0.0001 par value 750,000,000 shares authorized and 131,001,293 and 122,280,092 shares issued and outstanding at September 30, 2019 and December 31, 2018, respectively
13    13   
Additional paid-in capital 692,473    626,658   
Accumulated other comprehensive (loss) income (129)   15   
Accumulated deficit (596,998)   (367,750)  
Treasury stock, 7,568,182 shares at cost at September 30, 2019, and December 31, 2018
(49,464)   (49,464)  
Total Sorrento Therapeutics, Inc. stockholders’ equity
45,895    209,472   
Noncontrolling interests (39,226)   (1,972)  
Total equity 6,669    207,500   
Total liabilities and stockholders’ equity
$ 560,875    $ 624,087   
See accompanying notes to unaudited consolidated financial statements
2

SORRENTO THERAPEUTICS, INC.  
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except for per share amounts; unaudited)
  Three Months Ended September 30, Nine Months Ended September 30,
  2019 2018 2019 2018

Revenues:        
Net product revenues $ 3,810    $ 1,121    $ 11,868    $ 1,982   
Service revenues 1,968    2,984    6,530    12,282   
        Total revenues 5,778    4,105    18,398    14,264   
Operating costs and expenses:        
Cost of products sold 2,839    662    3,868    663   
Cost of services 2,387    1,515    6,947    4,052   
Research and development 27,573    19,567    77,916    52,124   
Acquired in-process research and development —    9,478    75,301    9,478   
Selling, general and administrative 25,234    20,102    78,128    41,102   
Intangible amortization 991    655    2,949    1,974   
Loss on contingent liabilities and acquisition consideration payable 37    33    103    13,696   
Total operating costs and expenses 59,061    52,012    245,212    123,089   
Loss from operations (53,283)   (47,907)   (226,814)   (108,825)  
Loss on trading securities (221)   (26)   (203)   (144)  
Loss on derivative liabilities (10,700)   —    (35,792)   —   
(Loss) gain on foreign currency exchange (521)   18    (619)   (551)  
Interest expense (9,459)   (2,684)   (28,059)   (48,744)  
Interest income 182    219    1,021    229   
Loss before income tax (74,002)   (50,380)   (290,466)   (158,035)  
Income tax benefit (221)   (826)   (782)   (3,152)  
Loss on equity method investments (1,431)   (900)   (3,902)   (3,926)  
Net loss (75,212)   (50,454)   (293,586)   (158,809)  
Net loss attributable to noncontrolling interests (10,797)   (3,126)   (64,338)   (5,045)  
Net loss attributable to Sorrento $ (64,415)   $ (47,328)   $ (229,248)   $ (153,764)  
Net loss per share - basic per share attributable to Sorrento $ (0.49)   $ (0.40)   $ (1.83)   $ (1.52)  
Net loss per share - diluted per share attributable to Sorrento $ (0.50)   $ (0.40)   $ (2.00)   $ (1.52)  
Weighted-average shares used during period - basic per share attributable to Sorrento 130,800    117,021    125,240    100,959   
Weighted-average shares used during period - diluted per share attributable to Sorrento 140,445    117,021    132,265    100,959   
 
See accompanying notes to unaudited consolidated financial statements
3

SORRENTO THERAPEUTICS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(In thousands; unaudited)
  Three Months Ended September 30, Nine Months Ended September 30,
  2019 2018 2019 2018
Net loss $ (75,212)   $ (50,454)   $ (293,586)   $ (158,809)  
Other comprehensive gain (loss):        
Foreign currency translation adjustments (177)   (74)   (144)   (163)  
Total other comprehensive loss (177)   (74)   (144)   (163)  
Comprehensive loss (75,389)   (50,528)   (293,730)   (158,972)  
Comprehensive loss attributable to noncontrolling interests (10,797)   (3,126)   (64,338)   (5,045)  
Comprehensive loss attributable to Sorrento $ (64,592)   $ (47,402)   $ (229,392)   $ (153,927)  
 
See accompanying notes to unaudited consolidated financial statements
4

SORRENTO THERAPEUTICS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(In thousands, except for share amounts; unaudited)
Nine Months Ended September 30, 2019
Common Stock Treasury Stock Additional
Paid-in Capital 		Accumulated
Other
Comprehensive
Income (Loss) 		Accumulated
Deficit 		Noncontrolling
Interest 		 
  Shares Amount Shares Amount Total
Balance, December 31, 2018 122,280,092    $ 13    7,568,182    $ (49,464)   $ 626,658    $ 15    $ (367,750)   $ (1,972)   $ 207,500   
Issuance of common stock upon exercise of stock options 158,699    —    —    —    289    —    —    —    289   
Issuance of common stock for public placement, net 229,168    —    —    —    947    —    —    —    947   
Equity contribution related to Semnur acquisition —    —    —    —    27,991    —    —    26,600    54,591   
Stock-based compensation —    —    —    —    8,978    —    —    —    8,978   
Issuance of 2019 Warrants —    —    —    —    4,288    —    —    —    4,288   
2019 Public Offering of common stock and warrants, net of issuance costs 8,333,334    —    —    —    23,322    —    —    —    23,322   
Adjustment to noncontrolling interest —    —    —    —    —    —    —    484    484   
Foreign currency translation adjustment —    —    —    —    —    (144)   —    (144)  
Net loss —    —    —    —    —    —    (229,248)   (64,338)   (293,586)  
Balance, September 30, 2019 131,001,293    $ 13    7,568,182    $ (49,464)   $ 692,473    $ (129)   $ (596,998)   $ (39,226)   $ 6,669   

Three Months Ended September 30, 2019
Common Stock Treasury Stock Additional
Paid-in Capital 		Accumulated
Other
Comprehensive
Income (Loss) 		Accumulated
Deficit 		Noncontrolling
Interest 		 
  Shares Amount Shares Amount Total
Balance, June 30, 2019 122,645,334    $ 13    7,568,182    $ (49,464)   $ 665,515    $ 48    $ (532,583)   $ (28,913)   $ 54,616   
Issuance of common stock upon exercise of stock options 22,625    —    —    —    30    —    —    —    30   
Equity contribution related to Semnur acquisition —    —    —    —    (409)   —    —    —    (409)  
Stock-based compensation —    —    —    —    4,015    —    —    —    4,015   
Issuance of 2019 Warrants —    —    —    —    —    —    —    —    —   
2019 Public Offering of common stock and warrants, net of issuance costs 8,333,334    —    —    —    23,322    —    —    —    23,322   
Adjustment to noncontrolling interest —    —    —    —    —    —    —    484    484   
Foreign currency translation adjustment —    —    —    —    —    (177)   —    —    (177)  
Net loss —    —    —    —    —    —    (64,415)   (10,797)   (75,212)  
Balance, September 30, 2019 131,001,293    $ 13    7,568,182    $ (49,464)   $ 692,473    $ (129)   $ (596,998)   $ (39,226)   $ 6,669   

5

Nine Months Ended September 30, 2018
  Common Stock Treasury Stock Additional
Paid-in Capital 		Accumulated
Other
Comprehensive
Income (Loss) 		Accumulated
Deficit 		Noncontrolling
Interest 		 
  Shares Amount Shares Amount Total
Balance, December 31, 2017 82,903,567    $ 9    7,568,182    $ (49,464)   $ 413,901    $ 242    $ (165,120)   $ 7,042    $ 206,610   
Adoption impact of ASC 606 —    —    —    —    —    —    910    —    910   
Issuance of common stock upon exercise of stock options 42,565    —    —    —    302    —    —    —    302   
Issuance of common stock for BDL settlement 309,916    —    —    —    2,340    —    —    —    2,340   
Issuance of common stock for Scilex settlement 1,381,346    —    —    —    13,744    —    —    —    13,744   
Issuance of common stock for public placement and investments, net 10,396,489    2    —    —    71,475    —    —    —    71,477   
Issuance of common stock for Virttu settlement 1,795,011    —    —    —    11,308    —    —    —    11,308   
Issuance of common stock related to conversion of notes payable 22,038,565    2    —    —    49,998    —    —    —    50,000   
Beneficial conversion feature recorded on convertible notes —    —    —    —    12,006    —    —    —    12,006   
Warrants issued in connection with convertible notes —    —    —    —    9,646    —    —    —    9,646   
Stock-based compensation —    —    —    —    4,218    —    —    (29)   4,189   
Foreign currency translation adjustment —    —    —    —    —    (163)   —    —    (163)  
Net loss —    —    —    —    —    —    (153,764)   (5,045)   (158,809)  
Balance, September 30, 2018 118,867,459    $ 13    7,568,182    $ (49,464)   $ 588,938    $ 79    $ (317,974)   $ 1,968    $ 223,560   

Three Months Ended September 30, 2018
  Common Stock Treasury Stock Additional
Paid-in Capital 		Accumulated
Other
Comprehensive
Income (Loss) 		Accumulated
Deficit 		Noncontrolling
Interest 		 
  Shares Amount Shares Amount Total
Balance, June 30, 2018 116,240,963    $ 12    7,568,182    $ (49,464)   $ 574,316    $ 153    $ (270,646)   $ 5,094    $ 259,465   
Issuance of common stock upon exercise of stock options 16,750    —    —    —    141    —    —    —    141   
Issuance of common stock for public placement and investments, net 2,609,746    1    —    —    13,204    —    —    —    13,205   
Issuance of common stock for Virttu settlement —    —    —    —    —    —    —    —    —   
Issuance of common stock related to conversion of notes payable —    —    —    —    —    —    —    —    —   
Beneficial conversion feature recorded on convertible notes —    —    —    —    —    —    —    —    —   
Warrants issued in connection with convertible notes —    —    —    —    —    —    —    —    —   
Stock-based compensation —    —    —    —    1,277    —    —    —    1,277   
Foreign currency translation adjustment —    —    —    —    —    (74)   —    —    (74)  
Net loss —    —    —    —    —    —    (47,328)   (3,126)   (50,454)  
Balance, September 30, 2018 118,867,459    $ 13    7,568,182    $ (49,464)   $ 588,938    $ 79    $ (317,974)   $ 1,968    $ 223,560   


 
See accompanying notes to unaudited consolidated financial statements
6

SORRENTO THERAPEUTICS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands; unaudited)
Nine Months Ended September 30,
Operating activities 2019 2018
Net loss $ (293,586)   $ (158,809)  
Adjustments to reconcile net loss to net cash used for operating activities:    
Depreciation and amortization 8,248    6,192   
Non-cash operating lease cost 3,069    —   
Non-cash interest expense 15,964    44,272   
Acquisition-related IPR&D 75,301    9,478   
Amortization of debt issuance costs 1,590    2,634   
Loss on trading securities 203    144   
Stock-based compensation 8,978    4,188   
Loss on derivative liabilities 35,792    —   
Loss on equity method investments 3,902    3,926   
Loss on contingent liabilities and acquisition consideration payable 103    13,696   
Deferred tax provision (782)   (3,062)  
Changes in operating assets and liabilities, excluding effect of acquisitions:    
Accounts receivable (7,727)   (67)  
Accrued payroll 4,429    3,683   
Prepaid expenses and other (3,699)   (99)  
Accounts payable 8,782    7,233   
Deferred revenue (581)   (3,482)  
Other (97)   (359)  
Acquisition consideration payable for Scilex —    (2,020)  
Accrued expenses and other liabilities 3,137    5,663   
Net cash used in operating activities (136,974)   (66,789)  
Investing activities    
Purchases of property and equipment (9,582)   (5,748)  
Purchase of assets related to Semnur, net of cash acquired (17,040)   —   
Purchase of assets related to Sofusa —    (10,000)  
Contributions to joint venture (1,162)   —   
Net cash used in investing activities (27,784)   (15,748)  
Financing activities    
Proceeds from public offering, net of issuance costs 23,322    —   
Proceeds from Early Conditional Loan, net of issuance costs 18,858    —   
Proceeds from bridge loan for Scilex regulatory milestone —    20,000   
Repayment of bridge loan for Scilex regulatory milestone —    (20,000)  
Proceeds from loan agreement —    1,586   
Short-term bridge loan, net of issuance costs —    19,675   
Short-term loan repayment (740)   —   
Scilex consideration for regulatory milestone —    (22,466)  
Payment on Scilex Notes (1,701)   —   
Proceeds from issuance of common stock, net 947    71,481   
Proceeds from issuance of Scilex notes, net of issuance costs —    134,275   
Proceeds from issuance of convertible notes —    37,849   
Proceeds from exercise of stock options 289    303   
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Net cash provided by financing activities 40,975    242,703   
Net change in cash, cash equivalents and restricted cash (123,783)   160,166   
Net effect of exchange rate changes on cash (156)   (154)  
Cash, cash equivalents and restricted cash at beginning of period 213,330    20,429   
Cash, cash equivalents and restricted cash at end of period $ 89,391    $ 180,441   
Supplemental disclosures:    
Cash paid during the period for:    
Income taxes $ 13    $ 15   
Interest paid $ 10,046    $ 1,453   
Supplemental disclosures of non-cash investing and financing activities:    
Semnur acquisition consideration paid in equity $ 54,591    $ —   
Semnur acquisition costs incurred but not paid $ 601    $ —   
BDL non-cash consideration $ —    $ 2,340   
Property and equipment costs incurred but not paid $ 1,408    $ 59   
     Scilex non-cash consideration for regulatory milestone $ —    $ 13,744   
     Conversion of convertible notes $ —    $ 50,000   
Reconciliation of cash, cash equivalents and restricted cash within the Company’s consolidated balance sheets:
Cash and cash equivalents 34,649    135,441   
Restricted cash 54,742    45,000   
Cash, cash equivalents, and restricted cash $ 89,391    $ 180,441   
 See accompanying notes to unaudited consolidated financial statements
8

SORRENTO THERAPEUTICS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2019
 
1. Nature of Operations and Business Activities
Nature of Operations and Basis of Presentation
Sorrento Therapeutics, Inc. (Nasdaq: SRNE), together with its subsidiaries (collectively, the “Company”) is a clinical stage and commercial biopharma company focused on delivering innovative and clinically meaningful therapies to patients and their families, globally, to address unmet medical needs. The Company primarily focuses on therapeutic areas in Immuno-Oncology and Non-Opioid Pain Management. The Company also has programs assessing the use of its technologies and products in auto-immune, inflammatory and neurodegenerative diseases.
At its core, the Company is an antibody-centric company and leverages its proprietary G-MAB™ library and targeted delivery modalities to generate the next generation of cancer therapeutics. The Company’s fully human antibodies include PD-1, PD-L1, CD38, CD123, CD47, c-MET, VEGFR2, CCR2 and CD137 among others.
The Company’s vision is to leverage these antibodies in conjunction with proprietary targeted delivery modalities to generate the next generation of cancer therapeutics. These modalities include proprietary chimeric antigen receptor T-cell therapy (“CAR-T”), dimeric antigen receptor T-cell therapy (“DAR-T”) and antibody drug conjugates (“ADCs”), as well as bispecific antibody approaches. The Company acquired Sofusa®, a revolutionary drug delivery system, in July 2018, which delivers biologics directly into the lymphatic system to potentially achieve improved efficacy and fewer adverse effects than standard parenteral immunotherapy. Additionally, the Company’s majority owned subsidiary, Scilex Holding Company (“Scilex Holding”), acquired the assets of Semnur Pharmaceuticals, Inc. (“Semnur”) in March 2019. Semnur’s SEMDEXATM (SP-102) compound is expected to be the first FDA-approved non-opioid corticosteroid formulated as a viscous gel injection in development for the treatment of lumbosacral radicular pain/sciatica, containing no neurotoxic preservatives, surfactants, solvents or particulates.
With each of the Company’s clinical and pre-clinical programs, it aims to tailor its therapies to treat specific stages in the evolution of cancer, from elimination, to equilibrium and escape. In addition, the Company’s objective is to focus on tumors that are resistant to current treatments and where it can design focused trials based on a genetic signature or biomarker to ensure patients have the best chance of a durable and significant response. The Company has several immuno-oncology programs that are in or close to entering the clinic. These include cellular therapies, an oncolytic virus and a palliative care program targeted to treat intractable cancer pain.
Through September 30, 2019, the Company had devoted substantially all of its efforts to developing products, raising capital and building infrastructure.  
The Company has reclassified historically presented revenue and cost of revenue to conform to the current period presentation. The reclassification had no impact on previously reported results of operations or financial position.
The accompanying consolidated financial statements include the accounts of the Company’s subsidiaries. For consolidated entities where the Company owns or is exposed to less than 100% of the economics, the Company records net income (loss) attributable to noncontrolling interests in its consolidated statements of operations equal to the percentage of the economic or ownership interest retained in such entities by the respective noncontrolling parties. All intercompany balances and transactions have been eliminated in consolidation.
In the opinion of management, the unaudited financial information for the interim periods presented reflects all adjustments, which are only normal, recurring and necessary for a fair statement of financial position, results of operations and cash flows. These consolidated financial statements should be read in conjunction with the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2018. Operating results for interim periods are not expected to be indicative of operating results for the Company’s 2019 fiscal year, or any subsequent period.
2. Liquidity and Going Concern
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. The Company has recurring losses from operations, recurring negative cash flows from operations and substantial cumulative net
9

losses to date and anticipates that it will continue to do so for the foreseeable future as it continues to identify and invest in advancing product candidates, as well as expanding corporate infrastructure.
The Company has plans in place to obtain sufficient additional funds to fulfill its operating and capital requirements for the next 12 months. The Company’s plans include continuing to fund its operating losses and capital funding needs through public or private equity or debt financings, strategic collaborations, licensing arrangements, asset sales, government grants or other arrangements. Although management believes such plans, if executed, should provide the Company sufficient financing to meet its needs, successful completion of such plans is dependent on factors outside of the Company’s control. As such, management cannot conclude that such plans will be effectively implemented within one year after the date that the financial statements are issued. As a result, management has concluded that the aforementioned conditions, among others, raise substantial doubt about the Company’s ability to continue as a going concern within one year after the date the financial statements are issued.
As of September 30, 2019, the Company had $356.5 million of long term debt outstanding, comprised of convertible notes issued pursuant to the March 2018 Securities Purchase Agreement (as defined below), the 2018 Purchase Agreements (as defined below) and the Indenture (as defined below) for Scilex Pharmaceuticals Inc. (“Scilex Pharma”) and the Loan Agreement (as defined below) (collectively, the “Debt Arrangements”) (See Note 10).
Each of the Debt Arrangements provides that, upon the occurrence of an event of default, the Purchasers or Lenders thereof (as applicable) may, by written notice to the Company, declare all of the outstanding principal and interest under such Debt Arrangement immediately due and payable. For purposes of the Debt Arrangements, an event of default includes, among other things, (i) the failure to pay outstanding indebtedness when due, (ii) the Company’s breach of certain representations, warranties, covenants or obligations under the documents relating to the Debt Arrangements, or (iii) the occurrence of certain insolvency events involving the Company. The Company believes that it is not probable that the material adverse event clause under the Debt Arrangements will be exercised.
If the Company is unable to raise additional capital in sufficient amounts or on terms acceptable, the Company may have to significantly delay, scale back or discontinue the development or commercialization of one or more of its product candidates. The Company may also seek collaborators for one or more of its current or future product candidates at an earlier stage than otherwise would be desirable or on terms that are less favorable than might otherwise be available. The consolidated financial statements do not reflect any adjustments that might be necessary if the Company is unable to continue as a going concern.
3. Significant Accounting Policies
Use of Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of expenses during the reporting period. Management believes that these estimates are reasonable; however, actual results may differ from these estimates.
Fair Value of Financial Instruments
The Company follows accounting guidance on fair value measurements for financial instruments measured on a recurring basis, as well as for certain assets and liabilities that are initially recorded at their estimated fair values. Fair value is defined as the exit price, or the amount that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Company uses the following three-level hierarchy that maximizes the use of observable inputs and minimizes the use of unobservable inputs to value its financial instruments:

•Level 1: Observable inputs such as unadjusted quoted prices in active markets for identical instruments.

•Level 2: Quoted prices for similar instruments that are directly or indirectly observable in the marketplace.

•Level 3: Significant unobservable inputs which are supported by little or no market activity and that are financial instruments whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant judgment or estimation.
10

Financial instruments measured at fair value are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires it to make judgments and consider factors specific to the asset or liability. The use of different assumptions and/or estimation methodologies may have a material effect on estimated fair values. Accordingly, the fair value estimates disclosed or initial amounts recorded may not be indicative of the amount that the Company or holders of the instruments could realize in a current market exchange.
The carrying amounts of cash equivalents and marketable securities approximate their fair value based upon quoted market prices. Certain of the Company’s financial instruments are not measured at fair value on a recurring basis, but are recorded at amounts that approximate their fair value due to their liquid or short-term nature, such as cash, accounts receivable and payable, and other financial instruments in current assets or current liabilities.
Inventory
The Company determines inventory cost on a first-in, first-out basis. The Company reduces the carrying value of inventories to a lower of cost or net realizable value for those items that are potentially excess, obsolete or slow-moving. The Company considers the need for allowances for excess and obsolete inventory based upon historical experience, sales trends, and specific categories of inventory and age of on-hand inventory. As of September 30, 2019, the Company’s inventory is primarily comprised of finished goods, and the related allowance for excess inventory was $2.2 million.
Research and Development Costs
All research and development costs are charged to expense as incurred. Such costs primarily consist of lab supplies, contract services, stock-based compensation expense, salaries and related benefits.
Acquired In-Process Research and Development Expense
The Company has acquired and may continue to acquire the rights to develop and commercialize new drug candidates. The up-front payments to acquire a new drug compound or drug delivery devices, as well as future milestone payments associated with asset acquisitions that do not meet the definition of a derivative and are deemed probable to achieve the milestones, are immediately expensed as acquired in-process research and development provided that the drug has not obtained regulatory approval for marketing and, absent obtaining such approval, have no alternative future use. The acquired in-process research and development related to the business combination of Virttu Biologics Limited (“Virttu”), for which certain products are under development and expected to be commercialized in the future, was capitalized and recorded within “Intangibles, net” on the accompanying consolidated balance sheets. The Company commenced amortization of acquired in-process research and development related to the business combination of Scilex Pharma upon commercialization of ZTlido® (lidocaine topical system) 1.8% in October 2018. Capitalized in-process research and development is reviewed annually for impairment or more frequently as changes in circumstance or the occurrence of events suggest that the remaining value may not be recoverable. (See Note 4 for further discussion of acquired in-process research and development expense related to the acquisition of Semnur).
Revenue Recognition
As of September 30, 2019, the future performance obligations for royalty and license revenues relate to the license agreements with ImmuneOncia Therapeutics, LLC (“ImmuneOncia”) and NantCell, Inc. (“NantCell”). The Company considers both of these entities as related parties and accounts for them as equity method and cost method investments, respectively.
The total consideration for the ImmuneOncia license performance obligation, effective September 1, 2016, represented $9.6 million. The estimated revenue expected to be recognized for future performance obligations, as of September 30, 2019, was approximately $8.1 million. The Company expects to recognize license revenue of approximately $0.5 million of the remaining performance obligation annually through the remaining term. The Company applied judgment in estimating the 20-year contract term, analogous to the expected life of the patent, over which revenue is recognized over time given the ongoing performance obligation related to the Company’s participation on a steering committee for the technologies under the agreement.
As of September 30, 2019, the NantCell license agreement, effective April 21, 2015, represented $110.0 million of contract liabilities reflected in long-term deferred revenue. See Note 9 for additional information regarding the remaining performance obligation for the agreement.
The Company does not disclose the value of unsatisfied performance obligations for (i) contracts with an original expected length of one year or less and (ii) contracts for which it recognizes revenue at the amount to which it has the right to
11

invoice for services performed. The Company applied the practical expedient in Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers to the revenue contracts for Concortis Biosystems Corp. (“Concortis”) sales and services and materials and supply agreements due to the general short-term length of such contracts.
The following table shows revenue disaggregated by product and services type for the three and nine months ended September 30, 2019 and 2018 (in thousands):
Three Months Ended September 30, Nine Months Ended September 30,
2019 2018 2019 2018
Scilex Pharma product sales $ 3,770    $ —    $ 11,289    $ —   
Other product sales 40    1,121    579    1,982   
Net product revenue $ 3,810    $ 1,121    $ 11,868    $ 1,982   
Concortis Biosystems Corporation
$ 1,607    $ 1,042    $ 4,622    $ 3,400   
Bioserv Corporation
233    1,528    1,540    4,895   
Joint development agreement —    —    —    3,333   
Other revenue 128    414    368    654   
Service revenue $ 1,968    $ 2,984    $ 6,530    $ 12,282   

The Company is obligated to accept from customers the return of products sold that are damaged or do not meet certain specifications. The Company may authorize the return of products sold in accordance with the terms of its sales contracts, and estimates allowances for such amounts at the time of sale. The Company has not experienced any sales returns.
Scilex Holding
The Company’s revenue is generated from product sales within the United States. The Company does not have significant costs associated with costs to obtain contract with its customer. Substantially all of the Company’s revenue and accounts receivable result from a sole customer.

Revenue from product sales is fully comprised of sales of ZTlido® (lidocaine topical system) 1.8%. The Company’s performance obligation with respect to sales of ZTlido® (lidocaine topical system) 1.8% is satisfied at a point in time, which transfers control upon delivery of product to the customer. The Company considers control to have transferred upon delivery because the customer has legal title to the asset, physical possession of the asset has been transferred to the customer, the customer has significant risks and rewards of ownership of the asset, and the Company has a present right to payment at that time. The Company identified a single performance obligation. Invoicing typically occurs upon shipment and the length of time between invoicing and when payment is due is not significant. The aggregate dollar value of unfulfilled orders as of September 30, 2019 was not material.

For product sales, the Company records gross-to-net sales adjustments for government and managed care rebates, chargebacks, wholesaler and distributor fees, sales returns and prompt payment discounts. Such variable consideration are estimated in the period of the sale and are estimated using a most likely amount approach based primarily upon provisions included in the Company’s customer contract, customary industry practices and current government regulations. There were no significant changes in estimates of variable consideration during the nine months ended September 30, 2019.
Concortis Biosystems Corporation (“Concortis”)
Revenues for Concortis operations are comprised of contract manufacturing associated with sales of customized reagents and relate to providing synthetic expertise to a customers’ synthesis of reagents by delivering proprietary cytotoxins, linkers and linker-toxins and ADC service using industry standard toxins and antibodies provided by customers. Revenues are recognized at a point in time upon the transfer of control, which is generally upon shipment given the short contract terms which are generally three months or less.
Bioserv Corporation (“Bioserv”)
Contract manufacturing services associated with the Company’s Bioserv operations related to finish and fill activities for drug products and reagents are recognized ratably over the contract term based on a time-based measure which reflects the transfer of services to the customer because the manufactured products are highly customized and do not have an alternative use
12

to the Company. As of December 31, 2018 and September 30, 2019, the estimated revenue expected to be recognized for future performance obligations associated with contract manufacturing services was approximately $1.6 million and $1.2 million, respectively.
The following table includes Bioserv sales and services revenue expected to be recognized in the future related to performance obligations that are undelivered or partially delivered at the end of the reporting period and do not include contracts with original durations of one year or less (in thousands):
Remainder of 2019 2020 2021 and thereafter
Contract manufacturing services $403    $701    $109   

Joint Development Agreement
On September 26, 2017, the Company entered into a joint development agreement with Celularity Inc. (“Celularity”) whereby the Company agreed to provide research services to Celularity through June 30, 2018 in exchange for an upfront payment of $5.0 million. The revenue related to the joint development agreement of $5.0 million was recognized over the length of the service agreement as services were performed. The Company recorded sales and services revenues under the joint development agreement of $3.3 million during the nine months ended September 30, 2018. The Company recorded no sales and services revenues under the joint development agreement during the nine months ended September 30, 2019 as such arrangement is complete.
Reorganization of Segments
Starting on January 1, 2019, the Company re-segmented its business into two new operating segments: the Sorrento Therapeutics segment and the Scilex segment.
Recent Accounting Pronouncements
In February 2016, the FASB issued ASU No. 2016-02, Leases. ASU No. 2016-02 is aimed at making leasing activities more transparent and comparable, and requires substantially all leases be recognized by lessees on their balance sheet as a right-of-use asset and corresponding lease liability, including leases currently accounted for as operating leases. ASU No. 2016-2 is effective for financial statements issued for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. In July 2018, the FASB issued ASU No. 2018-11, which allows for an optional transition method to adopt the lease standard by recognizing a cumulative-effect adjustment to the opening balance sheet of retained earnings in the period of adoption, with no adjustment to prior comparative periods. In March 2019, the FASB issued ASU No. 2019-01, which clarifies that entities are not subject to the transition disclosure requirements in Accounting Standards Codification (“ASC”) Topic 250-10-50-3 related to the effect of an accounting change on certain interim period financial information. ASU No. 2016-02 and all subsequent amendments (collectively, “ASC 842”) were effective for public entities for annual reporting periods beginning after December 15, 2018, including interim periods therein. The Company adopted ASC 842 during the first quarter of 2019 and elected to apply the cumulative-effect adjustment to the opening balance sheet and optional transition method to not present comparable prior periods as allowed under ASU No. 2018-11. The Company made the following practical expedients elections: (1) elected the short-term lease exception, (2) did not elect hindsight, and (3) elected to not separate its non-lease components from lease components. The Company adopted the transitional practical expedients, which allowed the Company to carry forward its historical assessment of whether existing agreements contained a lease and the classification of the Company’s existing operating leases, and also allowed the Company to not reassess initial direct costs. The adoption of ASC 842 resulted in the recording of $44.9 million in operating lease right-of-use (“ROU”) assets and $2.6 million and $47.8 million in current portion of operating lease liabilities and non-current operating lease liabilities, respectively. Deferred rent, recorded in other current liabilities and other non-current liabilities, was derecognized. There were no adjustments to retained earnings. The Company reports financial information for fiscal years ending on or before December 31, 2018 under the previous lease accounting standard.
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. The ASU 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. The ASU is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early application will be permitted for all organizations for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company is currently evaluating the impact that
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the adoption of ASU No. 2016-13 will have on the Company’s consolidated financial position, results of operations or cash flows.
In July 2019, the FASB issued ASU No. 2019-07, Codification Updates to SEC Sections - Amendments to SEC Paragraphs Pursuant to SEC Final Rule Releases No. 33-10532, Disclosure Update and Simplification, and Nos. 33-10231 and 33-10442, Investment Company Reporting Modernization and Miscellaneous Updates (SEC Update) (“ASU 2019-07”). ASU 2019-07 aligns the guidance in various sections of the ASC with the requirements of certain final rules of the Securities and Exchange Commission. ASU 2019-07 was effective immediately. The adoption of ASU 2019-07 did not have a material impact on the Company’s consolidated financial position, results of operations or cash flows.
4. Acquisitions
Acquisition of Semnur Pharmaceuticals, Inc.
On March 18, 2019, the Company, for limited purposes, entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Semnur, Scilex Holding, Sigma Merger Sub, Inc., a Delaware corporation and wholly owned subsidiary of Scilex Holding (“Merger Sub”), and Fortis Advisors LLC, solely as representative of the holders of Semnur equity (the “Equityholders’ Representative”). Pursuant to the Merger Agreement, Merger Sub merged with and into Semnur (the “Merger”), with Semnur surviving as a wholly owned subsidiary of Scilex Holding.
Concurrently with the execution of the Merger Agreement, the Company and each of the other holders of outstanding shares of capital stock of Scilex Pharma, the Company’s majority-owned subsidiary, contributed each share of Scilex Pharma capital stock that the Company or it owned to Scilex Holding in exchange for one share of Scilex Holding common stock (the “Contribution”). In connection with the Contribution, the Company provided Scilex Holding with a loan with an initial principal amount of $16.5 million in the form of a note payable, which loan was used to fund the acquisition of Semnur. As a result of the Contribution, and prior to the consummation of the Merger, Scilex Pharma became a wholly-owned subsidiary of Scilex Holding and the Company became the owner of approximately 77% of Scilex Holding’s issued and outstanding capital stock.
At the closing of the Semnur acquisition, Scilex Holding issued to the holders of Semnur’s capital stock and options to purchase Semnur’s common stock (collectively, the “Semnur Equityholders”) upfront consideration with a value of approximately $70.0 million. The upfront consideration was comprised of the following: (a) a cash payment of approximately $15.0 million, and (b) $55.0 million of shares of Scilex Holding common stock (47,039,315 shares issued and 352,972 shares issuable, valued at $1.16 per share) (the “Stock Consideration”).
On August 7, 2019, Scilex Holding entered into an amendment to the Merger Agreement to provide that, following the consummation of Scilex Holding’s first bona fide equity financing with one or more third-party financing sources on an arms’ length basis with gross proceeds to Scilex Holding of at least $40.0 million, certain of the former Semnur Equityholders will be paid cash in lieu of: (a) the 352,972 shares of the Company’s common stock otherwise issuable to such Semnur Equityholders pursuant to the Merger Agreement, and (b) any shares that would otherwise be issued to such Semnur Equityholders upon release of shares held in escrow pursuant to the Merger Agreement, with such shares in each case valued at $1.16 per share. The amendment resulted in a reclassification of $0.4 million from additional paid-in capital to accrued liabilities.
A portion of the cash consideration otherwise payable to the Semnur Equityholders was set aside for expenses incurred by the Equityholders’ Representative, and 4,749,095 shares of Scilex Holding common stock otherwise issuable to Semnur Equityholders were placed in escrow with a third party as security for the indemnification obligations of the Semnur Equityholders under the Merger Agreement, including in respect of breaches of representations and warranties of Semnur included in the Merger Agreement. The Semnur Equityholders that receive the Stock Consideration were required to sign an exchange and registration rights agreement with the Company (the “Exchange Agreement”), which is further described below.
Following the issuance of the Stock Consideration, the Company’s ownership in Scilex Holding was diluted to approximately 58% of Scilex Holding’s issued and outstanding capital stock. Pursuant to the Merger Agreement, and upon the terms and subject to the conditions contained therein, Scilex Holding also agreed to pay the Semnur Equityholders up to $280.0 million in aggregate contingent cash consideration based on the achievement of certain milestones, which is comprised of a $40.0 million payment that will be due upon obtaining the first approval of a New Drug Application of a Semnur product by the U.S. Food and Drug Administration (the “FDA”) and additional payments that will be due upon the achievement of certain amounts of net sales of Semnur products as follows: (a) a $20.0 million payment upon the achievement of $100.0 million in cumulative net sales of a Semnur product, (b) a $20.0 million payment upon the achievement of $250.0 million in cumulative net sales of a Semnur product, (c) a $50.0 million payment upon the achievement of $500.0 million in cumulative net sales of a
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Semnur product, and (d) a $150.0 million payment upon the achievement of $750.0 million in cumulative net sales of a Semnur product.
Pursuant to the Exchange Agreement, and upon the terms and subject to the conditions contained therein, if within 18 months following the closing of the Merger (the “Merger Closing”), 100% of the outstanding equity of Scilex Holding has not been acquired by a third party and Scilex Holding has not entered into a definitive agreement with respect to, or otherwise consummated, a firmly underwritten offering of Scilex Holding capital stock on a major stock exchange that meets certain requirements and includes the Stock Consideration, then holders of the Stock Consideration may collectively elect to exchange, during the 60-day period commencing the date that is the 18 month anniversary of the Merger Closing (the “Share Exchange”), the Stock Consideration for shares of the Company’s common stock with a value of $55.0 million based on a price per share of the Company’s common stock equal to the greater of (a) the 30-day trailing volume weighted average price of one share of the Company’s common stock as reported on The Nasdaq Stock Market LLC as of the consummation of the Share Exchange and (b) $5.55 (subject to adjustment for any stock dividend, stock split, stock combination, reclassification or similar transaction).
Pursuant to the terms of the Exchange Agreement, and subject to the limitations contained therein, within 30 days following consummation of the Share Exchange (if it occurs at all), the Company agreed to prepare and file with the SEC a registration statement to enable the public resale on a delayed or continuous basis of the shares of the Company’s common stock issued in the Share Exchange (the “Registration Statement”) and use its commercially reasonable efforts to maintain the effectiveness of such Registration Statement for up to three years thereafter. In the Exchange Agreement, the Company has also agreed to indemnify the applicable Semnur Equityholders and their affiliates for certain liabilities related to such Registration Statement, including certain liabilities arising under the Securities Act of 1933, as amended (the “Securities Act”), and the Securities Exchange Act of 1934, as amended (the “Exchange Act”).
Jaisim Shah, a member of the Company’s Board of Directors, was Semnur’s Chief Executive Officer, a member of its Board of Directors and a stockholder of Semnur prior to the acquisition transaction.
The transaction was accounted for as an asset acquisition since substantially all the value of the gross assets was concentrated in a single asset. Under the Merger Agreement, Scilex Holding acquired the Semnur SEMDEXATM (SP-102) technology for consideration valued at approximately $70.0 million, excluding contingent consideration, transaction costs of $3.1 million and liabilities assumed of $4.2 million, which was allocated based on the relative fair value of the assets acquired. The $70.0 million of consideration consisted of $15.0 million in cash and shares of Scilex Holding valued at $55.0 million. No contingent consideration was recorded as of September 30, 2019 since the related regulatory approval milestones are not deemed probable until they actually occur. As a result, approximately $75.3 million was expensed as a component of acquired in-process research and development.
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5. Fair Value Measurements
The following table presents the Company’s financial assets and liabilities that are measured at fair value on a recurring basis (in thousands):
  Fair Value Measurements at September 30, 2019
  Balance Quoted Prices in Active Markets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3)
Assets:        
Cash and cash equivalents $ 34,649    $ 34,649    $ —    $ —   
Restricted cash 54,742    54,742    —    —   
Marketable securities 94    81    —    13   
Total assets $ 89,485    $ 89,472    $ —    $ 13   
Liabilities:        
Derivative liabilities $ 9,000    $ —    $ —    $ 9,000   
Derivative liabilities - Non-current 29,500    —    —    29,500   
Acquisition consideration payable 11,312    —    —    11,312   
Acquisition consideration payable - Non-current 828    —    —    828   
Total liabilities $ 50,640    $ —    $ —    $ 50,640   
  Fair Value Measurements at December 31, 2018
  Balance Quoted Prices in Active Markets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3)
Assets:        
Cash and cash equivalents $ 158,738    $ 158,738    $ —    $ —   
Restricted cash 54,592    54,592    —    —   
Marketable securities 297    247    —    50   
Total assets $ 213,627    $ 213,577    $ —    $ 50   
Liabilities:        
Acquisition consideration payable $ 11,312    $ —    $ —    $ 11,312   
Acquisition consideration payable - Non-current 725    —    —    725   
Total liabilities $ 12,037    $ —    $ —    $ 12,037   

The Company’s financial assets and liabilities carried at fair value are comprised of cash, cash equivalents, restricted cash, marketable securities and acquisition consideration payable. Cash and cash equivalents consist of money market accounts and bank deposits which are highly liquid and readily tradable. These investments are valued using inputs observable in active markets for identical securities. Marketable securities are valued using inputs observable in active markets for identical securities. The fair value of the contingent consideration is measured on a recurring basis using significant unobservable inputs (Level 3). Contingent consideration is measured using the income approach and discounting to present value the contingent payments expected to be made based on assessment of the probability that the Company would be required to make such future payment.
The following table includes a summary of the Company’s contingent consideration liabilities and acquisition consideration payables associated with acquisitions.
(in thousands) Fair Value
Beginning balance at December 31, 2018 $ 12,037   
Re-measurement of Fair Value 103   
Ending balance at September 30, 2019 $ 12,140   
As of September 30, 2019, $9.9 million of the Virttu contingent liability remains to be paid in cash.
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The principal significant unobservable inputs used in the valuations of the contingent considerations are the discount rates, and probabilities assigned to scenario outcomes.
The Company recorded a loss on derivative liabilities of $9.6 million and $29.5 million for the three and nine months ended September 30, 2019, respectively, which was primarily attributed to revised probabilities related to the timing of marketing approval for ZTlido® (lidocaine topical system) 5.4% (“SP-103”), revised sales forecasts and tax indemnification obligations with respect to foreign note holders. The fair value of the derivative liabilities is estimated using the discounted cash flow method under the income approach combined with a Monte Carlo simulation model, which involves significant Level 3 inputs and assumptions including a discount rate of approximately 19.6%, net sales forecasts and estimated probabilities of 55% and 95% of not obtaining marketing approval before predetermined dates as of September 30, 2019.
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