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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549 
FORM 10-Q
 
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2020
 OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                  to                 
Commission File Number: 001-36225 
KINDRED BIOSCIENCES, INC.
(Exact name of registrant as specified in its charter)
 

Delaware46-1160142
(State of incorporation)
(I.R.S. Employer
Identification No.)
1555 Bayshore Highway, Suite 200
Burlingame, California 94010
(Address of principal executive office) (Zip code)
Registrant’s telephone number: (650701-7901
Securities registered pursuant to Section 12(b) of the Act:
Title of each classTrading SymbolName of each exchange on which registered
Common Stock, $0.0001 par valueKINThe NASDAQ Stock Market LLC
Preferred Stock Purchase RightsKINThe NASDAQ Stock Market LLC

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes       No  
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter time that the registrant was required to submit such files).    Yes       No  
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.


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Large accelerated filer
Accelerated filer
Non-accelerated filerSmaller reporting company
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by checkmark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes       No  

As of July 31, 2020, Kindred Biosciences, Inc. had outstanding 39,368,423 shares of common stock, $0.0001 par value.
 



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Kindred Biosciences, Inc.

TABLE OF CONTENTS
Part No.Item No.DescriptionPage
No.
I
1
2
3
4
II
1
1A
2
3
4
5
6




2

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PART I - FINANCIAL INFORMATION

 ITEM 1. FINANCIAL STATEMENTS

Kindred Biosciences, Inc.
Condensed Consolidated Balance Sheets
(In thousands, except share and per share amounts)
June 30, 2020December 31, 2019
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents$26,898  $15,986  
Short-term investments40,218  55,723  
Accounts receivable263  923  
Inventories389  4,218  
Prepaid expenses and other5,003  2,495  
Total current assets72,771  79,345  
Property and equipment, net29,569  29,777  
Long-term investments10,457  1,837  
Operating lease right-of-use assets3,082  3,001  
Other assets63  64  
Total assets$115,942  $114,024  
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable$639  $1,256  
Accrued compensation4,091  4,193  
Accrued liabilities1,562  4,131  
Current portion of operating lease liabilities657  644  
Total current liabilities6,949  10,224  
Long-term liabilities:
Long-term operating lease liabilities2,741  2,614  
Long-term loan payable, net of debt issuance costs19,436  19,265  
Total liabilities29,126  32,103  
Commitments and contingencies (Note 10)


Stockholders' equity:
Common stock, $0.0001 par value; 100,000,000 shares authorized; 39,332,921 and 39,203,533 shares issued and outstanding at June 30, 2020 and December 31, 2019, respectively
4  4  
Additional paid-in capital308,542  304,963  
Accumulated other comprehensive income44  13  
Accumulated deficit(221,774) (223,059) 
Total stockholders' equity86,816  81,921  
Total liabilities and stockholders' equity$115,942  $114,024  

The accompanying notes are an integral part of these condensed consolidated financial statements.
3

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Kindred Biosciences, Inc.
Condensed Consolidated Statements of Operations and Comprehensive Income (Loss)
(In thousands, except per share amounts)
(Unaudited)
 
Three months ended June 30,Six months ended June 30,
2020201920202019
Revenues:
Net product revenues
$163  $1,236  $766  $1,751  
Revenue from asset sale
38,700    38,700    
Partner royalty revenue
158    158    
Contract manufacturing revenue
546    546    
Total revenues39,567  1,236  40,170  1,751  
Operating costs and expenses:
Cost of product revenues (1)
27  169  3,604  261  
Contract manufacturing costs336    336    
   Research and development7,398  6,734  16,265  13,886  
   Selling, general and administrative5,105  9,065  13,978  18,966  
 Restructuring costs2,288    3,964    
Total operating costs and expenses15,154  15,968  38,147  33,113  
Income (loss) from operations24,413  (14,732) 2,023  (31,362) 
Interest and other income (expense), net(367) 425  (738) 1,000  
Net income (loss)24,046  (14,307) 1,285  (30,362) 
Change in unrealized gains or losses on available-for-sale securities
40  26  31  24  
Comprehensive income (loss)
$24,086  $(14,281) $1,316  $(30,338) 
Net income (loss) per share, basic
$0.61  $(0.37) $0.03  $(0.79) 
Weighted-average number of common shares outstanding, basic
39,240  38,887  39,213  38,340  
Net income (loss) per share, diluted
$0.60  $(0.37) $0.03  $(0.79) 
Weighted-average number of common shares outstanding, diluted
40,086  38,887  40,267  38,340  
(1) Includes $3,494,000 Finished Goods write-off in the first quarter of 2020 related to the Dechra Asset Purchase Agreement, consistent with the transition to proprietary Dechra branding and regulatory best practices related to label transitions on asset sale.

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

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Kindred Biosciences, Inc.
Condensed Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
Six months ended June 30,
   
20202019
Cash Flows from Operating Activities
Net income (loss)$1,285  $(30,362) 
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Stock-based compensation expense3,987  3,762  
Depreciation and amortization expense2,260  1,095  
(Gain)/loss on disposal of property and equipment(17) 122  
Amortization of discount on marketable securities(156) (232) 
Amortization of debt discount of long-term loan171    
Finished goods write off related to Dechra asset purchase (1)
3,494    
Changes in operating assets and liabilities:
Accounts receivable660  (34) 
Inventories335  (788) 
Prepaid expenses and other(2,507) (198) 
Accounts payable(642) 909  
Accrued liabilities and accrued compensation(1,746) (6,044) 
Net cash provided by (used in) operating activities7,124  (31,770) 
Cash Flows from Investing Activities
Purchases of investments
(51,798) (49,415) 
Maturities of investments
58,870  19,700  
Purchases of property and equipment
(2,902) (6,656) 
Proceeds from sale of property and equipment
26  3  
Net cash provided by (used in) investing activities4,196  (36,368) 
Cash Flows from Financing Activities
Exercises of stock options and purchase of ESPP shares
261  1,184  
Payment of restricted stock awards and units tax liability on net settlement
(669) (493) 
Net proceeds from sale of common stock
  43,125  
Net cash (used in) provided by financing activities(408) 43,816  
Net change in cash and cash equivalents
10,912  (24,322) 
Cash and cash equivalents at beginning of period
15,986  56,302  
Cash and cash equivalents at end of period
$26,898  $31,980  
(1) Includes $3,494,000 Finished Goods write-off in the first quarter of 2020 related to the Dechra Asset Purchase Agreement, due to the transition to proprietary Dechra brand labelling on asset sale.

Supplemental disclosure of non-cash investing and financing activities:

Purchases of property and equipment included in accounts payable and accrued liabilities
$31  $579  

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

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Kindred Biosciences, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

1. Description of Business, Basis of Presentation and Summary of Significant Accounting Policies
Kindred Biosciences, Inc. ("KindredBio", "we", "us" or "our") was incorporated on September 25, 2012 (inception) in the State of Delaware. On April 25, 2016, we filed a Certificate of Incorporation with the State of Delaware for a wholly owned subsidiary, KindredBio Equine, Inc. ("KindredBio Equine"). KindredBio Equine has one class of capital stock which is designated common stock, $0.0001 par value per share. The authorized number of shares of common stock for KindredBio Equine is 1,000. On February 1, 2019, we filed a Certificate of Incorporation with the State of Delaware for a wholly owned subsidiary, Centaur Biopharmaceutical Services, Inc. ("Centaur Biopharmaceutical Services"). Centaur Biopharmaceutical Services has one class of capital stock which is designated common stock, $0.0001 par value per share. The authorized number of shares of common stock for Centaur Biopharmaceutical Services is 1,000.
We are a commercial-stage biopharmaceutical company focused on saving and improving the lives of pets. Our activities since inception have consisted principally of raising capital, establishing facilities, recruiting management and technical staff and performing research and development and advancing our product candidates seeking regulatory approval. Our headquarters are located in Burlingame, California.
Our first product, Mirataz® (mirtazapine transdermal ointment) was approved in May 2018 and became commercially available to veterinarians in the United States in July 2018. In November 2019, our second product, Zimeta™ (dipyrone injection) for the control of fever in horses was approved by the FDA and became commercially available in December 2019. In addition, we have multiple other product candidates, including several biologics, in various stages of development.
On March 16, 2020, we entered into an Asset Purchase Agreement whereby we agreed to sell Mirataz, our transdermal drug for the management of weight loss in cats, to Dechra Pharmaceuticals PLC ("Dechra") for a cash purchase price of $43 million, of which $38.7 million will be paid on the closing date and $4.3 million will be paid out of escrow beginning in 12 months assuming no escrow claims, alongside an ongoing royalty on global net sales. The acquisition comprises worldwide marketing rights, intellectual property rights, marketing authorizations and associated regulatory documentation, third party supply contracts related to raw material and manufacture of the finished product, and certain product inventory. On April 15, 2020, we completed the sale of Mirataz to Dechra.
Concurrent with the sale of Mirataz, we announced a strategic realignment of our business model whereby we plan to rely more on a partnership-based model for commercialization strategy similar to the traditional human biotech commercialization strategy whereby pipeline assets are partnered with larger commercial partners that can maximize product opportunity in return for upfront payments, contingent milestones, and royalties on future sales. Our focus will be on accelerating our deep pipeline of late-stage biologics candidates in canine and feline markets, while stopping small molecule development for these species. We believe monoclonal antibodies are the future of veterinary medicine, and represent the greatest opportunity for value creation, given large potential markets for our programs and our competitive advantage in biologics. Accordingly, the companion animal commercial infrastructure will be substantially reduced. In connection with this restructuring, we eliminated 53 positions and recorded a restructuring charge of approximately $1.7 million related to severance payments and health care benefits, exclusive of stock compensation, representing about one-third of our workforce. The eliminated positions primarily relate to the companion animal sales force and research and development for small molecule programs.
On June 8, 2020, we announced a plan to strengthen our strategic position by, among other things, prioritizing our most attractive late stage programs and substantially reducing our expenses to best position the company for success with the previously announced business model. This restructuring reduced our workforce by approximately 24 employees and resulted in a restructuring charge of approximately $2.3 million related to severance payments and health care benefits, exclusive of stock compensation. We expect the restructuring to be completed in the third quarter of 2020.
We are subject to risks common to companies in the biotechnology and pharmaceutical industries. There can be no assurance that our research and development will be successfully completed, that adequate patent or other intellectual property protection for our technology will be obtained, that any products developed will obtain necessary government regulatory approval or that any approved products will be commercially viable. We operate in an environment of substantial competition
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from other animal health companies. In addition, we are dependent upon the services of our employees and consultants, as well as third-party contract research organizations and manufacturers.
Our contract manufacturers purchase raw materials from suppliers located in China and India in order to manufacture our products and product candidates. The December 2019 outbreak of the novel strain of coronavirus (COVID-19) in China and India and other countries with which we do business may result in the full or partial shutdown of manufacturers or other businesses that are affected by the coronavirus, which may adversely impact both our ability to obtain sufficient and timely supplies of our products and other product candidates and our revenue from those products. In addition to adversely affecting our ability to obtain sufficient and timely supplies of products and product candidates from suppliers, any outbreak of contagious diseases, such as the recent novel strain of coronavirus (COVID-19) that is affecting the global community, could adversely affect our business and operations in other ways, many of which cannot currently be determined or quantified. These uncertain factors, including the duration of the outbreak, the severity of the disease and the actions to contain or treat its impact, could impair our operations including, among others, employee mobility and productivity, availability of facilities, conduct of our clinical trials, manufacturing and supply capacity, and availability and productivity of third party service suppliers.
The accompanying unaudited interim condensed consolidated financial statements (“financial statements”) have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America (“U.S. GAAP”) for complete financial statements. These financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto for the year ended December 31, 2019 included in our annual report on Form 10-K as filed with the SEC on March 16, 2020. In the opinion of management, all adjustments, consisting of a normal and recurring nature, considered necessary for a fair presentation, have been included in these financial statements.

The accompanying financial statements include the accounts of Kindred Biosciences and its wholly owned subsidiaries (the "Company"). All inter-company accounts and transactions have been eliminated in consolidation.

Stock Offerings

In January 2019, we completed a public offering of 4,847,250 shares of common stock, which includes the exercise in full of the underwriters' option to purchase 632,250 additional shares of our common stock, at a public offering price of $9.50 per share for total gross proceeds of approximately $46,049,000. Net proceeds, after deducting underwriting discounts and commissions and offering expense, were approximately $43,140,000. On April 8, 2020, we entered into an At Market Offering ("ATM") whereby we may offer and sell shares of our common stock from time to time up to $25 million. As of June 30, 2020, no shares were sold through the ATM.

Borrowings
On September 30, 2019, we entered into a Loan and Security Agreement (the “Loan Agreement”) with Solar Capital Ltd., as collateral agent and lender, and the other lenders named in the Loan Agreement (Solar Capital Ltd. and the other lenders collectively, the “Lenders”). The Lenders have agreed to make available to KindredBio an aggregate principal amount of up to $50.0 million under the Loan Agreement. We plan to use the loan proceeds to support the development and commercialization of our products and product candidates as well as for working capital and general corporate purposes. The Loan Agreement provides for a term loan commitment of $50.0 million in three tranches: (1) a $20.0 million term A loan that was funded on September 30, 2019; (2) a $15.0 million term B loan that is to be funded at our request, subject to certain conditions described in the Loan Agreement being satisfied, no later than December 31, 2020; and (3) a $15.0 million term C loan that is to be funded at our request, subject to certain conditions described in the Loan Agreement being satisfied, on or before June 30, 2021. Each term loan has a maturity date of September 30, 2024. Each term loan bears interest at a floating per annum rate equal to the one-month LIBOR rate (with a floor of 2.17%) plus 6.75%. We are permitted to make interest-only payments on each term loan through October 31, 2021. The interest-only period can be extended by six months upon our satisfaction of the minimum liquidity requirements described in the Loan Agreement. See Note 6.

On March 16, 2020, we entered into a First Amendment to Loan and Security Agreement (the "First Amendment") with the Lenders in connection with the sale of our Mirataz asset. Among other things, the First Amendment increases the minimum cash amount, as defined in the Loan Agreement, required to be maintained by KindredBio to $10,000,000 at any time prior to the initial funding date of any term B loan, to $15,000,000 at all times on and after the initial funding date of any term B loan, and to $20,000,000 at all times on and after the initial funding date of any term C loan, and releases Solar Capital's lien in and to
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the assets that are being sold by KindredBio. We agreed to pay an amendment fee of One Hundred Thousand Dollars ($100,000), which was deemed fully earned and non-refundable on the First Amendment's effective date. The First Amendment also requires KindredBio to receive unrestricted net proceeds of at least $10,000,000 prior to December 31, 2021 pursuant to a specified sale of preferred or common stock or convertible subordinated debt financing.

Liquidity

We have incurred losses and negative cash flows from operations through the quarter ended March 31, 2020. As a result of the Mirataz asset sale in April 2020, we recorded a net income in the three and six months ended June 30, 2020. We had an accumulated deficit of $221,774,000 as of June 30, 2020. We expect to continue to incur losses and negative cash flows as we continue our product development activities, seek regulatory approvals for our product candidates, establish a biologics manufacturing capability, and commercialize any approved products. To date, we have been funded primarily through sales of our equity and recently through an asset sale. We might require additional capital until such time as we can generate operating revenues in excess of operating expenses. We believe that our cash, cash equivalents and investments totaling $77,573,000 as of June 30, 2020, the net reduction in our workforce and revenues from anticipated partnerships including royalties will be sufficient to fund our planned operations through mid-2022. In addition, the potential additional draw down of $30 million from our Loan Agreement, which is contingent on the achievement of certain milestones, and our April 8, 2020 ATM facility will provide us with access to additional cash and extend our runway, if required.

If we require additional funding for operations, we may seek such funding through public or private equity or debt financings or other sources, such as corporate collaborations and licensing arrangements. We may not be able to obtain financing on acceptable terms, or at all, and we may not be able to enter into corporate collaborations or licensing arrangements. The terms of any financing may result in dilution or otherwise adversely affect the holdings or the rights of our stockholders.
Revenue Streams

Except for the normal product sales, the second quarter of 2020 includes revenue from the sale of our Mirataz asset and the associated partner royalties and revenue from our contract manufacturing service.

Product revenue

Our product revenues consist of product revenues resulting from the sales of Mirataz and Zimeta. We account for a contract with a customer when there is a legally enforceable contract between us and our customer, the rights of the parties are identified, the contract has commercial substance, and collectability of the contract consideration is probable. Our customers could either be distributors who subsequently resell our products to third parties such as veterinarians, clinics or animals hospitals or the third parties themselves. Included in product sale for the second quarter of 2020 is revenue derived from co-marketing products for our partners in conjunction with sales of Mirataz and Zimeta.

Revenue from asset sale
On March 16, 2020, we entered into an Asset Purchase Agreement to sell Mirataz to Dechra for a cash purchase price of $43 million. On April 15, 2020, we completed the sale of Mirataz to Dechra and received payment of $38.7 million on the closing date. The remaining $4.3 million will be paid out of escrow beginning in 12 months assuming no escrow claims. We concluded our accounting treatment of the asset sale to Dechra meets the scope of Accounting Standards Codification, Topic "ASC 610-20-15-2", Gains and Losses from the Derecognition of Nonfinancial Assets. We considered our strategic realignment of our business model whereby we become a biologics-only company focused on accelerating our deep pipeline of late-stage biologics candidates in canine and feline markets. Accordingly, we plan to rely more on a partnership-based model for commercialization strategy whereby pipeline assets are partnered with larger commercial partners that can maximize product opportunity in return for upfront payment, contingent milestones, and royalties on future sales. Based on the above evaluation in the aggregate, we concluded the proper presentation of the sale of Mirataz within operating income as part of revenue. This is presented as a separate line item and described as revenue from asset sale.

Partner royalties

Related to the Dechra Asset Purchase Agreement, Dechra will pay us a royalty based on a percentage of worldwide Net Sales, on a country-by-country basis. Net sales is defined as gross invoiced sales amount less discounts and allowances, taxes on
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sales, shipping charges if included in invoice price, qualified returns and chargebacks. Revenue for each quarter is accrued based on a statement furnished by Dechra and adjustments made, if any, to be in line with payment received within forty-five days of the end of the applicable calendar quarter.

Contract manufacturing revenue

The manufacturing revenue stream generally represents revenue from the manufacturing of customer product(s) recognized over time, utilizing an input method that compares the cost of cumulative work-in-process to date to the most current estimate for the entire cost of the performance obligation through manufacturing runs. Under a manufacturing contract, a quantity of manufacturing runs is ordered and the product is manufactured according to the customer’s specifications and typically only one performance obligation is included. Each manufacturing run represents a distinct service that is sold separately and has stand-alone value to the customer. The product(s) are manufactured exclusively for a specific customer and have no alternative use. The customer retains control of their product during the entire manufacturing process and can make changes to the process or specifications at their request.

The customer and our project team typically have a timeline on each milestone and duration time. They also have an estimated start and finish date. When the project is moving forward, they constantly change to the actual date to track the project progress. The timing has been shared by both parties. This becomes the most important basis for our revenue recognition.

Because of the timing effect of revenue recognition, billings and cash collections can be recorded into three different ways: billed trade receivables, contract assets (unbilled receivables), and contract liabilities (customer deposits and deferred revenue). Contract assets are recorded when our right to consideration is conditioned on something other than the passage of time. Contract assets are reclassified to trade receivables on the balance sheet when our rights become unconditional. Contract liabilities represent customer deposits and deferred revenue billed and/or received in advance of our fulfillment of performance obligations. Contract liabilities convert to revenue as we perform our obligations under the contract.

Revenue Recognition

We account for a contract with a customer when there is a legally enforceable contract between us and our customer, the rights of the parties are identified, the contract has commercial substance, and collectability of the contract consideration is probable. Our customers could either be distributors who subsequently resell our products to veterinarians, clinics or animals hospitals, licensing partners or third parties.

In accordance with FASB Accounting Standards ASC 606, Revenue from Contracts with Customers, which we adopted on January 1, 2018, was applied the following steps to recognize revenue that reflects the consideration to which we expect to be entitled to receive in exchange for the promised goods or services:
1. Identify the contract with a customer
A contract with a customer exists when we enter into an enforceable contract with a customer. These contracts define each party's rights, payment terms and other contractual terms and conditions of the sale. We apply judgment in determining the customer’s ability and intention to pay, which is based on published credit and financial information pertaining to the customer.
2. Identify the performance obligations in the contract
Our product in a given purchase order is delivered at the same time and we do not separate an individual order into separate performance obligations. We have concluded the sale of finished goods and related shipping and handling are accounted for as a single performance obligation as there are no other promises to deliver goods beyond what is specified in each accepted customer order. For contract manufacturing, we have concluded the milestone of each manufacturing service are accounted for as a single performance obligation as there are no other promises beyond what is specified in each accepted customer order.
3. Determine the transaction price
The transaction price is determined based on the consideration which we will be entitled to receive in exchange for transferring goods or service to the customer, typically a fixed consideration in our contractual agreements.
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4. Allocate the transaction price to the performance obligations
The transaction price is allocated entirely to the performance obligation to provide pharmaceutical products or contract manufacturing service with each milestone its own price. The nature of the promises/obligations under our contracts is to transfer a distinct good or service. Accordingly, because a single performance obligation exists, including in each milestone pertaining to contract manufacturing, no allocation of the transaction price is necessary.
5. Determine the satisfaction of performance obligation
Revenue is recognized when control of the finished goods is transferred to the customer, net of applicable reserves for variable consideration. Control of the finished goods is transferred at a point in time, upon delivery to the customer.
For contract manufacturing service, revenue is recognized over time. Control of the finished manufactured products is transferred at a point in time, upon delivery to the customer.
Reserves for Variable Consideration

Revenues from product sales are recorded at the net sales price, which includes estimates of variable consideration for which reserves are established. Components of variable consideration include product returns, allowances and discounts. These estimates take into consideration a range of possible outcomes for the expected value (probability-weighted estimate) or relevant factors such as current contractual and statutory requirements, specific known market events and trends, industry data, and forecasted customer buying and payment patterns. Overall, these reserves reflect our best estimates of the amount of consideration to which it is entitled based on the terms of the respective underlying contracts. The amount of variable consideration included in the transaction price may be constrained and is included in the net sales price only to the extent that it is probable that a significant reversal in the amount of the cumulative revenue recognized where the contract will not occur in a future period. Actual amounts of consideration ultimately received may differ from our estimates. If actual results in the future vary from our estimates, we will adjust these estimates, which would affect net product revenues and earnings in the period such variances become known.

No reserves for contract manufacturing service are recorded as each manufacturing run represents a distinct service that is sold separately and has stand-alone value to the customer. The product(s) are manufactured exclusively for a specific customer and have no alternative use.

Product Returns

Consistent with the industry practice, we generally offer customers a limited right of return of damaged or expired product that has been purchased directly from us. Our return policy generally allows customers to receive credit for expired products within 90 days after the product’s expiration date. We estimate the amount of our product revenues that may be returned by our customers and record these estimates as a reduction of product revenues in the period the related product revenues are recognized, as well as within accrued liabilities, in the consolidated balance sheets. We currently estimate product return liabilities using probability-weighted available industry data and data provided by the our distributors such as the inventories remaining in the distribution channel. To-date, we have no returns and believe that returns of our product in future periods will be minimal. We do not record a return asset associated with the returned damaged or expired goods due to such asset is deemed to be fully impaired at the time of product return.

Our contract manufacturing customer retains control of their product during the entire manufacturing process and can make changes to the process or specifications at their request. There are no product returns.

Sales Discounts and Allowances

We compensate our distributors for sales order management, data and distribution and other services through sales discounts and allowances. However, such services are not distinct from our sale of products to distributors and, therefore, these discounts and allowances are recorded as a reduction of product revenues in the consolidated statements of operations and comprehensive loss, as well as a reduction to accounts receivable in the consolidated balance sheets.

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No discounts and allowances are recorded for contract manufacturing service as the price of each milestone is agreed upon when the contract is signed

Sales Commissions

We generally expense sales commissions when incurred because the amortization period would have been one year or less. These costs are recorded within sales and marketing expenses.

Cost of Revenues

Cost of product revenues consists primarily of the cost of direct materials, direct labor and overhead costs associated with manufacturing, inbound shipping and other third-party logistics costs. 

Contract manufacturing costs consist primarily of the cost of direct materials, direct labor and overhead costs associated with manufacturing, rent, facility costs and related machinery depreciation.

Inventories

We value inventory at the lower of cost or net realizable value. We determine the cost of inventory using the standard-cost method, which approximates actual cost based on a first-in, first-out method. We analyze our inventory levels quarterly and write down inventory subject to expire in excess of expected requirements, or that has a cost basis in excess of its expected net realizable value. In the quarter ended March 31, 2020, we wrote off $3,494,000 Mirataz inventory related to the Dechra Asset Purchase Agreement, due to the transition to Dechra brand labelling. Currently our inventory consists of Zimeta finished goods only.

Property, Plant and Equipment

Property and equipment are stated at cost less accumulated depreciation and amortization. We calculate depreciation using the straight-line method over the estimated useful lives of the assets, which range from two to five years for furniture, fixtures, lab and computer equipment and software, and fifteen to thirty-nine years for land improvements and real property. Land and assets held within construction in progress are not depreciated. Construction in progress is related to the construction or development of property and equipment that have not yet been placed in service for their intended use. Expenditures for repairs and maintenance of assets are charged to expense as incurred. We amortize leasehold improvements using the straight-line method over the estimated useful lives of the respective assets or the lease term, whichever is shorter. Upon retirement or sale, the cost and related accumulated depreciation and amortization of assets disposed of are removed from the accounts and any resulting gain or loss is included in other income/expense.

Use of Estimates
The preparation of financial statements and related disclosures in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. Estimates are based on historical experiences or on forecasts, including information received from third parties and other assumptions that the Company believes are reasonable under the circumstances. Estimates are periodically reviewed in light of changes in circumstances, facts and experience. Actual results could differ from those estimates.
Comprehensive Income (Loss)
Our comprehensive income (loss) includes the change in unrealized gains or losses on available-for-sale debt securities. The cumulative amount of gains or losses are reflected as a separate component of stockholders' equity in the condensed consolidated balance sheets as accumulated other comprehensive income (loss).
Recently Issued Accounting Pronouncements
In March 2020, the FASB issued ASU No. 2020-04, "Reference Rate Reform (Topic 848)", changes to the interbank offered rates (IBORs), and, particularly, the risk of cessation of the London Interbank Offered Rate ("LIBOR"). The
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amendments provide optional expedients and exceptions for applying U.S. GAAP to contracts that reference LIBOR expected to be discontinued because of reference rate reform. The expedients and exceptions do not apply to contract modifications made after December 31, 2022. The following optional expedients are permitted for contracts that are modified because of reference rate reform and that meet certain scope guidance: Modifications of contracts within the scope of Topics 470, Debt, should be accounted for by prospectively adjusting the effective interest rate. The amendments also permit an entity to consider contract modifications due to reference rate reform to be an event that does not require contract remeasurement at the modification date or reassessment of a previous accounting determination. When elected, the optional expedients for contract modifications must be applied consistently for all contracts. It applies to all entities within the scope of the affected accounting guidance and will take effect as of March 12, 2020 through December 31, 2022. We have one loan contract which references LIBOR rate. We have not modified the contract with our lenders yet. We are currently evaluating the new guidance and have not determined the impact this standard may have on our financial statements.

We do not believe there are any other recently issued standards not yet effective that will have a material impact on our financial statements when the standards become effective.
2. Revenues and Cost of Revenues
Beginning with the second quarter of 2020, our revenues consist of product revenues from Mirataz and Zimeta, Mirataz asset sale, partner royalties and contract manufacturing. We account for a contract with a customer when there is a legally enforceable contract between us and our customer, the rights of the parties are identified, the contract has commercial substance, and collectability of the contract consideration is probable. Our revenues are measured based on the consideration specified in the contract with each customer, net of product returns, discounts and allowances if applicable.
The following table summarizes revenues and costs for three and six months ended June 30, 2020 and 2019 (in thousands).
Three months ended June 30,Six months ended June 30,
2020201920202019
Revenues
Net product sale revenues$163  $1,236  $766  $1,751  
Revenue from asset sale38,700    38,700    
Partner royalty revenue158    158    
Contract manufacturing revenue546    546    
Total revenues39,567  1,236  40,170  1,751  
Costs of revenues
Cost of product sales (1)
27  169  3,604  261  
Contract manufacturing costs336    336    
Total costs of revenues363  169  3,940  261  
Gross margin$39,204  $1,067  $36,230  $1,490  
(1) Includes $3,494,000 Finished Goods write-off in the first quarter of 2020 related to the Dechra Asset Purchase Agreement, consistent with the transition to proprietary Dechra branding and regulatory best practices related to label transitions on asset sale.
Concentrations of credit risk
Our net product revenue was generated entirely from sales within the United States. Our product sales to two large distributors, namely Covetrus and MWI Animal Health, and three large distributors, namely Covetrus, MWI Animal Health and Midwest Veterinary Supply, each accounted for more than 10% of net revenues for the three and six months ended June 30, 2020. Approximately 95% and 75% of our gross product revenues were to two and three distributors for the three and six
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months ended June 30, 2020, respectively. Approximately 81% and 84% of our gross product revenues were to three distributors for the three and six months ended June 30, 2019, respectively.

Our accounts receivable from amounts billed for contract manufacturing services for the second quarter of 2020 is derived from one customer. The contract requires up-front payment and installment payments during the service period. We perform periodic evaluations of the financial condition of our customers and generally do not require collateral, but we can terminate any contract if a material default occurs.

Product returns

Our return policy generally allows customers to receive credit for expired products within 90 days after the product’s expiration date. We currently estimate product return liabilities of 2% for Mirataz and 3% for Zimeta of gross product revenue using probability-weighted available industry data and data provided by our distributors such as the inventories remaining in the distribution channel. Adjustments will be made in the future if actual results vary from our estimates.

Accounts receivable and allowance for doubtful accounts

Accounts receivable are stated at their carrying values, net of any allowances for doubtful accounts. Accounts receivable consist primarily of amounts due from distributors, for which collection is probable based on the customer's intent and ability to pay. Receivables are evaluated for collection probability on a regular basis and an allowance for doubtful accounts is recorded, if necessary. We have no allowance for doubtful accounts as of June 30, 2020 and December 31, 2019 as our analysis did not uncover any collection risks.

3. Fair Value Measurements
Certain assets and liabilities are carried at fair value. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. A fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last is considered unobservable, is used to measure fair value:
Level 1: Quoted prices in active markets for identical assets or liabilities.
Level 2: Observable inputs (other than Level 1 quoted prices) such as quoted prices in active markets for similar assets or liabilities, quoted prices in markets that are not active for identical or similar assets or liabilities, or other inputs that are observable or can be corroborated by observable market data.
Level 3: Unobservable inputs that are supported by little or no market activity and that are significant to determining the fair value of the assets or liabilities, including pricing models, discounted cash flow methodologies and similar techniques.
The carrying amount of financial instruments, including cash and cash equivalents, accounts payable and accrued liabilities approximate fair value due to the short maturities of these financial instruments. Financial assets, which consist of money market funds and available-for-sale securities, are measured at fair value on a recurring basis.
Financial assets, which consist of money market funds and available-for-sale securities, are measured at fair value on a recurring basis and are summarized as follows (in thousands):
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Fair Value Measurements as of June 30, 2020
DescriptionTotalQuoted Prices in
Active Markets (Level 1)
Significant Other
Observable Inputs
(Level 2)
Unobservable Inputs
(Level 3)
Cash equivalents:
Money market funds$26,593  $26,593  $  $  
Corporate notes175    175    
Short-term investments:
       U.S. treasury bills5,008  5,008      
U.S. Treasury bonds and notes24,275    24,275    
       Commercial paper7,796    7,796    
Corporate notes3,139    3,139    
Long-term investments:
U.S. Treasury bonds and notes9,998    9,998    
Corporate notes459    459    
$77,443  $31,601  $45,842  $  

Fair Value Measurements as of December 31, 2019
DescriptionTotalQuoted Prices in
Active Markets (Level 1)
Significant Other
Observable Inputs
(Level 2)
Unobservable Inputs
(Level 3)
Cash equivalents:
Money market funds$1,592  $1,592  $  $  
       Commercial paper13,580    13,580    
Short-term investments:
U.S. treasury bills8,524  8,524      
Commercial paper25,573    25,573    
U.S. government agency notes11,461    11,461    
Corporate notes10,165    10,165    
Long-term investments:
U.S. government agency notes801    801    
Corporate notes1,036    1,036    
$72,732  $10,116  $62,616  $  

During the six months ended June 30, 2020, there were no transfers of assets between Level 1, Level 2 or Level 3 of the fair value hierarchy.
At June 30, 2020 and December 31, 2019, we did not have any financial liabilities which were measured at fair value on a recurring basis.

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4. Investments
We classify all highly-liquid investments with stated maturities of greater than three months from the date of purchase and remaining maturities of less than one year as short-term investments. Investments with maturities beyond one year may be classified as short-term based on their highly liquid nature and because such investments are viewed as being available to support current operations. We classify and account for investments as available-for-sale and reflect realized gains and losses using the specific identification method. Changes in market value, if any, excluding other-than-temporary impairments, are reflected in other comprehensive income (loss).
The fair value of available-for-sale investments by type of security at June 30, 2020 was as follows (in thousands):
Amortized CostGross Unrealized GainsGross Unrealized LossesFair Value
Short-term investments:
   Commercial paper$7,774  $22  $  $7,796  
   U.S. treasury bills5,000  8    5,008  
   U.S. treasury bonds24,278  4  (7) 24,275  
   Corporate notes3,125  14    3,139  
40,177  48  (7) 40,218  
Long-term investments:
   U.S. treasury bonds9,998  1  (1) 9,998  
   Corporate notes456  3    459  
10,454  4  (1) 10,457  
Total available-for-sale investments$50,631  $52  $(8) $50,675  

The fair value of available-for-sale investments by type of security at December 31, 2019 was as follows (in thousands):
Amortized CostGross Unrealized GainsGross Unrealized LossesFair Value
Short-term investments:
   U.S. treasury bills $8,517  $7  $  $8,524  
   Commercial paper25,576  3  (6) 25,573  
   U.S. government agency notes11,460  2  (1) 11,461  
   Corporate notes 10,157  8    10,165  
55,710  20  (7) 55,723  
Long-term investments:
 U.S. government agency notes801      801  
   Corporate notes1,036      1,036  
1,837      1,837  
Total available-for-sale investments$57,547  $20  $(7) $57,560  


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5. Accrued Liabilities
Accrued liabilities consisted of the following (in thousands):
June 30, 2020December 31, 2019
Accrued consulting$318  $589  
Accrued research and development costs658  1,336  
Other expenses586  2,206  
$1,562  $4,131  

6. Borrowings
On September 30, 2019, we entered into the Loan and Security Agreement with Solar Capital Ltd. The Lenders have agreed to make available to KindredBio an aggregate principal amount of up to $50.0 million under the Loan Agreement. We plan to use the loan proceeds to support the development and commercialization of our products and product candidates as well as for working capital and general corporate purposes.The Loan Agreement provides for a term loan commitment of $50.0 million in three tranches: (1) a $20.0 million term A loan that was funded on September 30, 2019; (2) a $15.0 million term B loan that is to be funded at our request, subject to certain conditions described in the Loan Agreement being satisfied, no later than December 31, 2020; and (3) a $15.0 million term C loan that is to be funded at our request, subject to certain conditions described in the Loan Agreement being satisfied, on or before June 30, 2021. Each term loan has a maturity date of September 30, 2024. Each term loan bears interest at a floating per annum rate equal to the one-month LIBOR rate (with a floor of 2.17%) plus 6.75%. We are permitted to make interest-only payments on each term loan through October 31, 2021. The interest-only period can be extended by six months upon our satisfaction of the minimum liquidity requirements described in the Loan Agreement. We have agreed to maintain cash at all times equal to at least $5.0 million prior to the funding of the term B loan, at least $10.0 million after the funding of the term B loan and at least $15.0 million after the funding of the term C loan, plus in each case the amount of our accounts payable that have not been paid within 90 days from the invoice date subject to certain exceptions. Equal monthly payments of principal will be due and payable commencing at the end of the interest-only period of the term loans. In connection with the term loan, we incurred closing costs of $819,000, which are shown net of the proceeds and will be amortized over the term of the loan using the effective interest method. We are obligated to pay a facility fee in the amount of 0.50% of each term loan that is funded and a non-utilization fee in the amount of 0.25% of each term B loan and term C loan to the extent that such loans are not funded. We are obligated to pay a final fee equal to 3.60% of the aggregate amount of the term loans funded (or 4.35% of such funded loans if the interest-only period is extended as described above), such final fee to be due and payable upon the earliest to occur of (1) the maturity date, (2) the acceleration of the term loans, and (3) the prepayment of the term loans. We have the option to prepay all, but not less than all, of the outstanding principal balance of the term loans under the Loan Agreement. If we prepay the term loans prior to the maturity date, we must pay the Lenders a prepayment premium fee based on a percentage of the outstanding principal balance, equal to 3.0% if the payment occurs on or before September 30, 2020, 2.0% if the prepayment occurs after September 30, 2020 but on or before September 30, 2021, or 1.0% if the prepayment occurs after September 30, 2021. Our obligations under the Loan Agreement are secured by a first-priority security interest in substantially all of KindredBio’s assets, including our intellectual property, and a lien on our real property. The Loan Agreement contains customary representations, warranties and covenants and also includes customary events of default, including payment defaults, breaches of covenants, and a default upon the occurrence of a material adverse change affecting us. Upon the occurrence of an event of default, a default interest rate of an additional 5.00% per annum may be applied to the outstanding loan balance, and the Lenders may declare all outstanding obligations immediately due and payable and exercise all their rights and remedies as set forth in the Loan Agreement and under applicable law. We were in compliance with all covenants as of June 30, 2020.

In conjunction with the Dechra Asset Purchase Agreement, on March 16, 2020, we entered into a First Amendment to Loan and Security Agreement (the "First Amendment") with the Lenders in connection with the sale of our Mirataz asset. Among other things, the First Amendment increases the minimum cash amount, as defined in the Loan Agreement, required to be maintained by KindredBio to $10,000,000 at any time prior to the initial funding date of any term B loan, to $15,000,000 at all times on and after the initial funding date of any term B loan, and to $20,000,000 at all times on and after the initial funding date of any term C loan, and releases Solar Capital's lien in and to the assets that are being sold by KindredBio. We agreed to pay an amendment fee of One Hundred Thousand Dollars ($100,000), which shall be deemed fully earned and non-refundable on the First Amendment's effective date. The First Amendment also requires KindredBio to receive unrestricted net proceeds of
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at least $10,000,000 prior to December 31, 2021 pursuant to a specified sale of preferred or common stock or convertible subordinated debt financing.

As of June 30, 2020, assuming the principal payments start on November 1, 2021, our future debt payment obligations towards the principal and final fee, excluding interest payments and exit fee, for the respective fiscal years are as follows (in thousands):

2020$  
20211,111  
20226,667  
20236,667  
20246,275  
Total principal and final fee payments
20,720  
Less: Unamortized debt issuance costs(672) 
Less: Unaccreted value of final fee(612) 
Loan payable, long term$19,436  


7. Common Stock and Stock-Based Awards
Common Stock
During the six months ended June 30, 2020, we issued 26,104 shares of common stock in connection with the exercise of stock options for gross proceeds of $152,000, vested 206,196 restricted stock awards and restricted stock units and withheld 21,563 shares of restricted stock awards and 48,646 shares related to restricted stock units to satisfy employee tax withholding obligations arising in conjunction with the vesting of restricted stock and restricted stock units (see below).

Stock-Based Awards
The table below shows the number of shares of common stock underlying options granted to employees, directors and consultants, the assumptions used in the Black-Scholes option pricing model used to value those options and the resulting weighted-average grant date fair value per share:
Stock Option PlanThree months ended June 30,Six months ended June 30,
2020201920202019
Shares underlying options granted1,00020,500750,0001,049,500
Weighted-average exercise price$4.85$8.59$9.80$9.90
Weighted average risk- free interest rate0.42 %2.24 %1.66 %2.54 %
Weighted average expected term (years)6.16.15.85.9
Weighted average expected volatility56%56%54%57%
Expected dividend yield
Weighted-average grant date fair value per share$2.49$4.69$5.00$5.42

In June 2018, we adopted the 2018 Equity Incentive Plan (the “2018 Plan”), and reserved 3,000,000 shares of our common stock for issuance under the 2018 Plan. At the Annual Meeting of Stockholders of the Company held on June 15, 2020 (the “2020 Annual Meeting”), our stockholders approved an amendment to the 2018 Equity Incentive Plan (as amended, the “2018 Plan”) to increase the number of shares of common stock authorized for issuance by 1,600,000 shares. The 2018 Plan is the successor to our 2016 Equity Incentive Plan (the “2016 Plan”), which was retired on June 21, 2018 upon stockholders’ approval of our 2018 Plan. The 2016 Plan was the successor to our 2012 Equity Incentive Plan (the "2012 Plan"), which was retired on May 23, 2016 upon stockholders' approval of our 2016 Plan. All awards made under the 2016 and 2012 Plans shall remain subject to the terms of these plans. Options granted under the 2018 Plan may be either incentive stock options or
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nonstatutory stock options. The 2018 Plan also provides for the grant of stock appreciation rights, restricted stock awards, restricted stock unit awards, performance stock awards, performance cash awards and other stock awards. The exercise price of a stock option may not be less than 100% of the closing price of our common stock on the date of the grant. If, at any time we grant an incentive stock option, and the optionee directly or by attribution owns stock possessing more than 10% of the total combined voting power of all classes of KindredBio stock, the option price shall be at least 110% of the fair value and shall not be exercisable more than five years after the date of grant. Options generally vest over a period of one or four years