Savara Pharmaceuticals Filing - Savara Pharmaceuticals

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svra-10q_20170630.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended June 30, 2017

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

For the transition period from to

Commission File Number 001-32157

Savara Inc.

(Exact name of registrant as specified in its charter)

Delaware		84-1318182
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

900 South Capital of Texas Highway, Las Cimas IV, Suite 150 Austin, TX		78746
(Address of principal executive offices)		(Zip Code)

(512) 614-1848

(Registrant’s telephone number, including area code)

N/A

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

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

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

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

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

As of August 9, 2017, the registrant had 24,203,464 shares of common stock, $0.001 par value per share, outstanding.

Table of Contents

		Page
PART I.	FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited)	1
	Condensed Consolidated Balance Sheets	1
	Condensed Consolidated Statements of Operations and Comprehensive Loss	2
	Consolidated Statements of Changes in Redeemable Convertible Preferred Stock and Stockholders’ Deficit	3
	Condensed Consolidated Statements of Cash Flows	4
	Notes to Condensed Consolidated Financial Statements	5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	24
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	32
Item 4.	Controls and Procedures	32
PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings	34
Item 1A.	Risk Factors	34
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	55
Item 3.	Defaults Upon Senior Securities	55
Item 4.	Mine Safety Disclosures	55
Item 5.	Other Information	55
Item 6.	Exhibits	55
Signatures		56
Exhibit Index		57

Savara Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

(In thousands, except share and per share amounts)

(Unaudited)

	June 30, 2017			December 31, 2016

Assets
Current assets:
Cash and cash equivalents	$	61,133		$	13,373
Grants and award receivable		—			400
Prepaid expenses and other current assets		2,541			840
Total current assets		63,674			14,613
Property and equipment, net		672			793
In-process R&D		33,071			10,477
Goodwill		28,222			3,051
Other non-current assets		131			—
Total assets	$	125,770		$	28,934
Liabilities, redeemable convertible preferred stock and stockholders’ equity (deficit)
Current liabilities:
Accounts payable	$	1,932		$	536
Accrued expenses		5,487			2,477
Current portion of capital lease obligation		719			442
Total current liabilities		8,138			3,455
Long-term liabilities:
Accrued interest on convertible promissory notes		—			151
Debt facility		14,579			—
Convertible promissory notes		—			3,448
Put option derivative liability		—			979
Contingent consideration		11,685			9,708
Deferred tax liability		11,180			2,305
Capital lease obligation, net of current portion		297			579
Warrant liability		—			303
Other long-term liabilities		122			20
Total liabilities		46,001			20,948
Redeemable convertible preferred stock:
Series A redeemable convertible preferred stock, $0.001 par value, 0 and 1,799,906 shares authorized, issued, and outstanding, as of June 30, 2017 and December 31, 2016, respectively		—			3,232
Series B redeemable convertible preferred stock, $0.001 par value, 0 and 6,000,000 shares authorized as of June 30, 2017 and December 31, 2016, respectively; 0 and 5,675,387 shares issued and outstanding as of June 30, 2017 and December 31, 2016; respectively		—			17,301
Series C redeemable convertible preferred stock, $0.001 par value; 0 and 8,000,000 shares authorized as of June 30, 2017 and December 31, 2016, respectively; 0 and 4,452,582 shares issued and outstanding as of June 30, 2017 and December 31, 2016, respectively		—			23,328
Total redeemable convertible preferred stock		—			43,861
Stockholders’ equity (deficit):
Common stock, $0.001 par value, 500,000,000 and 27,000,000 shares authorized as of June 30, 2017 and December 31, 2016, respectively; 24,203,464 and 3,162,573 shares (after giving effect to the Exchange Ratio and Reverse Stock Split) issued and outstanding as of June 30, 2017 and December 31, 2016, respectively		26			5
Additional paid-in capital		134,222			3,117
Accumulated other comprehensive income (loss)		404			(591	)
Accumulated deficit		(54,883	)		(38,406	)
Total stockholders’ equity (deficit)		79,769			(35,875	)
Total liabilities, redeemable convertible preferred stock, and stockholder’s equity (deficit)	$	125,770		$	28,934

The accompanying notes are an integral part of these financial statements.

Savara Inc. and Subsidiaries

Condensed Consolidated Statements of Operations and Comprehensive Loss

(In thousands, except share and per share amounts)

(Unaudited)

	Three Months Ended June 30,						Six Months Ended June 30,
	2017			2016			2017			2016
Grant and award revenue	$	—		$	—		$	—		$	—
Operating expenses:
Research and development		4,164			1,290			7,111			2,552
General and administrative		5,088			608			6,924			953
Depreciation		91			85			181			170
Total operating expenses		9,343			1,983			14,216			3,675
Loss from operations		(9,343	)		(1,983	)		(14,216	)		(3,675	)
Other income (expense):
Interest expense		(516	)		(7	)		(761	)		(17	)
Foreign currency exchange loss		(122	)		(84	)		(154	)		(72	)
Loss on extinguishment of debt		(1,816	)		—			(1,816	)		—
Change in fair value of financial instruments		(177	)		23			(237	)		36
Total other income (expense)		(2,631	)		(68	)		(2,968	)		(53	)
Loss before income taxes		(11,974	)		(2,051	)		(17,184	)		(3,728	)
Income tax benefit		470			—			707			—
Net loss	$	(11,504	)	$	(2,051	)	$	(16,477	)	$	(3,728	)
Accretion of redeemable convertible preferred stock		(554	)		(2	)		(578	)		(26	)
Deemed dividend on beneficial conversion feature		(404	)		—			(404	)		—
Net loss attributable to common stockholders	$	(12,462	)	$	(2,053	)	$	(17,459	)	$	(3,754	)
Other comprehensive income:
Gain (loss) on foreign currency translation		851			—			995			—
Total Comprehensive Loss	$	(10,653	)	$	(2,051	)	$	(15,482	)	$	(3,728	)
Net loss per share:
Basic and diluted	$	(0.90	)	$	(1.97	)	$	(2.06	)	$	(3.63	)
Weighted average common shares outstanding
Basic and diluted		13,807,861			1,043,984			8,465,053			1,034,553

The accompanying notes are an integral part of these financial statements.

Savara Inc. and Subsidiaries

Consolidated Statements of Changes in Redeemable Convertible Preferred Stock and Stockholders’ Equity (Deficit)

Period Ended June 30, 2017

(In thousands, except share amounts)

(Unaudited)

	Redeemable Convertible Preferred Stock																					Stockholders’ Equity (Deficit)
	Redeemable Convertible Series A Preferred Stock						Redeemable Convertible Series B Preferred Stock						Redeemable Convertible Series C Preferred Stock									Common Stock											Accumulated
	Number of Shares			Amount			Number of Shares			Amount			Number of Shares			Amount			Total			Number of Shares			Amount		Additional Paid-In Capital			Accumulated Deficit			Other Comprehensive Income			Total
Balance on December 31, 2016		1,799,906		$	3,232			5,675,387		$	17,301			4,452,582		$	23,328		$	43,861			3,162,573		$	5	$	3,117		$	(38,406	)	$	(591	)	$	(35,875	)
Repurchase of forfeited restricted common stock		—			—			—			—			—			—			—			(19,045	)	—		—			—			—			—
Accretion of redeemable convertible preferred stock		—			22			—			460			—			96			578			—		—			(578	)	—			—				(578	)
Issuance of common stock upon exercise of warrants		—			—			—			—			—			—			—			111,799			—		384		—			—				384
Conversion of convertible notes into common stock		—			—			—			—			—			—			—			1,140,046			1		10,044		—			—				10,045
Conversion of redeemable convertible preferred stock to common stock as effected for the reverse merger exchange ratio		(1,799,906	)		(3,254	)		(5,675,387	)		(17,761	)		(4,452,582	)		(23,424	)		(44,439	)		7,034,102			7		44,431		—			—				44,438
Reclassification of warrant liability		—			—			—			—			—			—			—			—		—			370		—			—				370
Beneficial conversion feature		—			—			—			—			—			—			—			—		—			404		—			—				404
Business combination upon Merger		—			—			—			—			—			—			—			3,639,189			4		35,842		—			—				35,846
Issuance of common stock upon public offering, net closing costs		—			—			—			—			—			—			—			9,034,210			9		39,513		—			—				39,522
Issuance of detachable warrants with debt instrument		—			—			—			—			—			—			—			—		—			359		—			—				359
Issuance of common stock upon At The Market sales, net		—			—			—			—			—			—			—			23,550			—		100		—			—				100
Issuance of common stock for settlement of RSUs		—			—			—			—			—			—			—			72,361			—		—			—			—			—
Issuance of common stock upon cashless exercise of stock options		—			—			—			—			—			—			—			4,679			—		—			—			—			—
Stock-based compensation		—			—			—			—			—			—			—			—			—		236			—			—			236
Foreign exchange translation adjustment		—			—			—			—			—			—			—			—			—		—			—			995			995
Net loss incurred		—			—			—			—			—			—			—			—			—		—			(16,477	)					(16,477	)
Balance on June 30, 2017		—		$	—			—		$	—			—		$	—		$	—			24,203,464		$	26	$	134,222		$	(54,883	)	$	404		$	79,769

The accompanying notes are an integral part of these financial statements.

Savara Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

	Six Months Ended June 30,
	2017			2016
Cash flows from operating activities:
Net loss	$	(16,477	)	$	(3,728	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation		181			170
Changes in fair value of financial instruments		237			(36	)
Change in fair value of contingent consideration		1,977			—
Noncash interest		400			26
Loss on extinguishment of debt		1,816			—
Foreign currency gain/(loss)		154			72
Amortization of debt issuance costs		204			—
Stock-based compensation		236			112
Changes in operating assets and liabilities:
Grant and award receivable		400			—
Tax refund receivable		(666	)		—
Prepaid expenses and other current assets		(817	)		(180	)
Deferred rent		(7	)		16
Accounts payable and accrued expenses		1,847			233
Net cash used in operating activities	$	(10,515	)	$	(3,315	)
Cash flows from investing activities:
Cash acquired through Merger	$	3,442		$	—
Purchase of property and equipment		(60	)		(5	)
Net cash used in investing activities	$	3,382		$	(5	)
Cash flows from financing activity:
Proceeds from debt facility	$	14,894		$	—
Proceeds from convertible promissory note		3,569			—
Issuance of common stock upon exercise of warrants		385			—
Issuance of common stock upon public offering		39,522			—
Repayment of long-term debt		(3,567	)		—
Issuance of common stock upon at the market offerings, net		100			—
Proceeds from exercise of stock option		—			1
Proceeds from issuance of Series C preferred stock, net		—			776
Capital lease obligation principal payments		(5	)		(81	)
Net cash provided by financing activities	$	54,898		$	696
Effect of exchange rate changes on cash and cash equivalents		(5	)		—
Increase / (Decrease) in cash and cash equivalents	$	47,760		$	(2,624	)
Cash and cash equivalents beginning of period		13,373			16,683
Cash and cash equivalents end of period	$	61,133		$	14,059

Non-cash transactions:
Extinguishment and derecognition of put options		2,202			—
Conversion of convertible notes into common stock		8,249			—
Shares issued in connection of business combination and assumed equity awards		35,846			—
Accretion of Series A redeemable convertible preferred stock		22			3
Accretion of Series B redeemable convertible preferred stock		460			12
Accretion of Series C redeemable convertible preferred stock		96			11
Beneficial conversion feature		404			—

The accompanying notes are an integral part of these financial statements.

Savara Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

1. Description of Business and Basis of Presentation

Description of Business

Savara Inc. (“Savara,” the “Company,” or as used in the context of “we” or “us”) is a clinical stage specialty pharmaceutical company focusing on the development and commercialization of product candidates for patients with rare respiratory diseases, including cystic fibrosis (CF), and pulmonary alveolar proteinosis (PAP). Our lead clinical stage product candidate, Molgradex, is an inhaled formulation of recombinant human granulocyte-macrophage colony-stimulating factor (GM-CSF), intended for the treatment of PAP. Our other lead clinical stage product candidate, AeroVanc, is an inhaled formulation of vancomycin, intended for the treatment of persistent methicillin-resistant Staphylococcus aureus (MRSA) lung infection in CF patients. The Company and its wholly owned subsidiaries, Aravas Inc. and Sarara ApS, operate in one segment with its principal offices in Austin, Texas.

On April 27, 2017, Savara completed its business combination with Mast Therapeutics, Inc. ("Mast"), a publicly held company, in accordance with the terms of the Agreement and Plan of Merger and Reorganization (the "Merger Agreement"), dated January 6, 2017 (the "Merger"). In connection with and immediately prior to the effective time of the Merger, Mast implemented a reverse stock split at a ratio of one new share for every 70 shares of its common stock outstanding (the “Reverse Stock Split”). Under the terms of the Merger Agreement, each outstanding share of Savara common stock was then converted into Mast common stock at a ratio of approximately .5860 of a Savara share (the “Exchange Ratio”). No fractional shares were issued and instead, shareholders received cash for the value of their fractional shares. Immediately following the effective date of the Merger, Mast’s preexisting equity holders owned approximately 23% of the combined company, and Savara’s preexisting equity holders owned approximately 77%.

Accordingly, all operations presented in the accompanying financial statements and notes to the financial statements represent the historical activity of Savara, the private company prior to the Merger.

The accompanying financial statements and notes to the consolidated financial statements also give retroactive effect to the common stock Exchange Ratio and Reverse Stock Split of the Merger for all periods presented, including common stock warrants and common stock-based compensation awards.

Following the Merger, Mast was renamed “Savara Inc." and began trading on The Nasdaq Capital Market under the symbol "SVRA." Prior to the Merger, Mast was traded on the New York Stock Exchange under the symbol "MSTX."

The combined company’s pipeline includes:

•

Molgradex

•

AeroVanc

•

Aironite, a sodium nitrite solution for intermittent inhalation via nebulization, which is being developed for the treatment of heart failure with preserved ejection fraction (HFpEF).

Since inception, Savara has devoted substantially all of its efforts and resources to identifying and developing its product candidates, recruiting personnel, and raising capital. Savara has incurred operating losses and negative cash flow from operations and has no product revenue from inception to date. The Company has not yet commenced commercial operations.

Basis of Presentation

The condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States (“U.S. GAAP”) as defined by the Financial Accounting Standards Board (“FASB”). These condensed consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto for the year ended December 31, 2016.

Unaudited Interim Financial Information

The interim condensed consolidated financial statements included in this document are unaudited. The unaudited interim financial statements have been prepared on the same basis as the annual financial statements and reflect, in the opinion of management, all adjustments of a normal and recurring nature that are necessary for a fair statement of the Company’s financial position as of June 30, 2017, and its results of operations for the six months ended June 30, 2017 and 2016, and cash flows for the six months ended June 30, 2017 and 2016. The results of operations for the three and six months ended June 30, 2017 are not necessarily indicative of the results to be expected for the year ending December 31, 2017 or for any other future annual or interim period. The December 31, 2016 consolidated balance sheet was derived from audited financial statements, but does not include all disclosures required by U.S. GAAP. These condensed consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto for the year ended December 31, 2016.

2. Summary of Significant Accounting Policies

Liquidity

As of June 30, 2017, the Company had an accumulated deficit of approximately $54.9 million. The Company also had negative cash flow from operations of approximately $10.5 million during the six months ended June 30, 2017. The cost to further develop and obtain regulatory approval for any drug is substantial and, as noted below, the Company may have to take certain steps to maintain a positive cash position. Accordingly, the Company will need additional capital to further fund the development of, and seek regulatory approvals for, its product candidates and begin to commercialize any approved products.

The Company is currently focused primarily on the development of respiratory drugs and believes such activities will result in the Company’s continued incurrence of significant research and development and other expenses related to those programs. If the clinical trials for any of the Company’s product candidates fail or produce unsuccessful results and those product candidates do not gain regulatory approval, or if any of the Company’s product candidates, if approved, fails to achieve market acceptance, the Company may never become profitable. Even if the Company achieves profitability in the future, it may not be able to sustain profitability in subsequent periods. The Company intends to cover its future operating expenses through cash and cash equivalents on hand and through a combination of equity offerings, debt financings, government or other third-party funding, and other collaborations and strategic alliances. The Company cannot be sure that additional financing will be available when needed or that, if available, financing will be obtained on terms favorable to the Company or its stockholders.

While the Company has cash and cash equivalents of $61.1 million as of June 30, 2017, we intend to continue to raise additional capital through the issuance of additional equity and potentially through borrowings, and strategic alliances with partner companies. However, if such financings are not available timely and at adequate levels, the Company will need to reevaluate its operating plans. The condensed consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

Principles of Consolidation

The condensed consolidated financial statements of the Company are stated in U.S. dollars and are prepared using U.S. GAAP. These financial statements include the accounts of the Company and its wholly owned subsidiaries. The financial statements of the Company’s wholly owned subsidiaries are recorded in their functional currency and translated into the reporting currency. The cumulative effect of changes in exchange rates between the foreign entity’s functional currency and the reporting currency is reported in Accumulated Other Comprehensive Income. All intercompany transactions and accounts have been eliminated in consolidation.

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires the Company to make certain estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Management’s estimates include those related to the accrual of research and development costs, the valuation of preferred and common shares, certain financial instruments recorded at fair value, stock-based compensation, and the valuation allowance for deferred tax assets. The Company bases its estimates on historical experience and on various other market-specific and relevant assumptions that it believes to be reasonable under the circumstances. Accordingly, actual results could be materially different from those estimates.

Risks and Uncertainties

The product candidates being developed by the Company require approvals from the U.S. Food and Drug Administration (FDA) or foreign regulatory agencies prior to commercial sales. There can be no assurance that the Company’s product candidates will receive the necessary approvals. If the Company is denied regulatory approval of its product candidates, or if approval is delayed, it may have a material adverse impact on the Company’s business, results of operations and its financial position.

The Company is subject to a number of risks similar to other life science companies, including, but not limited to, risks related to the successful discovery and development of drug candidates, raising additional capital, development of competing drugs and therapies, protection of proprietary technology and market acceptance of the Company’s products. As a result of these and other factors and the related uncertainties, there can be no assurance of the Company’s future success.

Cash and Cash Equivalents

Cash and cash equivalents consist of cash and institutional bank money market accounts with original maturities of three months or less when acquired and are stated at cost, which approximates fair value.

Concentration of Credit Risk

Financial instruments, which potentially subject the Company to concentrations of credit risk, consist principally of cash and cash equivalents. The Company places its cash and cash equivalents with a limited number of high quality financial institutions and at times may exceed the amount of insurance provided on such deposits.

Accrued Research and Development Costs

The Company records the costs associated with research nonclinical studies, clinical trials, and manufacturing development as incurred. These costs are a significant component of the Company’s research and development expenses, with a substantial portion of the Company’s on-going research and development activities conducted by third-party service providers, including contract research and manufacturing organizations.

The Company accrues for expenses resulting from obligations under agreements with contract research organizations (“CROs”), contract manufacturing organizations (“CMOs”), and other outside service providers for which payment flows do not match the periods over which materials or services are provided to the Company. Accruals are recorded based on estimates of services received and efforts expended pursuant to agreements established with CROs, CMOs, and other outside service providers. These estimates are typically based on contracted amounts applied to the proportion of work performed and determined through analysis with internal personnel and external service providers as to the progress or stage of completion of the services. The Company makes significant judgments and estimates in determining the accrual balance in each reporting period. In the event advance payments are made to a CRO, CMO, or outside service provider, the payments will be recorded as a prepaid asset which will be amortized as the contracted services are performed. As actual costs become known, the Company adjusts its prepaids and accruals. Inputs, such as the services performed, the number of patients enrolled, or the study duration, may vary from the Company’s estimates resulting in adjustments to research and development expense in future periods. Changes in these estimates that result in material changes to the Company’s accruals could materially affect the Company’s results of operations. The Company has not experienced any material deviations between accrued and actual research and development expenses.

Business Combinations

Assets acquired and liabilities assumed as part of a business acquisition are recorded at their estimated fair value at the date of acquisition. The excess of purchase price over the fair value of assets acquired and liabilities assumed is recorded as goodwill. Determining fair value of identifiable assets, particularly intangibles, and liabilities acquired also requires management to make estimates, which are based on all available information and, in some cases, assumptions with respect to the timing and amount of future revenue and expenses associated with an asset.

Goodwill and Acquired In-Process Research and Development (IPR&D)

Goodwill and acquired IPR&D are not amortized but are tested annually for impairment or more frequently if impairment indicators exist. The Company adopted accounting guidance related to annual and interim goodwill and acquired IPR&D impairment tests which allows the Company to first assess qualitative factors before performing a quantitative assessment of the fair value of a reporting unit. If it is determined on the basis of qualitative factors that the fair value of the reporting unit is more likely than not less than the carrying amount, a quantitative impairment test is required. The Company experienced a $.1 million and $.4 million increase in the carrying value of goodwill and IPR&D, respectively, related to Savara ApS, from the acquisition date, July 15, 2016, which was due to foreign currency translation. Additional goodwill and IPR&D were recorded with respect to the Merger.

Tax Refund Receivable

The Company has recorded a Danish tax credit earned by its subsidiary, Savara ApS for the post-acquisition period in 2016 and the six months ended June 30, 2017. Under Danish Tax Law, Denmark remits a research and development tax credit equal to 22% of qualified research and development expenditures, not to exceed established thresholds. As of June 30, 2017, the credits had not yet been received and a receivable of $1.1 million was recorded on the balance sheet in prepaid expenses and other current assets. The portion of the total Danish tax credit related to the post-acquisition period in 2016 of approximately $.4 million is expected to be collected in November 2017.

Segment Reporting

Operating segments are identified as components of an enterprise about which separate discrete financial information is available for evaluation by the chief operating decision maker, or decision making group, in making decisions on how to allocate resources and assess performance. Our chief operating decision maker is the chief executive officer. We have one operating segment, specialty pharmaceuticals within the respiratory system.

Fair Value of Financial Instruments

The accounting standard for fair value measurements provides a framework for measuring fair value and requires disclosures regarding fair value measurements. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, based on the Company’s principal or, in absence of a principal, most advantageous market for the specific asset or liability.

The Company uses a three-tier fair value hierarchy to classify and disclose all assets and liabilities measured at fair value on a recurring basis, as well as assets and liabilities measured at fair value on a non-recurring basis, in periods subsequent to their initial measurement. The hierarchy requires the Company to use observable inputs when available, and to minimize the use of unobservable inputs, when determining fair value.

The three tiers are defined as follows:

•

Level 1 – Observable inputs that reflect quoted market prices (unadjusted) for identical assets or liabilities in active markets;

•

Level 2 – Observable inputs other than quoted prices in active markets that are observable either directly or indirectly in the marketplace for identical or similar assets and liabilities; and

•

Level 3 – Unobservable inputs that are supported by little or no market data, which require the Company to develop its own assumptions.

Financial instruments carried at fair value include cash and cash equivalents and contingent consideration related to the acquisition of Serendex for which any change is reflected in general and administrative expense, as well as certain warrants classified as liabilities and embedded put options separated from the convertible promissory notes which were converted to common equity or derecognized during the period ended June 30, 2017 as a result of the Merger (Notes 6, 8, and 9). These remaining financial instruments are carried at fair value on a recurring basis.

Financial instruments not carried at fair value include accounts payable and accrued liabilities. The carrying amounts of these financial instruments approximate fair value due to the highly liquid nature of these short-term instruments.

Net Loss per Share

Basic net loss attributable to common stockholders per share is calculated by dividing the net loss by the weighted average number of shares of common stock outstanding during the period without consideration of common stock equivalents. Since the Company was in a loss position for all periods presented, diluted net loss per share is the same as basic net loss per share for all periods presented as the inclusion of all potential dilutive securities would have been antidilutive.

Redeemable Convertible Preferred Stock and Series B and Series C Warrants

The Series A, Series B, and Series C redeemable convertible preferred stock, previously classified in temporary equity as it was redeemable at the written request of the holders of at least two-thirds of the then outstanding shares of preferred stock, at any time after October 31, 2022, was converted to common stock on the effective date of the Merger subject to the Exchange Ratio. Additionally, certain outstanding warrants to purchase the Series B convertible preferred stock (“Series B Warrants”) previously classified as liabilities were exercised on the effective date of the Merger with any residual Series B warrants expiring in May 2017. Certain outstanding warrants to purchase the Series C redeemable convertible preferred stock (“Series C Warrants”) were reclassified from a liability to common equity as the Series C Warrants have been converted to warrants to purchase common stock subject to the Exchange Ratio following the Merger.

Stock-Based Compensation

The Company recognizes the cost of stock-based awards granted to employees based on the estimated grant-date fair value of the awards. The value of the portion of the award that is ultimately expected to vest is recognized as expense ratably over the requisite service period. The Company recognizes the compensation costs for awards that vest over several years on a straight-line basis over the vesting period (see Note 12). Forfeitures are recognized when they occur, which may result in the reversal of compensation costs in subsequent periods as the forfeitures arise. The Company recognizes the cost of stock-based awards granted to nonemployees at their then-current fair values as services are performed, and such awards are remeasured through the counterparty performance date.

Manufacturing Commitments and Contingencies

The Company is subject to various manufacturing royalties and payments related to its product candidate, Molgradex. Upon the successful development, registration and attainment of approval by the proper health authorities, such as the FDA, in any territory except Latin America, Central America and Mexico, the Company must pay a royalty of three percent (3%) on annual net sales to the manufacturer of its Active Pharmaceutical Ingredients (“API”). Under this agreement with the API manufacturer, no signing fee or milestones are included in the royalty payments, and there is no minimum royalty. Additionally, Savara has a commitment to acquire a working cell bank and a master cell bank for approximately $2.0 million from this API manufacturer in the third quarter of 2017.

The Company is also subject to certain contingent milestone payments up to approximately 7.0 million euros based upon various development activities and regulatory approvals payable to the Company’s manufacturer of its nebulizer used to administer Molgradex. In addition to these milestones, the Company will owe a royalty to the manufacturer of its nebulizer based on net sales. The royalty rate ranges from three and a half percent (3.5%) to five percent (5%) depending on the device technology used by the Company to administer the product.

Income Taxes

The Company uses the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of assets and liabilities. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect of a change in tax rates on deferred tax assets and liabilities will be recognized in the period that includes the enactment date. A valuation allowance is established against the deferred tax assets to reduce their carrying value to an amount that is more likely than not to be realized.

Recent Accounting Pronouncements

In February 2016, the FASB issued Accounting Standards Update 2016-02, “Leases” (“ASU 2016-02”). The update aims at making leasing activities more transparent and comparable, and requires substantially all leases to be recognized by lessees on their balance sheet as a right-of-use asset and a corresponding lease liability, including leases currently accounted for as operating leases. The update also requires improved disclosures to help users of financial statements better understand the amount, timing and uncertainty of cash flows arising from leases. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018 with early adoption permitted. The Company is currently evaluating the impact of the adoption of ASU 2016-02 on its financial statements.

In August 2016, the FASB issued Accounting Standards Update 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments” (“ASU 2016-15”), which intended to add or clarify guidance on the classification of certain cash receipts and payments on the statement of cash flows. The new guidance addresses cash flows related to the following: debt prepayment or extinguishment costs, settlement of zero-coupon bonds, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims, proceeds from the settlement of corporate-owned life insurance policies and bank-owned life insurance policies, distributions received from equity method investees, beneficial interest in securitization transactions, and the application of predominance principle to separately identifiable cash flows. ASU 2016-15 is effective for the Company for annual periods beginning after December 15, 2017, and interim periods within those fiscal years with early adoption permitted. The Company is currently evaluating the effect of this new guidance on its financial statements.

In January 2017, the FASB issued Accounting Standards Update 2017-01, “Business Combinations (Topic 805): Clarifying the Definition of a Business” (“ASU 2017-01”), which intended to clarify the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. ASU 2017-01 is effective for the Company for annual periods beginning after December 15, 2017. The Company’s early adoption of this standard did not have a material impact on the Company’s financial statements.

In May 2017, the FASB issued Accounting Standards Update 2017-09, “Compensation – Stock Compensation (Topic 718): Scope of Modification Accounting” (“ASU 2017-09”), which intended to provide clarity when to account for a change to the terms or conditions of a share-based payment award as a modification. Under the new guidance, modification accounting is required only if the fair value, the vesting conditions, or the classification of the award (as equity or liability) changes as a result of the change in terms or conditions. ASU 2017-09 is effective for the Company for annual periods beginning on or after December 15, 2017 with early adoption permitted. The Company’s early adoption of this standard did not have a material impact on the Company’s financial statements.

3. Prepaid expenses and other current assets

Prepaid expenses, consisted of (in thousands):