Zai Lab Ltd: Form 10-Q for the period ended Jun 30, 2023

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our 2022 Annual Report and our unaudited condensed consolidated financial statements and the accompanying notes for the three and six months ended June 30, 2023 included in Item 1. Financial Statements.

Overview

We are a patient-focused, innovative, commercial-stage, global biopharmaceutical company with a substantial presence in both Greater China and the United States. We are focused on discovering, developing, and commercializing products that address medical conditions with significant unmet needs in the areas of oncology, autoimmune disorders, infectious diseases, and neuroscience. We intend to leverage our competencies and resources to positively impact human health in Greater China and worldwide. We currently have five products that have received marketing approval in one or more territories in Greater China (our “commercial products”). We have commercially launched four of those products – ZEJULA®, Optune®, QINLOCK®, and NUZYRA® – and we expect to commercially launch VYVGART® later this year. We also have thirteen programs in late-stage product development and a number of ongoing pivotal trials across our portfolio.

Since our inception, we have incurred net losses and negative cash flows from our operations. Substantially all of our losses have resulted from funding our research and development programs and selling, general and administrative costs associated with our operations. Developing high quality product candidates requires significant investment in our research and development activities over a prolonged period of time, and a core part of our strategy is to continue making sustained investments in this area. Our ability to generate profits and positive cash flow from operations over the next several years depends upon our ability to successfully market our commercial products and to successfully expand the indications for these products and develop and commercialize our other product candidates. We expect to continue to incur substantial expenses related to our research and development activities. For example, our licensing and collaboration agreements may require us to make upfront payments upon our entry into such agreements and milestone payments upon the achievement of certain development, regulatory, and sales-based milestones as well as certain royalties at tiered percentage rates based on annual net sales of the licensed products in the licensed territories. In addition, we expect to incur substantial costs related to the commercialization of our product candidates, in particular during the early launch phase.

As we pursue our strategy of growth and development, we anticipate that our financial results will fluctuate from quarter to quarter and year to year depending in part on the balance between the success of our commercial products and the level of our research and development expenses. We cannot predict whether or when products in our pipeline, including new indications for our current commercial products, will receive regulatory approval. Further, if we receive such regulatory approval, we cannot predict whether or when we may be able to successfully commercialize such product or whether or when such product may become profitable.

Recent Developments

Commercial Products

We continued to increase net product revenues for each of our commercial products in the second quarter of 2023, compared to the second quarter of 2022, driven by the increased access for ZEJULA, QINLOCK, and NUZYRA as a result of their inclusion in the National Reimbursement Drug List (“NRDL”) and for Optune as a result of increased supplemental insurance plan coverage.

We also received the following regulatory approvals for our commercial products during the second quarter of 2023:

• Optune for GBM in Taiwan: In May 2023, the Taiwan Food and Drug Administration approved the Marketing Authorization Application (“MAA”) for Optune for the treatment of patients with glioblastoma multiforme (“GBM”).
• VYVGART for gMG in mainland China: In June 2023, we received approval from the NMPA for the Biologics License Application (“BLA”) for VYVGART (efgartigimod alfa injection), a first-in-class neonatal Fc receptor (“FcRn”) antagonist, as an add on standard therapy for the treatment of adult patients with generalized myasthenia gravis (“gMG”) who are anti-acetylcholine receptor (“AChR”) antibody positive. We expect to commercially launch VYVGART in mainland China later this year.

Product Candidates

We continued to advance our product candidates through our research and development and commercial operations, including the following developments with respect to our clinical trials and regulatory approvals:

Oncology

• ZEJULA (niraparib, PARP): In July 2023, we announced the publication in JAMA Oncology of data from the pivotal Phase III PRIME study evaluating ZEJULA as a first-line maintenance therapy in Chinese patients with newly diagnosed advanced ovarian cancer and demonstrating that an individual starting dose (“ISD”) of 200 or 300mg based on baseline bodyweight and platelet count can bring significant benefit to patients with an improved safety and tolerability profile of ZEJULA compared to a fixed 300mg starting dose. The data demonstrated that maintenance treatment with ZEJULA can significantly extend progression-free survival (“PFS”) versus a placebo and can reduce the risk of disease progression or death by 55% among patients with newly diagnosed advanced ovarian cancer, regardless of postoperative residual disease or biomarker status. For example, with a median follow-up of 27.5 months, median PFS (“mPFS”) with ZEJULA versus placebo in the intention-to-treat (“ITT”) population was 24.8 versus 8.3 months (hazard ratio (“HR”), 0.45; 95% confidence internal (“CI”), 0.34–0.60; p<.001). At the time of data cut-off, overall survival (“OS”) data were not yet mature in the ITT population. Utilization of an individual starting dose demonstrated a tolerable safety profile in the maintenance setting. Grade ≥3 treatment-emergent adverse events (“TEAEs”) and serious adverse events (“SAEs”) were reported in 54.5% versus 17.8% and 18.8% vs 8.5% in ZEJULA-treated and placebo-treated patient, respectively. Similar proportions of ZEJULA-treated and placebo-treated patients (6.7% vs 5.4%) discontinued therapy due to TEAEs. The findings are consistent with prior studies that indicate that ZEJULA monotherapy as first-line maintenance treatment can provide statistically and clinically meaningful benefit in a broad population of patients, regardless of postoperative residual disease or biomarker status.
• Tumor Treating Fields (TTFields or Optune):
• NSCLC: In June 2023, we announced with our partner NovoCure Limited (“NovoCure”) that the Phase III LUNAR clinical trial demonstrated a statistically significant and clinically meaningful extension in OS for patients with metastatic non-small cell lung cancer (“NSCLC”) after platinum-based therapies. The LUNAR trial met its primary endpoint with a statistically significant and clinically meaningful 3-month improvement in median OS when TTFields therapy was added to standard therapies (HR: 0.74, P=0.035). Patients randomized to receive TTFields therapy together with standard therapies (n=137) demonstrated median OS of 13.2 months compared to 9.9 months in patients treated with standard therapies alone (n=139). A profound OS benefit from TTFields therapy was demonstrated in the immune checkpoint inhibitor (“ICI”) subgroup. Patients randomized to receive TTFields therapy and physician’s choice ICI (n=66) demonstrated a median OS of 18.5 months versus 10.8 months in patients treated with ICIs alone (n=68; HR=0.63; P=0.03), and patients randomized to receive TTFields therapy and docetaxel (n=71) had a positive survival trend with a median OS of 11.1 months versus 8.7 months in patients treated with docetaxel alone (n=71). TTFields therapy was well-tolerated with no added systemic toxicities and few grade 3 (no grade 4 or 5) device-related adverse events. NovoCure presented the positive results at the 2023 American Society of Clinical Oncology (“ASCO”) Annual Meeting in June 2023. We participated in the Greater China portion of the study.
• Pancreatic Cancer: In July 2023, NovoCure announced the results of a pre-specified interim analysis for the Phase III PANOVA-3 clinical trial evaluating the safety and efficacy of TTFields therapy together with nab-paclitaxel and gemcitabine for the treatment of patients with unresectable, locally advanced pancreatic cancer. An independent data monitoring committee (“DMC”) reviewed the safety and efficacy data for all patients in the fully enrolled clinical trial. The interim analysis resulted in a DMC recommendation that the clinical trial proceed to final analysis. Zai Lab participated in the Greater China portion of the study.
• KRAZATI® (adagrasib, KRASG12C): In April 2023 and May 2023, our partner Mirati Therapeutics, Inc. (“Mirati”) announced the inclusion of adagrasib as the only KRASG12C inhibitor in the National Comprehensive Cancer Network (“NCCN”) Guidelines for Central Nervous System (“CNS”) Cancers for patients with KRASG12C-mutated NSCLC with CNS metastases and for KRASG12C-mutation positive pancreatic adenocarcinoma cancer patients, respectively. Also, in April 2023, Mirati presented updated clinical data for adagrasib as a targeted treatment for pancreatic ductal adenocarcinoma, biliary tract cancer,

and other solid tumors harboring a KRASG12C mutation at the 2023 American Society of Clinical Oncology (“ASCO”) Plenary series. Data was concurrently published in the Journal of Clinical Oncology. In June 2023, we completed enrollment in China for the global Phase 2 KRYSTAL-7 trial of adagrasib in combination with pembrolizumab as first-line treatment for patients with advanced KRASG12C-mutated NSCLC, and in July 2023, we completed enrollment in China for the global Phase 3 KRYSTAL-10 trial of adagrasib in combination with cetuximab versus chemotherapy in patients with previously treated advanced KRASG12C-mutated colorectal cancer.

• Repotrectinib (ROS1/TRK): In May 2023, our partner Bristol Myers Squibb (“BMS”) announced that the FDA had accepted its New Drug Application (“NDA”) for repotrectinib, a next generation tyrosine kinase inhibitor (“TKI”), for the treatment of adult patients with ROS1-positive locally advanced or metastatic NSCLC based on results from the TRIDENT-1 trial. The FDA granted the application priority review and assigned a Prescription Drug User Fee Act (“PDUFA”) date of November 27, 2023. In June 2023, the NMPA accepted our NDA for repotrectinib for the same indications, after granting priority review in May 2023.
• TIVDAK® (Tisotumab Vedotin, Antibody Drug Conjugate (“ADC”)): In April 2023, our partner Seagen Inc. (“Seagen”) presented the interim analysis for the Phase II innovaTV 207 study in head and neck cancer at the 2023 American Association of Cancer Research (“AACR”) Annual Meeting. At data cutoff (November 28, 2022), confirmed objective response rate (“ORR”) was 40% (95% confidence interval (“CI”): 16.3, 67.7), with 1 complete response and 5 partial responses. The safety profile was generally consistent with that observed across TIVDAK monotherapy clinical studies. In addition, in February 2023, Seagen completed global target patient enrollment for the Phase III confirmatory innovaTV 301 study in second- or third-line recurrent or metastatic cervical cancer. We are participating in the global trial and ongoing extension study in Greater China.
• Bemarituzumab (FGFR2b): In July 2023, we enrolled the first patient in China in the global Phase III FORTITUDE-101 study of bemarituzumab plus chemotherapy, versus placebo plus chemotherapy, in first-line gastric cancer with FGFR2b overexpression.

Autoimmune Disorders, Infectious Diseases, and Neuroscience

• VYVGART (Efgartigimod, FcRn):
• gMG: In June 2023, our partner argenx BV (“argenx”) announced that the FDA approved VYVGART Hytrulo (efgartigimod alfa and hyaluronidase-qvfc) injection for subcutaneous use in gMG. In July 2023, the NMPA accepted our BLA for efgartigimod alfa injection (subcutaneous (“SC”) injection) for the treatment of adult patients with gMG.
• CIDP: In July 2023, we and argenx announced positive topline results from the global registrational ADHERE study evaluating VYVGART Hytrulo in adults with chronic inflammatory demyelinating polyneuropathy (“CIDP”). The study met its primary endpoint (p=0.000039), demonstrating a significantly lower risk of relapse with VYVGART Hytrulo compared to placebo. VYVGART Hytrulo demonstrated a 61% reduction (HR: 0.39 95% CI: 0.25; 0.61) in the risk of relapse versus placebo, and 67% of patients in open-label Stage A demonstrated evidence of clinical improvement, indicating that IgG autoantibodies play a significant role in the underlying biology of CIDP. The safety and tolerability profile was consistent with previous clinical trials and the confirmed safety profile of VYVGART. We participated in the Greater China portion of the study.
• BP: In May 2023, we enrolled the first patient in China in the global Phase II/III BALLAD study of SC efgartigimod in adult patients with bullous pemphigoid (“BP”).
• XACDURO® (Sulbactam-Durlobactam or SUL-DUR, Asia Pacific Rights): In May 2023, our partner Entasis Therapeutics, Inc. (“Entasis”), a wholly owned subsidiary of Innoviva, Inc., announced that the FDA approved XACDURO for the treatment of adults with hospital-acquired bacterial pneumonia and ventilator-associated bacterial pneumonia caused by susceptible strains of Acinetobacter baumannii-calcoaceticus complex. Our NDA for the treatment of infections caused by Acinetobacter baumannii, including multidrug-resistant and carbapenem-resistant Acinetobacter baumannii strains, is under review at the NMPA and has been granted priority review status.
• KarXT (Xanomeline-Trospium, M1/M4-Preferring Muscarinic Agonist): In June 2023, we enrolled the first patient in the registrational bridging study in mainland China for KarXT for the treatment of patients with schizophrenia.

Corporate Updates

We continued to enhance our portfolio through strategic partnerships and to strengthen our organizational structure to support the evolving needs of our business:

• Business Development: In April 2023, we entered into a strategic partnership and global license agreement with MediLink Therapeutics (Suzhou) Co., Ltd. (“MediLink”). Through this collaboration, we expanded our lung cancer franchise and global oncology pipeline with an early-stage next generation DLL3 ADC program, ZL-1310. DLL3 is an inhibitor of the Notch ligand that is overexpressed in small cell lung cancer and neuroendocrine tumors. ZL-1310 has demonstrated an encouraging pre-clinical profile. ZL-1310 is progressing to the clinical stage, and we plan to focus on advancing its global development.
• Organizational Update: The Company promoted Yajing Chen to Chief Financial Officer, effective July 7, 2023. Dr. Chen previously served as our Senior Vice President and Deputy Chief Financial Officer, helping to oversee finance, planning and forecasting, accounting, tax, treasury, and procurement matters since joining the Company in September 2021. She is a seasoned finance executive with more than 20 years of experience in the life sciences industry as well as a Ph.D. trained scientist. She joined the Company from AstraZeneca where she held various roles of increasing responsibility from 2006 to 2021, including Chief Financial Officer for the U.S. Oncology Business Unit from 2019 to 2021 and Finance Controller of the Global Oncology Business Unit from 2016 to 2019. Her scientific background combined with her significant executive management experience, finance expertise at leading global companies, and business acumen provide a unique and valuable perspective to the Company and will help drive our next phase of growth. Dr. Chen succeeds Billy Cho, who stepped down from his role and left the Company on July 7, 2023.

Legal and Regulatory Developments

Our business has been and continues to be impacted by legal and regulatory developments in the jurisdictions in which we operate, particularly in mainland China where our operations and product markets are primarily located. In March 2023, the People’s Government of Hainan Province published revised Regulations for the Administration of the Imported Urgently Needed Drugs and Medical Devices in the Hainan Bo’ao Lecheng International Medical Tourism Pilot Zone (the “BMTPZ”), which became effective in May 2023. Under these regulations, medical institutions in the BMTPZ meeting certain qualifications may apply to use our products that meet specified requirements, including drugs or medical devices that address specific urgent clinical needs that cannot be met with existing approved products. We have successfully used this pathway in the past, and with the revised regulation, we will continue to look for opportunities to use this pathway to accelerate our entry into the China market for product candidates in advance of NMPA approval. In July 2023, the Ministry of Science and Technology of the People’s Republic of China published an updated Service Guide for the Examination and Approval of Sampling, Collecting, Trading, Exporting Human Genetic Resources, which will impact the Company’s practices in filing for an advance approval with the HGRAC. In addition, in July 2023, a revised Counter-Espionage Law intended to strengthen provisions on the protection of national security in mainland China went into effect, which may increase our cyber security or operational costs and could subject us to investigative or enforcement actions by the Chinese government or regulatory authorities.

Factors Affecting Our Results of Operations

Research and Development Expenses

We believe our ability to successfully develop product candidates will be the primary factor affecting our long-term competitiveness, as well as our future growth and development. Developing high quality product candidates requires a significant investment of resources over a prolonged period of time, and a core part of our strategy is to continue making sustained investments in research and development, including internal discovery activities. As a result of this commitment, our pipeline of product candidates has been advancing and expanding, with thirteen late-stage clinical product candidates being investigated as of June 30, 2023.

We have financed our activities primarily through private placements, our initial public offering in September 2017 and multiple follow-on offerings on Nasdaq and our secondary listing and initial public offering on the Hong Kong Stock Exchange in September 2020. Through June 30, 2023, we have raised approximately $164.6 million from private equity financing and approximately $2,462.7 million in net proceeds after deducting underwriting commissions and the offering expenses payable by us from our initial public offerings and follow-on offerings. Our operations have consumed substantial amounts of cash since inception. The net cash used in our operating activities was $128.0 million and $132.0 million for the six months ended June 30, 2023 and 2022, respectively. We expect our expenditures to increase in connection with our ongoing activities, particularly as we advance the clinical development of our thirteen late-stage clinical product candidates, research and develop our clinical- and pre-clinical-stage product candidates, and initiate additional clinical trials of, and seek regulatory approval for, these and other future product candidates. These expenditures include:

• expenses incurred for contract research organizations (“CROs”), contract manufacture organizations (“CMOs”), investigators, and clinical trial sites that conduct our clinical studies;
• employee compensation related expenses, including salaries, benefits, and equity compensation expenses;
• expenses for licensors;
• the cost of acquiring, developing, and manufacturing clinical study materials;
• facilities and other expenses, which include office leases and other overhead expenses;
• costs associated with pre-clinical activities and regulatory operations; and
• expenses associated with the construction and maintenance of our manufacturing facilities.

Selling, General, and Administrative Expenses

Our selling, general, and administrative expenses consist primarily of personnel compensation and related costs, including share-based compensation for commercial and administrative personnel. Other selling, general, and administrative expenses include product distribution and promotion costs, professional service fees for legal, intellectual property, consulting, auditing, and tax services as well as other direct and allocated expenses for rent and maintenance of facilities, insurance, and other supplies used in selling, general, and administrative activities. We anticipate that our selling, general, and administrative expenses will increase in future periods to support increases in our commercial and research and development activities and as we continue to discover, develop, commercialize, and manufacture our products and product candidates. These increases will likely include expanded infrastructure as well as increased headcount, and share-based compensation, product distribution, promotion, and insurance costs. We also anticipate incurring additional legal, compliance, accounting, and investor and public relations expenses associated with being a public company listed on both Nasdaq and the Hong Kong Stock Exchange.

Our Ability to Commercialize Our Product Candidates

As of August 1, 2023, thirteen of our product candidates are in late-stage clinical development and various others are in clinical and pre-clinical development in Greater China and the United States. Our ability to generate revenue from our product candidates is dependent on our receipt of regulatory approvals for and successful commercialization of such product candidates, which may not occur. Certain of our product candidates may require additional pre-clinical and/or clinical development, regulatory approvals in multiple jurisdictions, manufacturing supply, substantial investment, and significant marketing efforts before we generate any revenue from product sales.

License and Collaboration Arrangements

Our results of operations have been, and we expect them to continue to be, affected by our license and collaboration agreements. We are required to make upfront payments upon our entry into such agreements and milestone payments upon the achievement of certain development, regulatory, and sales-based milestones for the relevant products under these agreements as well as certain royalties at tiered percentage rates based on annual net sales of the licensed products. We recorded research and development expense related to upfront license fees and development milestones of $18.3 million and $19.3 million for the three and six months ended June 30, 2023, respectively, and $10.4 million for both the three and six months ended June 30, 2022. We may be obligated to pay up to an additional aggregate amount of approximately $2,443.8 million in development and regulatory milestone payments and $3,437.4 million in sales-based milestone payments that are contingent on product performance as well as certain royalties at tiered percentage rates on annual net sales. These milestones may occur before the Company has commercialized or received any revenue from the licensed product, or they may not occur at all. If these milestones do occur, we view related payments as positive because they signify that the product is advancing toward potential commercial launch or achieving higher sales levels.

The COVID-19 Pandemic

Our results of operations have been adversely affected by the COVID-19 pandemic, including by government actions and quarantine measures taken in response in 2022 and increased infection rates in the first quarter of 2023 after COVID restrictions were lifted or eased, particularly in mainland China where our operations and product markets are primarily located. The COVID-19 pandemic did not have a material adverse effect on our business or results of operations in the second quarter of 2023.

Results of Operations

The following table presents our results of operations ($ in thousands):

NM - Not Meaningful

Revenues

Product Revenue

The following table presents the components of the Company’s product revenue ($ in thousands):

Our product revenue is primarily derived from the sales of ZEJULA, Optune, QINLOCK, and NUZYRA in mainland China and Hong Kong, net of sales returns and rebates to distributors in mainland China with respect to the sales of these products. We had a minimal amount of revenue for VYVGART from our named patient program in mainland China in the second quarter of 2023.

Our net product revenue increased by $21.3 million and $38.0 million in the three and six months ended June 30, 2023, respectively, primarily driven by increased sales volumes and decreased negative effects from the COVID-19 pandemic. The adverse effects of the COVID-19 pandemic had a more significant impact on our sales volumes for the three and six months ended June 30, 2022 and the first quarter in 2023, due to decreased patient access to our products, such as through reduced hospital access during periods of lockdown or high infection rates, fewer newly diagnosed oncology patients, and delayed or interrupted treatments. The COVID-19 pandemic did not have a material adverse effect on our sales volume in the second quarter of 2023.

For the three and six months ended June 30, 2023, our product revenue included negative adjustments of $1.3 million and $5.2 million, respectively, to compensate distributors for sales of QINLOCK and NUZYRA at prices prior to the price reductions made in connection with their addition to the NRDL. The Company lowered the selling price of ZEJULA due to its inclusion in the NRDL in December 2021 for certain therapies. In June 2022, the Company lowered the selling price for QINLOCK and NUZYRA. Accordingly, for the three and six months ended June 30, 2022, our product revenue included negative adjustments of $3.2 million and $5.8 million, respectively, to compensate distributors for sales of ZEJULA, QINLOCK and NUZYRA at prices prior to the price reductions. Such sales rebates to distributors on previously purchased products are customary in our industry to compensate those distributors for the new NRDL selling price.

The following table presents net revenue by product ($ in thousands):

NM - Not Meaningful

Cost of Sales

Cost of sales increased by $6.4 million and $12.0 million in the three and six months ended June 30, 2023, respectively. These increases were primarily due to increasing sales volumes and higher royalties.

Research and Development Expenses

The following table presents the components of our research and development expenses ($ in thousands):

Research and development expenses increased by $10.6 million and $5.2 million in the three and six months ended June 30, 2023, respectively, primarily due to:

• an increase of $7.8 million and $8.8 million, respectively, in licensing fees in connection with increased upfront and milestone payments for our license and collaboration agreements;
• an increase of $2.3 million and $6.2 million, respectively, in personnel compensation and related costs primarily due to headcount growth and grants of share options and restricted shares and the continued vesting of option and restricted share awards; and
• an increase of $0.3 million and $1.0 million, respectively, in CROs/CMOs/Investigators expenses related to ongoing and newly initiated clinical trials.

The increase in research and development expenses in the six months ended June 30, 2023 was partially offset by a decrease of $10.9 million in CROs/CMOs/Investigators expenses due to compensation from collaboration partners related to our clinical trials.

The following table presents our research and development expenses by program ($ in thousands):

Research and development expenses attributable to clinical programs remained relatively flat during the three months ended June 30, 2023. Research and development expenses attributable to clinical programs decreased by $11.2 million in the six months ended June 30, 2023, primarily driven by compensation from collaboration partners related to our clinical trials in the three months ended March 31, 2023.

Research and development expenses attributable to pre-clinical programs increased by $8.8 million and $8.7 million in the three and six months ended June 30, 2023, respectively, primarily driven by increased license fees.

Although we manage our external research and development expenses by program, we do not allocate our internal research and development expenses by program because our employees and internal resources may be engaged in projects for multiple programs at any given time.

Selling, General, and Administrative Expenses

The following table presents our selling, general and administrative expenses by program ($ in thousands):

Selling, general, and administrative expenses increased by $4.5 million and $10.0 million in the three and six months ended June 30, 2023, respectively, primarily due to:

• an increase of $5.2 million and $6.9 million, respectively, in other costs mainly related to selling, rental, and administrative expenses for commercial operations in mainland China, Hong Kong, and Taiwan; and
• an increase of $1.6 million and $4.3 million, respectively, in personnel compensation and related costs which was primarily driven by headcount growth, particularly in commercial and administrative personnel, and grants of share options and restricted shares and the continued vesting of option and restricted share awards; those increases were partially offset by
• a decrease of $2.3 million and $1.2 million, respectively, in professional service fees primarily related to legal expenses.

Gain on Sale of Intellectual Property

During the second quarter of 2023, we sold certain patent rights and related know-how to a third party, resulting in a gain of $10.0 million in the three and six months ended June 30, 2023. We had no such intellectual property sales resulting in gains or losses in the prior year periods.

Interest Income

Interest income increased by $8.9 million and $19.0 million in the three and six months ended June 30, 2023, respectively, due to increased interest rates.

Foreign Currency Loss

Foreign currency loss increased by $5.2 million in the three months ended June 30, 2023, primarily driven by increased remeasurement loss due to depreciation of the Renminbi (“RMB”) against the U.S. dollar.

Foreign currency loss decreased by $1.4 million in the six months ended June 30, 2023, primarily driven by decreased remeasurement loss due to depreciation of the RMB against the U.S. dollar.

Other Expenses, Net

Other expenses, net decreased by $4.1 million in the three months ended June 30, 2023 primarily as a result of a decrease in equity investment loss in MacroGenics of $3.9 million.

Other expenses, net decreased by $10.2 million in the six months ended June 30, 2023 primarily as a result of a decrease in equity investment loss in MacroGenics of $11.3 million, partially offset by a decrease in governmental subsidies of $1.5 million.

Income Tax Expense

There was no change in our income tax expense, which was zero in the three and six months ended June 30, 2023 and 2022.

Critical Accounting Policies and Significant Judgments and Estimates

We prepare our financial statements in conformity with U.S. GAAP, which requires us to make judgments, estimates, and assumptions. We periodically evaluate these judgments, estimates, and assumptions based on the most recently available information, our own historical experiences, and various other assumptions that we believe to be reasonable under the circumstances. Since the use of estimates is an integral component of the financial reporting process, actual results could differ from our expectations as a result of changes in our estimates. Some of our accounting policies require a higher degree of judgment than others in their application and require us to make significant accounting estimates.

The selection of critical accounting policies, judgments, and other uncertainties affecting application of those policies, and the sensitivity of reported results to changes in conditions and assumptions are factors that should be considered when reviewing our financial statements. We believe the following accounting policies involve the most significant judgments and estimates used in the preparation of our financial statements.

Revenue Recognition

Description

In mainland China, we sell our products to distributors, who ultimately sell the products to healthcare providers. Based on the nature of the arrangements, the performance obligations are satisfied upon the product’s delivery to distributors.

Judgments and Uncertainties

Rebates are offered to distributors, consistent with pharmaceutical industry practices. The estimated amount of unpaid or unbilled rebates, if any, is recorded as a reduction of revenue. We estimate rebates based on contracted rates, sales volumes, and level of distributor inventories.

Sensitivity of Estimate to Change

Actual amounts of rebates paid or billed may differ from our estimates. We regularly review the factors and judgments underlying these estimates and adjust the amounts of rebates accordingly. If actual results vary from our estimates, we also adjust these estimates accordingly, which would affect net product revenue and earnings in the period such variances become expected or known.

Research and Development Expenses

Description

Research and development expenses are charged to expense as incurred when these expenditures relate to our research and development services and have no alternative future uses.

Pre-clinical and clinical trial costs are a significant component of our research and development expenses. We have a history of contracting with third parties that perform various pre-clinical and clinical trial activities on our behalf in the ongoing development of our product candidates. Expenses related to pre-clinical and clinical trials are accrued based on our estimates of the actual services performed by the third parties for the respective period.

Judgments and Uncertainties

The process of estimating our research and development expenses involves reviewing open contracts and purchase orders, communicating with our personnel to identify services that have been performed on our behalf, and estimating the level of service performed and the associated costs incurred for the services when we have not yet been invoiced or otherwise notified of the actual costs. The majority of our service providers invoice us in arrears for services performed, on a pre-determined schedule, or when contractual milestones are met; however, some require advanced payments. We make estimates of our research and development expenses as of each balance sheet date in our financial statements based on facts and circumstances known to us at that time.

Sensitivity of Estimate to Change

Although we do not expect our estimates to be materially different from amounts actually incurred, our understanding of the status and timing of services performed relative to the actual status and timing of services performed may vary and may result in us reporting expenses that are too high or too low in any particular period. To date, we have not made any material adjustments to our prior estimates of research and development expenses.

Share-Based Compensation

Description

Share-based awards for our employees are measured at grant date fair value and recognized as expenses (1) immediately at grant date if no vesting conditions are required; or (2) using a straight-line method over the requisite service period, which is the vesting period.

To the extent the required vesting conditions are not met resulting in forfeiture of the share-based awards, previously recognized compensation expense relating to those awards are reversed.

Judgments and Uncertainties

We determine the fair value of stock options granted to employees using the Black-Scholes option valuation model. Using this model, fair value is calculated based on assumptions with respect to (i) the expected volatility of our ADS price, (ii) the periods of time over which grantees are expected to hold their options prior to exercise (expected lives), (iii) the expected dividend yield on our ADSs, and (iv) risk-free interest rates, which are based on quoted U.S. Treasury rates for securities with maturities approximating the expected lives of the options. Expected volatility has been estimated based on actual movements in some comparable companies’ stock price over the most recent historical periods equivalent to the options’ expected lives. The expected term of the share options represents the average period the share options are expected to remain outstanding. As the Company does not have sufficient historical information since its IPO to develop reasonable expectations about future exercise patterns and post-vesting employment termination behavior, the expected term of options granted is derived from the average midpoint between the weighted average vesting and the contractual term, also known as the simplified method. The expected dividend yield is zero as we have never paid dividends and do not currently anticipate paying any in the foreseeable future.

Sensitivity of Estimate to Change

The assumptions used in this method to determine the fair value of our option shares consider historical trends, macroeconomic conditions, and projections consistent with the Company’s operating strategy. Changes in these estimates can have a significant impact on the determination of fair value of the option shares. If factors change or different assumptions are used, our share-based compensation expenses could be materially different for any period.

Income Taxes

Description

In accordance with the provisions of ASC 740, Income Taxes, we recognize in our financial statements the benefit of a tax position if the tax position is “more likely than not” to prevail based on the facts and technical merits of the position. Tax positions that meet the “more likely than not” recognition threshold are measured at the largest amount of tax benefit that has a greater than fifty percent likelihood of being realized upon settlement. We estimate our liability for unrecognized tax benefits which are periodically assessed and may be affected by changing interpretations of laws, rulings by tax authorities, changes and/or developments with respect to tax audits, and expiration of the statute of limitations. The ultimate outcome for a particular tax position may not be determined with certainty prior to the conclusion of a tax audit and, in some cases, appeal or litigation process.

Judgments and Uncertainties

We consider positive and negative evidence when determining whether some portion or all of our deferred tax assets will not be realized. This assessment considers, among other matters, the nature, frequency, and severity of current and cumulative losses, forecasts of future profitability, the duration of statutory carry-forward periods, our historical results of operations, and our tax planning strategies. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Based upon the level of our historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, we believe it is more likely than not that we will not realize the deferred tax assets resulted from the tax loss carried forward in the future periods.

Sensitivity of Estimate to Change

The actual benefits ultimately realized may differ from our estimates. As each audit is concluded, adjustments, if any, are recorded in our financial statements in the period in which the audit is concluded. Additionally, in future periods, changes in facts and circumstances and new information may require us to adjust the recognition and measurement estimates with regard to individual tax positions. Changes in recognition and measurement estimates are recognized in the period in which the changes occur. As of June 30, 2023 and 2022, we did not have any significant unrecognized uncertain tax positions.

Liquidity and Capital Resources

To date, we have financed our activities primarily through private placements, our September 2017 initial public offering and various follow-on offerings on Nasdaq, and our September 2020 secondary listing and initial public offering on the Hong Kong Stock Exchange. Through June 30, 2023, we have raised approximately $164.6 million in private equity financing and approximately $2,462.7 million in net proceeds after deducting underwriting commissions and the offering expenses payable by us in our initial public offering and subsequent follow-on offerings on Nasdaq and our initial public offering on the Hong Kong Stock Exchange. Our operations have consumed substantial amounts of cash since inception. The net cash used in our operating activities was $128.0 million and $132.0 million for the six months ended June 30, 2023 and 2022, respectively. As of June 30, 2023, we had commitments for capital expenditures of $3.9 million, mainly for the purpose of plant construction and installation. For information on our research and development activities and expenditures see the Research and Development Expenses, License and Collaboration Arrangements, and Results of Operations sections in MD&A above.

As of June 30, 2023, we had cash and cash equivalents, restricted cash, and short-term investments of $876.4 million. Based on our current operating plan, we expect that our cash, cash equivalents, restricted cash, and short-term investments, will enable us to meet our cash requirements and fund our operating expenses and capital expenditure requirements for at least the next 12 months. However, in order to bring to fruition our research and development objectives, we may ultimately need additional funding sources, and there can be no assurances that such funding will be made available to us on acceptable terms or at all.

The following table presents information regarding our cash flows ($ in thousands):

Net Cash Used in Operating Activities

Net cash used in operating activities decreased by $4.0 million to $128.0 million in the six months ended June 30, 2023, primarily due to a decrease of $50.3 million in net loss, partially offset by a decrease of $35.2 million in net changes in operating assets and liabilities and a decrease of $11.1 million in adjustments to reconcile net loss to net cash used in operating activities.

Net Cash Used in Investing Activities

Net cash used in investing activities decreased by $132.6 million to $11.3 million in the six months ended June 30, 2023. The decrease was primarily due to a decrease of $160.3 million in purchases of short-term investments, an increase of $10.0 million in proceeds from sale of intellectual property, and a decrease of $8.3 million in purchases of property and equipment, partially offset by a decrease of $45.5 million in proceeds from the maturity of short-term investments.

Net Cash Used in Financing Activities

Net cash used in financing activities increased by $3.1 million to $5.4 million in the six months ended June 30, 2023, primarily due to a decrease of $2.9 million in proceeds from exercises of stock options and an increase of $0.3 million in employee taxes paid related to net share settlement of equity awards.

Recently Issued Accounting Standards

For more information regarding recently issued accounting standards, see Part II – Item 8. Financial Statements and Supplementary Data – Recent Accounting Pronouncements in our 2022 Annual Report. The Company has not adopted any new accounting standards since December 31, 2022.

We are exposed to market risk including foreign exchange risk, credit risk, and inflation risk.

Foreign Exchange Risk

Renminbi, or RMB, is not a freely convertible currency. The State Administration of Foreign Exchange, under the authority of the People’s Bank of China (“PBOC”), controls the conversion of RMB into foreign currencies. The value of RMB is subject to changes in central government policies and to international economic and political developments affecting supply and demand in the China Foreign Exchange Trading System market. The cash and cash equivalents of the Company included aggregated amounts of RMB158.7 million and RMB316.8 million, which were denominated in RMB, representing 3% and 5% of the cash and cash equivalents as of June 30, 2023 and December 31, 2022, respectively.

While our financial statements are presented in U.S. dollars, our business mainly operates in mainland China with a significant portion of our transactions settled in RMB, and as such, we do not believe that we currently have significant direct foreign exchange risk and have not used derivative financial instruments to hedge our exposure to such risk. Although, in general, our exposure to foreign exchange risks should be limited, the value of your investment in our ADSs and ordinary shares will be affected by the exchange rate between the U.S. dollar and the RMB and between the HK dollar and the RMB, respectively, because the value of our business is effectively denominated in RMB, while ADSs and ordinary shares are traded in U.S. dollars and HK dollars, respectively.

The value of the RMB against the U.S. dollar and other currencies may fluctuate and is affected by, among other things, changes in Greater China’s political and economic conditions. The conversion of RMB into foreign currencies, including U.S. dollars, has been based on rates set by the PBOC. On July 21, 2005, the Chinese government changed its decade-old policy of pegging the value of the RMB to the U.S. dollar. Under the revised policy, the RMB is permitted to fluctuate within a narrow and managed band against a basket of certain foreign currencies. This change in policy resulted in a more than 20% appreciation of the RMB against the U.S. dollar in the following three years. Between July 2008 and June 2010, this appreciation halted, and the exchange rate between the RMB and U.S. dollar remained within a narrow band. In June 2010, the PBOC announced that the Chinese government would increase the flexibility of the exchange rate, and thereafter allowed the RMB to appreciate slowly against the U.S. dollar within the narrow band fixed by the PBOC. However, in August 2015, the PBOC significantly devalued the RMB.

The value of our ADSs and our ordinary shares will be affected by the foreign exchange rates between U.S. dollars, HK dollars, and the RMB. For example, to the extent that we need to convert U.S. dollars or HK dollars into RMB for our operations or if any of our arrangements with other parties are denominated in U.S. dollars or HK dollars and need to be converted into RMB, appreciation of the RMB against the U.S. dollar or the HK dollar would have an adverse effect on the RMB amount we receive from the conversion. Conversely, if we decide to convert RMB into U.S. dollars or HK dollars for the purpose of making payments for dividends on ordinary shares or ADSs or for other business purposes, appreciation of the U.S. dollar or the HK dollar against the RMB would have a negative effect on the conversion amounts available to us.

Since 1983, the Hong Kong Monetary Authority (“HKMA”) has pegged the HK dollar to the U.S. dollar at the rate of approximately HK$7.80 to US$1.00. However, there is no assurance that the HK dollar will continue to be pegged to the U.S. dollar or that the HK dollar conversion rate will remain at HK$7.80 to US$1.00. If the HK dollar conversion rate against the U.S. dollar changes and the value of the HK dollar depreciates against the U.S. dollar, our assets denominated in HK dollars will be adversely affected. Additionally, if the HKMA were to repeg the HK dollar to, for example, the RMB rather than the U.S. dollar, or otherwise restrict the conversion of HK dollars into other currencies, then our assets denominated in HK dollars will be adversely affected.

Credit Risk

Financial instruments that are potentially subject to significant concentration of credit risk consist of cash and cash equivalents, short-term investments, accounts receivable, and notes receivable.

The carrying amounts of cash and cash equivalents and short-term investments represent the maximum amount of loss due to credit risk. As of June 30, 2023 and December 31, 2022, we had cash and cash equivalents of $859.2 million and $1,008.5 million and short-term investments of $15.5 million and nil, respectively. As of June 30, 2023 and December 31, 2022, all of our cash and cash equivalents and short-term investments were held by major financial institutions located in mainland China and international financial institutions outside of mainland China which we believe are of high credit quality and for which we monitor continued credit worthiness.

Accounts receivable are typically unsecured and are derived from product sales and collaborative arrangements. We manage credit risk related to our accounts receivable through ongoing monitoring of outstanding balances and limiting the amount of credit extended based upon payment history and credit worthiness. Historically, we have collected receivables from customers within the credit terms with no significant credit losses incurred. As of June 30, 2023, our two largest customers accounted for approximately 31% of our total accounts receivable collectively.

Certain accounts receivable balances are settled in the form of notes receivable. As of June 30, 2023, such notes receivable included bank acceptance promissory notes that are non-interest bearing and due within six months. These notes receivable were used to collect the receivables based on an administrative convenience, given these notes are readily convertible to known amounts of cash. In accordance with the sales agreements, whether to use cash or bank acceptance promissory notes to settle the receivables is at our discretion, and this selection does not impact the agreed contractual purchase prices.

Inflation Risk

In recent years, mainland China has not experienced significant inflation. Although the global economy, including the U.S. economy, experienced rising inflation in recent years, which can increase the costs of our products and product candidates purchased from third parties and, as a result, adversely affect our results of operations, inflation has not had a material impact on our results of operations. Although we have not been materially affected by inflation in the past, we can provide no assurance that we will not be affected in the future by higher rates of inflation in mainland China or in other countries in which our third-party partners operate.

Management’s Evaluation of our Disclosure Controls and Procedures

Our management, including our Chief Executive Officer and Chief Financial Officer, performed an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) as of the end of the period covered by this report. Our disclosure controls and procedures are designed to ensure that the information required to be disclosed in the reports that we file or furnish under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure. Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objective. Based upon that evaluation, our management has concluded that, as of June 30, 2023, our disclosure controls and procedures were effective.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting (as such item is defined in Rules 13a-15(f)) during the fiscal quarter ended June 30, 2023 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

We are subject to risks and uncertainties that could, directly or indirectly, adversely affect our business, results of operations, financial condition, liquidity, cash flows, strategies, and/or prospects. There have been no material changes in our risk factors from those disclosed in the “Risk Factors” section of our 2022 Annual Report.