Verrica Pharmaceuticals Inc.: Form 10-Q for the period ended Sep 30, 2023

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with (i) our unaudited interim condensed financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q and (ii) our audited financial statements and notes thereto and management’s discussion and analysis of financial condition and results of operations for the years ended December 31, 2021 and 2022 included in our Annual Report on Form 10-K for the year ended December 31, 2022, filed with the Securities and Exchange Commission (the “SEC”) on March 6, 2023. Our financial statements have been prepared in accordance with U.S. GAAP.

We own various U.S. federal trademark applications and unregistered trademarks, including our company name and YCANTH*. All other trademarks or trade names referred to in this Quarterly Report on Form 10-Q are the property of their respective owners. Solely for convenience, the trademarks and trade names in this report are referred to without the symbols ® and ™, but such references should not be construed as an indication that their respective owners will not assert, to the fullest extent under applicable law, their rights thereto.*

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”), including, without limitation, statements regarding our expectations, beliefs, intentions or future strategies that are signified by the words “expect,” “anticipate,” “intend,” “believe,” “may,” “plan,” “seek” or similar language. All forward-looking statements included in this document are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements. Our business and financial performance are subject to substantial risks and uncertainties. Our actual results could differ materially from those discussed in these forward-looking statements. In evaluating our business, you should carefully consider the information set forth in this Quarterly Report under Part II - Item 1A “Risk Factors,” and in our other filings with the SEC.

Overview

We are a dermatology therapeutics company developing and selling medications for skin diseases requiring medical intervention. We are primarily focused on developing clinician administered therapies in areas of high unmet need. Our current product pipeline consists of one approved product, YCANTH solution for the treatment of molluscum contagiosum in adult and pediatric patients two years of age and older, as well as three product candidates: (i) VP-102, a propriety drug-device combination that contains a GMP-controlled formulation of cantharidin which is being developed for potential use in treating external genital warts and common warts, (ii) VP-315, an oncolytic peptide-based injectable therapy for the potential treatment of dermatology oncologic conditions, including basal cell carcinoma, and (iii) VP-103, a second cantharidin based drug device combination for the potential treatment of plantar warts.

On July 21, 2023, the U.S. Food and Drug Administration, or FDA, approved YCANTH (VP-102) topical solution for the treatment of molluscum contagiosum in adult and pediatric patients two years of age and older. There are currently no other products approved by the FDA, nor is there an established standard of care for this disease, resulting in significant undertreated populations. Molluscum and common warts are two of the largest unmet needs in dermatology. YCANTH is the first FDA-approved product for the treatment of molluscum and has the potential for its active pharmaceutical ingredient, or API, to be characterized as a new chemical entity, or NCE, with the five years of non-patent regulatory exclusivity associated with that designation. Physicians obtain YCANTH in two primary ways, either through a “white bag” service with our specialty pharmacy partner or on a buy and bill basis through our distribution partner, FFF Enterprises. YCANTH is currently reimbursed under a miscellaneous J-code, which we expect will be replaced by an assigned permanent J-code by January 2024, which we expect will be published by April 2024. In addition, YCANTH has been granted a C-code which is used by hospitals and clinics on a temporary basis until our permanent J-code is assigned. To date, we have reached over 112 million covered lives in the United States through positive insurance payor coverage decisions.

We also believe VP-102 has the potential to qualify for pediatric exclusivity in common warts, which would provide for an additional six months of non-patent exclusivity. In addition, our granted patents and pending patent applications include claims drawn to our cantharidin formulations, applicator devices and related accessories, dosing regimens, methods of preparation including methods of synthesis, and methods of use.

In June 2019, we announced positive topline results from our COVE-1 Phase 2 open label clinical trial of VP-102 for the treatment of verruca vulgaris, or common warts. Based on results of our Phase 2 trial we are evaluating the timing and design of a Phase 3 trial of VP-102 for the treatment of common warts. We held a Type C meeting on November 6, 2023 on common warts clinical trials and the FDA is expected to issue meeting minutes within 30 days of the meeting.

In addition, we are also developing VP-102 for the treatment of external genital warts. We initiated a Phase 2 clinical trial evaluating the optimal dose regimen, efficacy, safety and tolerability of VP-102 in patients with external genital warts in June 2019.

In November 2020, we announced positive topline results from our Phase 2 clinical trial of VP-102 for the treatment of external genital warts. Based on results of the Phase 2 trial we are evaluating the timing and design of a Phase 3 trial of VP-102 for the treatment of external genital warts.

We also intend to develop our product candidate, VP-315, an intratumorally injected, chemotherapeutic peptide for the treatment of dermatological oncology indications. VP-315 has been observed to activate the adaptive immune system by inducing lysis and immunogenic cell death through release of immuno-stimulants and a repertoire of tumor neoantigens. The FDA accepted our IND in November 2021. In April 2022, we dosed the first patient in Part 1 of a 3-part Phase 2, multicenter, open-label, dose-escalation proof-of-concept trial with a safety run-in designed to assess the safety, pharmacokinetics, and efficacy in subjects with biopsy proven basal cell carcinoma. In Part 1 of the trial, VP-315 demonstrated a favorable safety and tolerability profile with no reported serious adverse events. We initiated Part 2 of the trial in April 2023. In June 2023, the protocol was amended to remove Part 3 of the trial by expanding Part 2, which we expect will expedite the conclusion of Phase 2. We expect to complete this Phase 2 trial in the first half of 2024.

In addition, we are conducting necessary drug development activities for VP-103, our second cantharidin-based product candidate, and are evaluating when to initiate a Phase 2 clinical trial for the treatment of plantar warts.

On March 17, 2021, we entered into a collaboration and license agreement, or the Torii Agreement, with Torii Pharmaceutical Co., Ltd., or Torii, pursuant to which we granted Torii an exclusive license to develop and commercialize our product candidates that contain a topical formulation of cantharidin for the treatment of molluscum contagiosum and common warts in Japan, including VP-102. Additionally, we granted Torii a right of first negotiation with respect to additional indications for the licensed products and certain additional products for use in the licensed field, in each case in Japan. Pursuant to the Torii Agreement, we are entitled to receive an up-front payment from Torii of $11.5 million. On July 25, 2022 Torii dosed the first patient in its Phase 3 trial of VP-102 (referred to as TO-208 in Japan) for molluscum contagiosum in Japan, triggering an $8.0 million milestone payment. Additionally, we are entitled to receive from Torii an additional $50.0 million in aggregate payments contingent on achievement of specified development, regulatory, and sales milestones, in addition to tiered transfer price payments for supply of product in the percentage range of the mid-30s to the mid-40s of net sales.

On March 7, 2022, pursuant to the Torii Agreement, we entered into a Clinical Supply Agreement with Torii, whereby we are obligated to supply product to Torii for use in clinical trials and other development activities. We recognized billed and unbilled collaboration revenue of $0.1 and $0.3 million, respectively for the three months ended September 30, 2023 and 2022 and $0.3 and $1.0 million, for the nine months ended September 30, 2023 and 2022, respectively related to supplies and development activity pursuant to this agreement.

In August 2020, we entered into an exclusive license agreement with Lytix Biopharma AS, or Lytix, pursuant to which we obtained a worldwide, license for certain technology of Lytix to develop VP-315 for use in all malignant and pre-malignant dermatological indications, other than metastatic melanoma and metastatic Merkel cell carcinoma.

We have commercially launched YCANTH in August 2023 in the United States for the treatment of molluscum contagiosum. We have built a specialized sales organization in the United States focused on pediatric dermatologists, dermatologists, and select pediatricians. We also plan to advance VP-102 for common warts and external genital warts through a separate regulatory approval process. In the future, we also intend to pursue commercialization for YCANTH, as well as VP-102 for common warts and genital warts, in additional geographic regions, either alone or together with a strategic partner.

Since our inception in 2013, our operations have focused on developing VP-102, organizing and staffing our company, business planning, raising capital, establishing our intellectual property portfolio and conducting clinical trials. We have funded our operations primarily through the sale of equity and equity-linked securities and through borrowings under loan agreements.

On July 26, 2023, we entered into a Credit Agreement with OrbiMed (the “Initial Lender”), and each other lender that may from time to time become a party thereto (each, including the Initial Lender, and together with their affiliates, successors, transferees and assignees, the “Lenders”). The Credit Agreement provides for a five-year senior secured credit facility in an aggregate principal amount of up to $125 million (the “Loan Facility”), of which we borrowed $50.0 million on July 26, 2023, resulting in net proceeds to us of approximately $44.1 million after payment of certain fees and transaction related expenses. In addition, up to $25.0 million will be made available on or prior to June 30, 2024, up to $30.0 million will be made available on or prior to December 31, 2024, up to $10.0 million will be made available on or prior to March 31, 2025, and up to $10.0 million will be made available on or prior to June 30, 2025, in each case, subject to our achievement of certain revenue targets. Amounts borrowed under the Loan Facility will mature on July 26, 2028. On the Closing Date, we also issued the Initial Lender a warrant to purchase up to 518,551 shares of our common stock, at an exercise price of $6.0264 per share, which shall have a term of 10 years from the issuance date.

As of September 30, 2023, we had cash and cash equivalents of $84.3 million. We believe that our existing cash and cash equivalents as of September 30, 2023, will be sufficient to support our planned operations into the first quarter of 2025.

Since inception, we have incurred significant operating losses. For the nine months ended September 30, 2023 and 2022, our net loss was $42.4 million and $18.6 million, respectively. As of September 30, 2023, we had an accumulated deficit of $205.8 million.

We expect to continue to incur significant expenses and operating losses for the foreseeable future. We anticipate that our expenses will increase significantly in connection with our ongoing activities, as we:

• continue commercialization of YCANTH;
• continue our ongoing clinical program evaluating VP-315 for the treatment of basal cell carcinoma and potentially additional dermatological oncology indications;
• initiate clinical trials evaluating VP-102 for the treatment of external genital warts;
• continue our ongoing clinical programs evaluating VP-102 for the treatment of common warts as well as initiate and complete additional clinical trials, as needed;
• initiate clinical trials evaluating VP-103 for the treatment of plantar warts;
• pursue regulatory approvals for VP-102 for the treatment of common warts, external genital warts, or any other indications we may pursue for VP-102, as well as for VP-103 or VP-315;
• seek to discover and develop additional product candidates;
• further establish a commercialization infrastructure and scale up external manufacturing and distribution capabilities to commercialize YCANTH and any other product candidates for which we may obtain regulatory approval, including VP-102, VP-315 and VP-103;
• seek to in-license or acquire additional product candidates for other dermatological conditions;
• adapt our regulatory compliance efforts to incorporate requirements applicable to marketed products;
• maintain, expand and protect our intellectual property portfolio;
• hire additional commercial, administrative, clinical, manufacturing and scientific personnel;
• add operational, financial and management information systems and personnel, including personnel to support our product development and planned commercialization efforts; and
• incur additional legal, accounting and other expenses in operating as a public company.

Critical Accounting Estimates

Our management’s discussion and analysis of our financial condition and results of operations is based on our financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires us to make estimates, judgments and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities as of the dates of the balance sheets and the reported amounts of expenses during the reporting periods. In accordance with GAAP, we evaluate our estimates and judgments on an ongoing basis.

A summary of our significant accounting policies are disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022. However, we believe that the additional accounting policies disclosed in Note 2 to our condensed financial statement are important to understanding and evaluating our reported financial results.

Components of Results of Operations

Product Revenue, Net

We recognize revenue from sales of YCANTH, or the Product, in accordance with ASC Topic 606 – Revenue from Contracts with Customers. YCANTH became available for commercial sale and shipment to patients with a prescription in the United States in the three months ended September 30, 2023. We sell the Product to a pharmaceutical wholesaler/distributor, or the Customer who in turn sells the Product directly to clinics, hospitals, and federal healthcare programs. Revenue is recognized as the Product is physically delivered to the Customer.

Gross product sales are reduced by corresponding gross-to-net, or GTN, estimates using the expected value method, resulting in our reported “Product revenue, net” in the accompanying consolidated statements of operations. Product revenue, net reflects the amount we ultimately expect to realize in net cash proceeds, taking into account the current period gross sales and related cash receipts and the subsequent cash disbursements on these sales that we estimate for the various GTN categories discussed below. The GTN estimates are based upon information received from external sources, such as written or oral information obtained from our customers with respect to their period-end inventory levels and sales to end-users during the period, in combination with management’s informed judgments. Due to the inherent uncertainty of these estimates, the actual amount of product returns, government chargebacks, prompt pay discounts, commercial rebates, Medicaid rebates, co-pay assistance and distribution, data, and group purchasing organizations, or

GPOs, administrative fees may be materially above or below the amount estimated. Variance between actual amounts and estimated amounts may result in prospective adjustments to reported net product revenue.

Each of the GTN estimate categories are discussed below:

Product Returns Allowances: The Customer is contractually permitted to return purchased Product in certain circumstances. We estimate expected returns based on our review of similar products in the industry. As historical data for returns of the Product becomes available over time, we will utilize historical return rates of the Product in making our estimates. Returned Product is typically destroyed, since substantially all returns are due to expiry and cannot be resold.

Government Chargebacks: The Product is subject to pricing limits under certain federal government programs, including Medicare and the 340B drug pricing program. Qualifying entities, or the End-Users, purchase the Product from the Customer at their applicable qualifying discounted price. The chargeback amount we incur represents the difference between our contractual sales price to the Customer and the end-user’s applicable discounted purchase price under the government program.

Medicaid Rebates: The Product is subject to state government-managed Medicaid programs, whereby rebates are issued to participating state governments. These rebates arise when a patient treated with the Product is covered under Medicaid, resulting in a discounted price for the Product under the applicable Medicaid program. The Medicaid rebate accrual calculations require us to project the magnitude of our sales, by state, that will be subject to these rebates.

Patient Assistance: We offer a voluntary co-pay patient assistance program intended to provide financial assistance to eligible patients with a prescription drug co-payment required by payors and coupon programs for cash payors. The calculation of the current liability for this assistance is based on an estimate of claims and the cost per claim that we expect to receive associated with YCANTH that has been recognized as revenue but remains in the distribution channel inventories at the end of each reporting period.

Distribution, Data, and GPO Administrative Fees: Distribution, data, and GPO administrative fees are paid to authorized wholesalers/distributors of our products for various commercial services including contract administration, inventory management, delivery of end-user sales data, and product returns processing. These fees are based on a contractually-determined percentage of our applicable sales.

Collaboration Revenue

Collaboration revenue represents revenue from the Torii Agreement pursuant to which we granted Torii an exclusive license to develop and commercialize our product candidates that contain a topical formulation of cantharidin for the treatment of molluscum contagiosum and common warts in Japan, including VP-102.

Operating Expenses

Selling, General and Administrative Expenses

Selling, general and administrative expenses consist principally of salaries and related costs for personnel in sales, executive and administrative functions, including stock-based compensation, travel expenses and recruiting expenses. Other selling, general and administrative expenses include cost of samples, sponsorships, consumer and health care professional marketing and advertising expense, insurance costs, and professional fees for audit, tax and legal services.

We anticipate that our selling, general and administrative expenses, including payroll and related expenses, will increase in the future as we continue to increase our headcount to support the expected growth in our business, expand our operations and organizational capabilities, and commercialize YCANTH. We also anticipate increased expenses associated with general operations, including costs related to audit, tax and legal services, director and officer insurance premiums, and investor relations costs.

Research and Development Expenses

Research and development expenses consist of expenses incurred in connection with the discovery and development of YCANTH for the treatment of molluscum contagiosum, potential follow-on indications for VP-102 and our other product candidates. We expense research and development costs as incurred. These expenses include:

• expenses incurred under agreements with contract research organizations, or CROs, as well as investigative sites and consultants that conduct our clinical trials and preclinical studies;
• manufacturing and supply scale-up expenses and the cost of acquiring and manufacturing preclinical and clinical trial supply and commercial supply, including manufacturing validation batches;
• outsourced professional scientific development services;
• employee-related expenses, which include salaries, benefits and stock-based compensation;
• expenses relating to regulatory activities; and
• laboratory materials and supplies used to support our research activities.

Research and development activities are central to our business model. Product candidates in later stages of clinical development generally have higher development costs than those in earlier stages of clinical development, primarily due to the increased size and duration of later-stage clinical trials. We expect our research and development expenses to increase over the next several years as we increase personnel costs, including stock-based compensation, initiate and conduct clinical trials of VP-102 in patients with common warts, VP-102 in patients with external genital warts, VP-315 for dermatological oncology indications,VP-103 in patients with plantar warts, and conduct other clinical trials and prepare regulatory filings for our product candidates.

The successful development of our product candidates is highly uncertain. At this time, we cannot reasonably estimate or know the nature, timing and costs of the efforts that will be necessary to complete the remainder of the development of, or when, if ever, material net cash inflows may commence from YCANTH or our product candidates. This uncertainty is due to the numerous risks and uncertainties associated with the duration and cost of clinical trials, which vary significantly over the life of a project as a result of many factors, including:

• the number of clinical sites included in the trials;
• the length of time required to enroll suitable patients;
• the number of patients that ultimately participate in the trials;
• the number of doses patients receive;
• the duration of patient follow-up; and
• the results of our clinical trials.

Our expenditures are subject to additional uncertainties, including the manufacturing process for our product candidates, the terms and timing of regulatory approvals, and the expense of filing, prosecuting, defending and enforcing any patent claims or other intellectual property rights. We may never succeed in achieving regulatory approval for our product candidates. We may obtain unexpected results from our clinical trials. We may elect to discontinue, delay or modify clinical trials of our product candidates. A change in the outcome of any of these variables with respect to the development of a product candidate could mean a significant change in the costs and timing associated with the development of that product candidate. For example, if the FDA or other regulatory authorities were to require us to conduct clinical trials beyond those that we currently anticipate, or if we experience significant delays in enrollment in any of our clinical trials, we could be required to expend significant additional financial resources and time on the completion of clinical development.

Cost of Product Revenue

Cost of product revenue includes the cost of inventory sold, which includes direct manufacturing and supply chain costs. Prior to FDA approval, all product purchased from such suppliers was included as a component of research and development expense, as we were unable to assert that the inventory had future economic benefit until YCANTH received FDA approval. Pursuant to the supply agreement, we purchased and included in research and development expenses approximately $4.5 million of raw cantharidin and processed API. The raw cantharidin and processed API is sufficient to produce approximately 14 million finished drug product applicators to be used for commercially saleable product and other VP-102 product candidates. In addition, we purchased other components and services related to YCANTH for commercially saleable product and included approximately $1.2 million in research and development expenses prior to FDA approval. As a result, cost of product revenue related to YCANTH will initially reflect a lower average per unit cost of materials over approximately the next nine months as previously expensed inventory is utilized for commercial production and sold to customers. If we included those costs previously expensed as a component of cost of product revenue, our cost of product revenue for the three and nine months ended September 30, 2023 would have been $0.3 million.

Cost of Collaboration Revenue

The costs of collaboration revenue consists of payments for manufacturing supply to support development and testing services pursuant to the Torii Clinical Supply Agreement.

Results of Operations for the Three Months Ended September 30, 2023 and 2022

The following table summarizes our results of operations for the three months ended September 30, 2023 and 2022 (in thousands):

Product Revenue, Net

Product revenue, net was $2.8 million for three months ended September 30, 2023 and relates to the initial delivery of YCANTH to FFF, our distribution partner. As YCANTH, our first FDA approved product, became available for commercial sale and shipment to patients in the three months ended September 30, 2023, we did not recognize any product revenue prior to that point.

Collaboration Revenue

Collaboration revenue was $0.1 and $8.3 million, respectively for each of the three months ended September 30, 2023 and 2022. Revenue for the three months ended September 30, 2023 is related to clinical supplies and development activity provided to Torii pursuant to the Clinical Supply Agreement entered into on March 7, 2022. For the three months ended September 30, 2022, collaboration revenue was related to an $8.0 million milestone payment and $0.3 million related to clinical supplies and development activity provided to Torii.

Selling, General and Administrative Expenses

Selling, general and administrative expenses were $20.1 million for the three months ended September 30, 2023, compared to $3.9 million for the three months ended September 30, 2022. The increase of $16.1 million was primarily a result of higher expenses related to commercial activities for YCANTH including increased marketing and sponsorship costs of $3.7 million, increased compensation, recruiting fees, benefits and travel due to ramp-up of sales force in the three months ended September 30, 2023 of $3.8 million as well as $7.4 million related to vesting of restricted stock units.

Research and Development Expenses

Research and development expenses were $6.5 million for the three months ended September 30, 2023, compared to $2.8 million for the three months ended September 30, 2022. The increase of $3.7 million was primarily attributable to an increase in clinical costs for VP-315 of $1.4 million, increased chemistry, manufacturing and control, or CMC, costs of $0.9 million related to pre-approval activity and increased stock compensation expense of $0.8 million related to vesting of restricted stock units upon FDA approval and commercial launch of YCANTH.

The following table summarizes our research and development expense by product candidate or, for unallocated expenses, by type, for the three months ended September 30, 2023 and 2022. We did not incur any research and development expense for VP-103 during the three months ended September 30, 2023 or 2022. Unallocated expenses include compensation and other personnel related costs. Stock compensation expense included $0.8 million related to vesting of restricted stock.

Interest Income

Interest income was $0.8 million for the three months ended September 30, 2023, compared to $0.1 million for the three months ended September 30, 2022, primarily due to higher cash balance and increased interest rates.

Interest Expense

Interest expense of $1.7 million for the three months ended September 30, 2023 consisted of interest expense pursuant to the OrbiMed Credit Agreement entered into on July 26, 2023 as noted in Note 7. Interest expense for the three months ended September 30, 2022 consisted of interest expense on the Mezzanine Loan Agreement as noted in Note 7 to our condensed financial statements. On July 11, 2022 we voluntarily repaid the Mezzanine Loan Agreement.

Loss on Extinguishment of Debt

For the three months ended September 30, 2022, we recognized a $1.4 million loss on debt extinguishment which was made up entirely of non-cash unamortized debt issuance costs as a result of the voluntary repayment of the Mezzanine Loan Agreement on July 11, 2022.

Results of Operations for the Nine Months Ended September 30, 2023 and 2022

The following table summarizes our results of operations for the nine months ended September 30, 2023 and 2022 (in thousands):

Product Revenue, Net

Product revenue, net was $2.8 million for the nine months ended September 30, 2023. As YCANTH, our first FDA approved product, became available for commercial sale in the three months ended September 30, 2023, we did not recognize any product revenue in the three and nine months ended September 30, 2022.

Collaboration Revenue

Collaboration revenue was $0.3 million for the nine months ended September 30, 2023 compared to $9.0 million for the nine months ended September 30, 2022. For the nine months ended September 30, 2023 and 2022 collaboration revenue included $0.3 and $1.0 million, respectively, related to clinical supplies and development activity provided to Torii pursuant to the Clinical Supply Agreement entered into on March 7, 2022. The nine month period ended September 30, 2022 also included license revenue related to an $8.0 million milestone payment.

Selling, General and Administrative Expenses

Selling, general and administrative expenses were $30.3 million for the nine months ended September 30, 2023 compared to $14.2 million for the nine months ended September 30, 2022. The increase of $16.1 million was primarily a result of higher expenses related to commercial activities for VP-102 including increased marketing and sponsorship costs of $4.1 million, increased compensation, recruiting fees, benefits and travel due to ramp-up of sales force in the three months ended September 30, 2023 of $2.5 million as well as $7.4 million related to vesting restricted stock units and increased legal costs of $0.7 million.

Research and Development Expenses

Research and development expenses were $15.0 million for the nine months ended September 30, 2023, compared to $9.2 million for the nine months ended September 30, 2022. The increase of $5.8 million was primarily attributable to an increase of $5.4 million in CMC and clinical costs related to our development of VP-102 for molluscum, common warts and external genital warts and increased stock compensation expense of $0.8 million related to vesting of restricted stock upon FDA approval and commercial launch partially offset by a payment made to Lytix upon the achievement of a regulatory milestone for VP-315 of $1.0 million during the nine months ended September 30, 2022.

The following table summarizes our research and development expense by product candidate or, for unallocated expenses, by type for the nine months ended September 30, 2023 and 2022. We did not incur any research and development expense for VP-103 during the nine months ended September 30, 2023 or 2022. Unallocated expenses include compensation and other personnel related costs.

Interest Income

Interest income was $1.9 million for the nine months ended September 30, 2023 compared to $0.2 million for the nine months ended September 30, 2022 primarily due to higher cash balance and increased in higher interest rates.

Interest Expense

Interest expense of $1.7 million for the nine months ended September 30, 2023 consisted of interest expense pursuant to the OrbiMed Credit Agreement entered into on July 26, 2023 as noted in Note 7 to our condensed financial statements. Interest expense for the nine months ended September 30, 2022, consisted of interest expense on the Mezzanine Loan Agreement as noted in Note 7 to our condensed financial statements. On July 11, 2022 we voluntarily repaid the Mezzanine Loan Agreement.

Loss on Extinguishment of Debt

For the nine months ended September 30, 2022, we recognized a $1.4 million loss on debt extinguishment which was made up entirely of non-cash unamortized debt issuance costs as a result of the voluntary repayment of the Mezzanine Loan Agreement on July 11, 2022.

Liquidity and Capital Resources

Since our inception, we have incurred net losses and negative cash flows from our operations. We have financed our operations since inception primarily through sales of our convertible preferred stock, the sale of our common stock in our IPO, receiving aggregate gross proceeds of $123.2 million and most recently, $28.1 and $26.9 million in net proceeds from issuance of common stock in follow-on offerings in March 2021 and July 2022, respectively, and $20.0 million from the Torii Agreement. In February 2023, we closed an underwritten offering of 750,000 shares of our common stock and pre-funded warrants to purchase 4,064,814 shares of common stock. The shares of common stock were sold at a price of $6.75 per share and the pre-funded warrants were sold at a price of $6.7499 per pre-funded warrant, resulting in total net proceeds of $30.3 million, after deducting underwriting discounts and commissions, and offering expenses.

As of September 30, 2023, we had cash and cash equivalents of $84.3 million. Cash in excess of immediate requirements is invested in accordance with our investment policy, primarily with a view to liquidity and capital preservation.

On March 10, 2020, we entered into a mezzanine loan and security agreement and a loan and security agreement, or the Loan Agreements, with Silicon Valley Bank. Upon entering into the Loan Agreements, we borrowed $35.0 million in term loans, or the Term A Loan, from the Mezzanine Lenders. We entered into amendments to the Loan Agreements in October 2020 under which we borrowed an additional $5.0 million in term loans, or the Term B1 Loan and together with the Term A Loan, the Loans, on March 1, 2021.

On July 11, 2022, we voluntarily repaid in full the debt outstanding under the Loan Agreements. Our prepayment amount was approximately $43.8 million, inclusive of principal amount of debt, the final payment fee, and accrued interest, and satisfied all of our outstanding debt obligations under the Loan Agreements. We did not incur any prepayment penalties in connection with the repayment of the amounts payable under the Loan Agreements, which had a scheduled maturity of March 1, 2024. The prepayment was made in full using restricted cash of $40.0 million, which was set aside as cash collateral in a March 2022 amendment to the Mezzanine Loan Agreement, as well as cash on hand.

On July 21, 2023, the FDA approved YCANTH (VP-102) topical solution for the treatment of molluscum contagiosum in adult and pediatric patients two years of age and older. Our first commercial sale of YCANTH occurred in August 2023 to FFF, our sole specialty pharmacy distributor.

On July 26, 2023, we entered into the Credit Agreement which provides for a $125.0 million Loan Facility. We borrowed $50.0 million on July 26, 2023, resulting in net proceeds to us of approximately $44.1 million after payment of certain fees and transaction related expenses. In addition, up to $25.0 million will be made available on or prior to June 30, 2024, up to $30.0 million will be made available on or prior to December 31, 2024, up to $10.0 million will be made available on or prior to March 31, 2025, and up to $10.0 million will be made available on or prior to June 30, 2025, in each case, subject to our achievement of certain revenue targets. Amounts borrowed under the Loan Facility will mature on July 26, 2028.

During the term of the Loan Facility, interest payable in cash by us will accrue on any outstanding balance due under the Loan Facility at a rate per annum equal to the higher of (x) the SOFR rate (which is the forward-looking term rate for a one-month tenor based on the secured overnight financing rate administered by the CME Group Benchmark Administration Limited) and (y) 4.00% plus, in either case, 8.00%. During an event of default, any outstanding amount under the Loan Facility will bear interest at a rate of 4.00% in excess of the otherwise applicable rate of interest. We will pay certain fees with respect to the Loan Facility, including an upfront fee, an unused fee on the undrawn portion of the Loan Facility, an administration fee, a prepayment premium and an exit fee, as well as certain other fees and expenses of the Administrative Agent and the Lenders.

Cash Flows

The following table summarizes our cash flows for the nine months ended September 30, 2023 and 2022 (in thousands):

Operating Activities

During the nine months ended September 30, 2023, operating activities used $24.1 million of cash, primarily resulting from a net loss of $42.4 million partially offset by non-cash stock-based compensation of $12.3 million. Net cash provided by changes in operating assets and liabilities consisted primarily of a decrease in prepaid and other assets of $1.0 million and an increase in accounts payable and accrued expenses of $7.8 million partially offset by an increase in accounts receivable of $3.9 million.

During the nine months ended September 30, 2022, operating activities used $13.7 million of cash, primarily resulting from a net loss of $18.6 million partially offset by non-cash stock-based compensation of $3.8 million, non-cash loss on extinguishment of debt of $1.4 million and non-cash interest expense of $0.4 million. Net cash used by changes in operating assets and liabilities consisted primarily of a decrease in accounts payable and accrued expenses of $1.0 million.

Investing Activities

During the nine months ended September 30, 2023, net cash used in investing activities of $0.1 million was primarily due to purchase of fixed assets.

During the nine months ended September 30, 2022, net cash provided by investing activities of $47.3 million was primarily due to sales and maturities of marketable securities of $52.0 million partially offset by purchases of marketable securities of $4.5 million.

Financing Activities

During the nine months ended September 30, 2023, net cash provided by financing activities of $74.2 million was primarily related to net cash proceeds of $44.1 million from the OrbiMed Credit Agreement and proceeds of $30.3 million, net of issuance costs from the issuance of common stock and pre-funded warrants.

During the nine months ended September 30, 2022, net cash used in financing activities of $16.9 million was primarily related to repayment of outstanding debt of $43.8 million partially offset by proceeds of $26.9 million, net of issuance costs, from the issuance of common stock

Funding Requirements

Our first commercial sale of YCANTH occurred in August 2023 to FFF, our specialty pharmacy distributor. While we expect to generate revenue from the sale of YCANTH, we expect our expenses to increase in connection with our ongoing activities, particularly as we initiate commercialization of YCANTH and continue the research and development of, continue or initiate clinical trials of, and seek marketing approval for, our product candidates. Following the approval of YCANTH, for the treatment of molluscum contagiosum, we expect to incur significant commercialization expenses related to sales, marketing, manufacturing and distribution. Furthermore, we expect to incur additional costs associated with operating as a public company. We will need substantial additional financing to fund our operations. If we are unable to raise capital when needed or on attractive terms, we would be forced to delay, reduce or eliminate our research and development programs or future commercialization efforts.

We believe that our existing cash and cash equivalents of $84.3 million as of September 30, 2023, will be sufficient to support our planned operations into the first quarter of 2025. Our future capital requirements will depend on many factors, including:

• the level of sales achieved, and costs related to the commercialization of YCANTH;
• the costs, timing and outcome of regulatory review of our product candidates;
• the scope, progress, results and costs of our clinical trials;
• the scope, prioritization and number of our research and development programs;
• the costs of preparing, filing and prosecuting patent applications, maintaining and enforcing our intellectual property rights and defending intellectual property-related claims;
• our ability to maintain compliance with covenants under our loan agreements;
• the extent to which we acquire or in-license other product candidates and technologies;
• the impact on the timing of our clinical trials and our business;
• the costs to scale up and secure manufacturing arrangements for commercial production of YCANTH and any product candidate we successfully commercialize; and
• the costs of establishing or contracting for sales and marketing capabilities for YCANTH and if we obtain regulatory approvals to market our product candidates.

Identifying potential product candidates and conducting preclinical studies and clinical trials is a time-consuming, expensive and uncertain process that takes many years to complete, and we may never generate the necessary data or results required to obtain marketing approval and achieve product sales. In addition, YCANTH, and our other product candidates, if approved, may not achieve commercial success. Our commercial revenues will be derived solely from sales of YCANTH in the near term. We may need to continue to rely on additional financing to achieve our business objectives. Adequate additional financing may not be available to us on acceptable terms, or at all.

Until such time, if ever, as we can generate substantial product revenues, we expect to finance our cash needs through a combination of equity offerings, debt financings, collaborations, strategic alliances and licensing arrangements. Our ability to raise additional capital may be adversely impacted by potential worsening global economic conditions and the disruptions to, and volatility in, the credit and financial markets in the United States and worldwide. To the extent that we raise additional capital through the sale of equity or convertible debt securities, ownership interests of existing stockholders may be diluted, and the terms of these securities may include liquidation or other preferences that adversely affect our existing stockholders’ rights. Debt financing, if available, may involve agreements that include covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making capital expenditures or declaring dividends.

If we raise funds through additional collaborations, strategic alliances or licensing arrangements with third parties, we may have to relinquish valuable rights to our technologies, future revenue streams, research programs or product candidates or to grant licenses on terms that may not be favorable to us. If we are unable to raise additional funds through equity or debt financings when needed, we may be required to delay, limit, reduce or terminate our product development or future commercialization efforts or grant rights to develop and market product candidates that we would otherwise prefer to develop and market ourselves.

Contractual Obligations and Commitments

As of September 30, 2023, there have been no material changes to our contractual obligations and commitments as previously disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022.

There have been no material changes to our quantitative and qualitative disclosures about market risk as previously disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022.

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this Quarterly Report on Form 10-Q to ensure that the information required to be disclosed by us in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and that information required to be disclosed in the reports we file or submit under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosures. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost benefit relationship of possible controls and procedures. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective at the reasonable assurance level as of September 30, 2023.

Changes in Internal Control over Financial Reporting

There have been no changes in our internal control over financial reporting identified in connection with the evaluation required by Rule 13a-15(b) and 15d-15(b) of the Exchange Act that occurred during the quarter ended September 30, 2023, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item. 1 Legal Proceedings

On June 6, 2022, plaintiff Kranthi Gorlamari, or Gorlamari, filed a putative class action complaint captioned Gorlamari v. Verrica Pharmaceuticals Inc., et al., in the U.S. District Court for the Eastern District of Pennsylvania against us and certain of our current and former officers and directors (“Defendants”). Gorlamari filed an amended complaint on January 12, 2023. The amended complaint alleges that Defendants violated federal securities laws by, among other things, failing to disclose certain manufacturing deficiencies at the facility where our contract manufacturer produced bulk solution for the VP-102 drug device and that such deficiencies posed a risk to the prospects for regulatory approval of VP-102 for the treatment of molluscum. The amended complaint seeks unspecified compensatory damages and other relief on behalf of Gorlamari and all other persons and entities which purchased or otherwise acquired our securities between May 19, 2021 and May 24, 2022. Briefing on Defendants' motion to dismiss the amended complaint was completed on May 23, 2023. The litigation is still in the early stages, and we intend to vigorously defend itself against these allegations.

We are involved in ordinary, routine legal proceedings that are not considered by management to be material. We believe the ultimate liabilities resulting from such legal proceedings will not materially affect our financial position or our results of operations or cash flows.

Our business is subject to risks and events that, if they occur, could adversely affect our financial condition and results of operations and the trading price of our securities. In addition to the other information set forth in this quarterly report on Form 10-Q, you should carefully consider the factors described in Part I, Item 1A. “Risk Factors” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2022, filed with the Securities and Exchange Commission on March 6, 2023. Except as described below, there have been no material changes to the risk factors described in that report.

Product liability lawsuits against us could cause us to incur substantial liabilities and to limit commercialization of YCANTH and any products that we may develop.

We face an inherent risk of product liability exposure related to the testing of our product candidates in human clinical trials and will face an even greater risk in connection with the commercialization of YCANTH. If we cannot successfully defend ourselves against claims that YCANTH or our product candidates caused injuries, we will incur substantial liabilities. For example, YCANTH, may cause local skin reactions, can cause life threatening or fatal toxicities if administered orally, can cause ocular toxicity if in contact with the eyes and is flammable. Regardless of merit or eventual outcome, liability claims may result in:

• decreased demand for YCANTH and any product candidates that we may develop;
• injury to our reputation and significant negative media attention;
• withdrawal of clinical trial participants;
• significant costs to defend the related litigation;
• substantial monetary awards paid to trial participants or patients;
• loss of revenue;
• reduced resources of our management to pursue our business strategy; and
• the inability to successfully commercialize YCANTH and any other products that we may develop.

We currently hold $10 million in product liability insurance coverage in the aggregate, with a per incident limit of $10 million, which may not be adequate to cover all liabilities that we may incur. We may need to increase our insurance coverage. Insurance coverage is increasingly expensive. We may not be able to maintain insurance coverage at a reasonable cost or in an amount adequate to satisfy any liability that may arise.

We may not be able to generate sufficient cash to service our indebtedness or borrow additional funds pursuant to our Loan Facility.

We have entered into a Credit Agreement with OrbiMed, pursuant to which we may borrow up to $125.0 million. Our obligations under the Credit Agreement are secured by all or substantially all of our assets.

We are subject to a number of affirmative and restrictive covenants pursuant to the Credit Agreement, which limit or restrict our ability to (subject to certain qualifications and exceptions): create liens and encumbrances; incur additional indebtedness; merge, dissolve, liquidate or consolidate; make acquisitions, investments, advances or loans; dispose of or transfer assets; pay dividends or make other payments in respect of their capital stock; amend certain material documents; redeem or repurchase certain debt; engage in certain transactions with affiliates; and enter into certain restrictive agreements. In addition, we are required to maintain at least $10 million of unrestricted cash and cash equivalents at all times. Our obligations under the Credit Agreement are subject to acceleration upon the occurrence of an event of default (subject to notice and grace periods). We are currently in compliance with the Credit Agreement covenants. If we are unable to achieve certain milestones, generate sufficient revenue and raise additional capital through a combination of equity offerings, debt financings and license and collaboration agreement we will no longer be in compliance with these covenants. We may also enter into other debt agreements in the future which may contain similar or more restrictive terms.

Our ability to make scheduled monthly payments or to refinance our debt obligations depends on numerous factors, including the amount of our cash reserves and our actual and projected financial and operating performance. These amounts and our performance are subject to certain financial and business factors, as well as prevailing economic and competitive conditions, some of which may be beyond our control. We cannot assure you that we will maintain a level of cash reserves or cash flows from operating activities sufficient to permit us to pay the principal, premium, if any, and interest on our existing or future indebtedness. If our cash flows and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay capital expenditures, sell assets or operations, seek additional capital or restructure or refinance our indebtedness. We cannot assure you that we would be able to take any of these actions, or that these actions would permit us to meet our scheduled debt service obligations. Failure to comply with the conditions of the Credit Agreement could result in an event of default, which could result in an acceleration of amounts due under the Credit Agreement. We may not have sufficient funds or may be unable to arrange for additional financing to repay our indebtedness or to make any accelerated payments, and OrbiMed could seek to enforce security interests in the collateral securing such indebtedness, which would harm our business.

In addition, the Credit Agreement provides up to $25.0 million will be made available on or prior to June 30, 2024, up to $30.0 million will be made available on or prior to December 31, 2024, up to $10.0 million will be made available on or prior to March 31, 2025, and up to $10.0 million will be made available on or prior to June 30, 2025, in each case, subject to certain revenue requirements. If we are unable to achieve the revenue targets by the applicable dates, we would be unable to borrow additional funds pursuant to the Loan Facility, which could negatively impact our ability to fund our operations.