TARS US Equity☆

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our “Selected Financial Data” and our financial statements and the related notes to those statements included elsewhere in this Annual Report on 10-K. In addition to historical financial information, the following discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results and timing of selected events may differ materially from those anticipated in these forward-looking statements as a result of many factors, including, but not limited to, those discussed under the section titled “Risk Factors” and elsewhere in this Annual Report on 10-K. See the section titled “Special Note Regarding Forward-Looking Statements” elsewhere in this Annual Report on 10-K.

Overview

Our Business

We are a late clinical-stage biopharmaceutical company focused on the development and commercialization of therapeutic candidates to address large market opportunities initially in ophthalmic conditions where there are limited treatment alternatives. Our lead product candidate, TP-03, is a novel therapeutic in Phase 2b/3 that is being developed for the treatment of blepharitis caused by the infestation of Demodex mites, which is referred to as Demodex blepharitis. Blepharitis (“Blephar” is a reference to eyelid and “itis” is a reference to inflammation) is a condition characterized by inflammation of the eyelid margin, redness and ocular irritation, including a specific type of eyelash dandruff called collarettes. The healthy interaction of the eyelid and the surface of the eyeball is crucial to ocular health. Poorly controlled and progressive blepharitis can lead to worsening of corneal damage over time and, in extreme cases, blindness.

According to published studies, there are an estimated 20 million patients in the United States who suffer from blepharitis, with approximately 45% or nine million of cases caused by Demodex infestation. Further, the possible number of Demodex blepharitis cases may be as high as approximately 25 million, based on our internal research indicating approximately 58% of patients presenting to eye care clinics have collarettes and a published study estimating that at least 45 million people annually visit an eye care clinic.

We believe that TP-03 has the potential to be the first FDA-approved therapeutic for the treatment of Demodex blepharitis and become the standard of care. The active pharmaceutical ingredient ("API") of TP-03, lotilaner, is designed to paralyze and eradicate mites and other parasites through the inhibition of parasite-specific gamma-aminobutyric acid-gated chloride ("GABA-Cl") channels).

To date, we have completed four Phase 2 trials for TP-03 in Demodex blepharitis, all of which met their primary, secondary and/or exploratory endpoints, as applicable, and during which TP-03 was well tolerated. Our Phase 2b/3 trial, Saturn-1, commenced in September 2020 and was fully enrolled by the first quarter of 2021. We expect to begin our second pivotal trial, Saturn-2, in the second quarter of 2021. Saturn-1 and Saturn-2 have primary and secondary endpoints consistent with those of our Europa and Io Phase 2 trials. We expect these TP-03 pivotal trials to support our submission of a new drug application ("NDA") with the United States Food and Drug Administration ("FDA") for the treatment of Demodex blepharitis.

We intend to further advance our pipeline with lotilaner API to address several diseases across therapeutic categories in human medicine, including eye care, dermatology, and other diseases. These targeted diseases with high unmet medical need currently include Meibomian Gland Disease ("MGD"), rosacea, Lyme disease, and malaria.

Recent Business and Clinical Highlights

TP-03 Type C Meeting: In December 2020, we had a Type C meeting with the FDA for TP-03 in the treatment of Demodex blepharitis. This meeting confirmed our planned NDA pathway with respect to the data and information required in the NDA filing.

TP-03 Pivotal Trials: Saturn-1 enrollment was completed in the first quarter of 2021. We expect to initiate our second pivotal trial, Saturn-2, in the second quarter 2021.

TP-03 Out-License: On March 26, 2021, we executed the LianBio Agreement with LianBio, granting exclusive commercial rights of TP-03 for the treatment of Demodex blepharitis and MGD within The People’s Republic of China, Macau, Hong Kong, and Taiwan (the "Territory"). We are contractually entitled to receive (i) an aggregate $25 million by June 30, 2021, (ii) regulatory and sales milestone receipts totaling $75 million and $100 million, respectively, (iii) tiered royalties in the low double-digits on the net sales of TP-03 within the Territory, and (iv) a minority interest in LianBio. We expect to receive $70 million from these contractual milestones during the next 12 months.

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Corporate and Financial Overview

We were incorporated as a Delaware corporation in November 2016, and our headquarters is located in Irvine, California. Since our inception in November 2016, we have devoted substantially all of our resources to organizing and staffing our company, acquiring intellectual property, clinical development of our product candidates, building our research and development capabilities, raising capital, and enhancing our corporate infrastructure.

To date we have financed our operations through private placements of preferred stock and convertible promissory notes. From inception through September 2020, we have raised net proceeds of approximately $101.0 million through private placements of preferred stock.

On October 20, 2020, we completed our initial public offering ("IPO") through an underwritten sale of 5,500,000 shares of our common stock at a price of $16.00 per share. The aggregate net proceeds from the offering (after deducting underwriting discounts and commissions and other offering expenses), inclusive of an additional 825,000 common shares sold upon the full exercise of the underwriters’ purchase option, were $91.7 million. Concurrent with the IPO, all then-outstanding shares of our convertible preferred stock outstanding (see Note 4) automatically converted into an aggregate of 11,107,018 issued common shares.

In advance of the IPO, on October 8, 2020, our board of directors approved a 1-for-7.4276 reverse stock split of our capital stock. All share and per share information included in the accompanying financial statements has been adjusted to reflect this reverse stock split.

We have incurred significant net operating losses in every year since our inception and expect to continue to incur significant operating expenses and increasing operating losses for the foreseeable future. Our net losses were $26.8 million and $4.7 million for the years ended December 31, 2020 and 2019, respectively. Our net losses may fluctuate significantly from quarter to quarter and year to year and could be substantial. As of December 31, 2020 and 2019, we had an accumulated deficit of $32.8 million and $6.0 million, respectively, from research and development and general and administrative activities since our inception. We anticipate that our operating expenses will increase significantly as we:

•conduct additional clinical trials of our lead product candidate, TP-03, for the treatment of Demodex blepharitis including our Phase 2b/3 trial, Saturn-1, and our Phase 3 trial, Saturn-2;

•advance the clinical development of TP-03 for the treatment of MGD, TP-04 for the potential treatment of rosacea and TP-05 for potential Lyme prophylaxis and community malaria reduction;

•seek regulatory and marketing approvals for product candidates that successfully complete clinical development, if any;

•establish our own sales force in the United States to commercialize our products for which we obtain regulatory approval;

•engage with contract manufacturers to ensure a sufficient supply chain capacity to provide commercial quantities of any products for which we may obtain marketing approval;

•maintain, expand and protect our intellectual property portfolio;

•hire additional staff, including clinical, scientific, technical, regulatory, marketing, operations, financial, and other support personnel, to execute our business plan; and

•add information systems and personnel to support our product development and potential future commercialization efforts, and to enable us to operate as a public company.

We do not have any products approved for sale and we have not yet generated any revenue from product sales. We do not expect to generate revenues from product sales unless and until we successfully complete clinical development and obtain regulatory approval for a product candidate and commercially launch such product. Until such time as we can generate significant revenue from product sales, if ever, we expect to finance our operations through private or public equity or debt

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financings, or collaborations, strategic alliances, or licensing arrangements with third parties. Adequate funding may not be available to us when needed on acceptable terms, or at all. If we raise additional funds through collaborations, strategic alliances, or licensing arrangements with third parties, we may have to relinquish valuable rights to our intellectual property, future revenue streams, research programs or product candidates or grant licenses on terms that may not be favorable to us. If we are unable to raise additional capital or enter into such agreements as and when needed, we could be forced to significantly delay, scale back, or discontinue our product development and/or commercialization plans, which would negatively and adversely affect our financial condition.

Because of the numerous risks and uncertainties associated with drug product development, we are unable to accurately predict the timing or amount of increased expenses or when or if we will be able to achieve or maintain profitability. Even if we are able to generate revenue from product sales, we may not become profitable. If we fail to become profitable or are unable to sustain profitability on a continuing basis, then we may be unable to continue our operations at planned levels.

As of December 31, 2020, our aggregate cash and cash equivalents was $168.1 million – see “Liquidity and Capital Resources.”

Impact of the COVID-19 Pandemic on our Operations

Efforts to contain the spread of COVID-19 in the United States (including in California where our corporate headquarters and laboratory facility are located) and other countries have included quarantines, shelter-in-place orders, and various other government restrictions in order to control the spread of this virus.

We have been carefully monitoring the COVID-19 pandemic as it continues to progress and its potential impact on our business. We have taken important steps to ensure the workplace safety of our employees when working within our laboratory and administrative offices, or when traveling to our clinical trial sites. We have also implemented an interim work-from-home policy and we may take further actions as may be required by federal, state or local authorities.

To date, we have been able to continue our key business activities and advance our clinical programs. However, in the future, it is possible that our clinical development timelines and business plans could be adversely affected. We maintain regular communication with our vendors and clinical sites to appropriately plan for, and mitigate, the impact of the COVID-19 pandemic on our operations. Specifically, for our Phase 2b/3 Saturn-1 trial, we have instituted various protocols for our sites, including increasing health screening of individuals and providing enhanced communication and training to staff regarding COVID-19. We have also over-enrolled trial participants and identified additional clinical sites in case there are site closures due to COVID-19. However, the ultimate effect from this pandemic on our development timelines for TP-03 and our other product candidates is inherently uncertain.

See the section titled “Risk Factors” in this report for a further discussion of the potential adverse impact of COVID-19 on our business, results of operations and financial condition.

Components of our Results of Operations

Operating Expenses

Our operating expenses since inception have consisted solely of research and development expenses and general and administrative expenses.

Research and Development Expenses

Our research and development expenses consist of expenses incurred in connection with the development of our product candidates, including:

•fees paid to third parties to conduct certain research and development activities on our behalf, including under agreements with CROs;

•payments under licensing agreements, such as our upfront in-license fee for lotilaner;

•consulting costs and certain allocated payroll and employee-related expenses (including stock-based compensation and salaries) for personnel engaged in research and development functions;

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•costs related to compliance with clinical regulatory requirements;

•costs of procuring drug products for use in our preclinical studies and clinical trials; and

•facilities expenses, which include direct and allocated expenses for rent of our laboratory.

We expense both internal and external research and development expenses as incurred or as certain upfront or milestone payments become contractually due to licensors upon achievement of clinical or regulatory events. We recognize external research and development costs based on an evaluation of the progress-to-completion of (i) specific tasks performed or deliverables provided by CROs and contract manufacturing organizations ("CMOs") and (ii) patient visits for dosing or other follow-up. To estimate period expense for recognition, we use information provided to us by our service providers and we then apply the corresponding fee schedule.

We track our external research and development expenses on a program-by-program basis, such as fees paid to CROs, CMOs, and research laboratories in connection with our pre-clinical development, process development, manufacturing and clinical development activities. However, we do not currently track employee time on a program-by-program basis. For the years ended December 31, 2020 and 2019, substantially all of our external and internal research and development expenses are attributable to our TP-03 program for Demodex blepharitis.

We expect our research and development expenses to increase substantially in the future, as we seek to initiate and progress additional clinical trials for our product candidates, including TP-03 for the potential treatment of MGD, TP-04 for the potential treatment of rosacea, and TP-05 for potential Lyme prophylaxis and community malaria reduction. We expect to complete our clinical programs for these product candidates, and as appropriate, pursue regulatory approval and prepare for the possible commercialization for each.

General and Administrative Expenses

Our general and administrative expenses consist of personnel-related costs including payroll, benefits, and stock-based compensation for our executive, finance, and other administrative functions. Other general and administrative expenses include consulting fees, legal services, rent and other facilities costs, and other general operating expenses not otherwise classified as research and development expenses.

We expect that our general and administrative expenses will increase substantially in the future as a result of expanding our operations, including hiring personal, preparing for potential commercialization of our product candidates, and additional facility occupancy costs, as well various incremental costs associated with being a public company (including increased legal and accounting fees, regulatory costs associated with maintaining compliance with the rules of the Nasdaq Stock Market and SEC regulations, investor relations activities, directors and officers liability insurance premiums, and other accompanying compliance and governance costs).

Other Income (Expense), Net

Other income (expense), net consists primarily of (i) interest income earned on our cash and cash equivalents and (ii) interest expense on convertible promissory notes (converted to equity instruments in December 2019; comprised of coupon interest, amortization of debt issuance costs, and non-cash accretion of its estimated discount at issuance).

Income Tax Provision

Since our inception, we have not recorded any U.S. federal or state income tax benefits for the net operating losses we have incurred in each year, or for our earned research and development tax credits, due to our uncertainty of realizing a benefit from either. As a result of the Tax Cuts and Jobs Act of 2017, net operating losses (for U.S. income tax purposes) generated prior to December 31, 2018 can be carried forward for up to 20 years, while net operating losses generated after December 31, 2017 can be carried forward indefinitely, but are limited to 80% utilization against taxable income. Our California net operating losses will begin to expire in 2037. The federal research and development tax credits begin to expire in 2037 unless previously utilized, and the California credit carryforwards are available indefinitely.

Results of Operations

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Comparison of the Years Ended December 31, 2020 and 2019

The following table summarizes our results of operations for the years ended December 31, 2020 and 2019 (in thousands):

Year EndedDecember 31,

(in thousands)

Operating expenses:

Other income (expense):

Interest income (expense), net 188 (40) 228

Loss on extinguishment of convertible notes — (255) 255

Change in fair value of derivative liabilities — (76) 76

Provision for income taxes (1) (1) —

Research and Development Expenses

Research and development expenses increased by $15.7 million for the year ended December 31, 2020. The increase was primarily due to (i) an upfront payment to our licensor (in the form of our common stock) then valued at $3.1 million as consideration for the September 2020 expansion of our in-license for lotilaner to cure or treat all diseases and conditions in humans (beyond that of the eye or skin for which we already held exclusive rights to treat with lotilaner), (ii) TP-03 clinical milestone achievement in September 2020, requiring a $1.0 million payment to our licensor, (iii) increased manufacturing, development, and research activities of $10.7 million to conduct our clinical studies for TP-03, and (iv) increased payroll and personnel-related expenses (including stock-based compensation) of $1.7 million due to additional clinical and formulation development employees to drive our product development initiatives.

General and Administrative Expenses

General and administrative expenses increased by 7.0 million for the year ended December 31, 2020. The increase was primarily due to (i) $2.5 million increase in payroll and personnel-related expenses (including stock-based compensation) for employee additions, (ii) $2.2 million increase in legal service costs and market research activities, and (iii) $2.3 million increase in consulting, insurance, and other administrative expenses.

Interest Income (Expense), Net

The change in interest income (expense), net was primarily due to convertible promissory notes issued to our co-founders and certain other related parties, aggregating $2.0 million in principal value (see below). During the year ended December 31, 2019, interest expense recognized on these notes was $0.1 million and was partially offset by interest income from our bank deposits and money market fund investments. These convertible promissory notes were all converted in December 2019 and we therefore had no interest expense for the year ended December 31, 2020.

Loss on Extinguishment of Convertible Notes

The loss on extinguishment of convertible notes was due to the extinguishment of convertible promissory notes issued to our co-founders and certain other related parties, aggregating $2.0 million in principal value (see section below). On December 13, 2019 we completed the issuance of Series B preferred stock upon which the then-outstanding notes, along with accrued interest, converted into 2.0 million shares of Series B preferred stock. Since these notes were converted in December 2019, no change in fair value of derivative liabilities was recorded for the year ended December 31, 2020.

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Change in Fair Value of Derivative Liabilities

During May, August, and October 2019, we issued convertible promissory notes to our co-founders and certain other related parties, aggregating $2.0 million in principal value. These notes contained stock-settled redemption features that were required to be separately accounted for as derivative liabilities on the balance sheet until December 13, 2019 when we completed a qualified equity financing.

These then-outstanding notes converted at the option of the holder into 2.0 million shares of Series B preferred stock. Change in fair value of derivative liabilities consists of non-cash changes in the fair value of these stock-settled redemption features. We classified the rights as a derivative liability on our balance sheet that was initially recorded at fair value and that we remeasured to fair value at December 13, 2019, and we recognized changes in the fair value of the derivative associated with the rights as a component of other income (expense) in our statement of operations. Since these notes were converted in December 2019, no change in fair value of derivative liabilities was recorded for the year ended December 31, 2020.

Liquidity and Capital Resources

Sources of Liquidity

Since our inception in 2016 and through December 31, 2020, our operations have been substantially financed by cash proceeds of $61.0 million from private placements of Series A and Series B preferred stock. In September 2020, we issued 2,857,079 shares of our Series C preferred stock for cash proceeds of $39.8 million. On October 20, 2020, we completed our IPO through an underwritten sale of 5,500,000 shares of its common stock at a price of $16.00 per share. The aggregate proceeds from the IPO, inclusive of an additional 825,000 common shares sold upon the full exercise of the underwriters’ purchase option, after deducting underwriting discounts and commissions and other IPO expenses, were $91.7 million.

We will continue to be dependent upon equity, debt financing, and/or other forms of capital raises at least until we are able to generate significant positive cash flows from our operations. As of December 31, 2020, we had cash and cash equivalents of $168.1 million. We have no ongoing material financing commitments, such as lines of credit or guarantees, that are expected to affect our liquidity over the next five years.

Funding Requirements

Our primary use of cash is to fund operating expenditures. These consist of research and development expenses (including activities within our pre-clinical, clinical, regulatory, and drug manufacturing initiatives) and general and administrative expenses. Our use of cash is impacted by the timing and extent of the required payments for each of these activities.

We believe that our cash and cash equivalents of $168.1 million as of December 31, 2020, and our expected $70 million of initial proceeds from our March 2021 out-license of TP-03 in the China territory (see above and Note 11), will enable us to fund our operating expenses and capital expenditure requirements into the first half of 2023. We have based this cash runway estimate on our current assumptions. These assumptions may require future adjustments as part of our ongoing business decisions within pipeline development and other corporate initiatives. Accordingly, we may require additional capital resources earlier than we currently expect.

To date, we have not generated any product revenue. We do not expect to generate any product revenue unless and until we (1) complete development of any of our product candidates; (2) obtain applicable regulatory approvals; and (3) successfully commercialize or enter into other collaborative agreements for our product candidates. We do not know with certainty when, or if, any of these items will ultimately occur. However, we expect to recognize "license fee revenue" in the first quarter of 2021 for our TP-03 out-license in the China territory.

We expect to incur significant operating losses for the foreseeable future, and for these losses to further increase, as we ramp up our clinical development programs and begin activities for commercial launch readiness. We may also encounter unforeseen expenses, difficulties, complications, delays and other currently unknown factors that could adversely affect our business.

We will likely require additional capital to fully develop our product candidates and to execute our business strategy. Our requirements of a future capital raise will depend on many factors, including:

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•the scope, timing, rate of progress and costs of our drug discovery efforts, preclinical development activities, laboratory testing and clinical trials for our product candidates;

•the number and scope of clinical programs we decide to pursue;

•the cost, timing and outcome of preparing for and undergoing regulatory review of our product candidates;

•the scope and costs of development and commercial manufacturing activities;

•the cost and timing associated with commercializing our product candidates, if they receive marketing approval;

•the amount of revenue, if any, received from commercial sales of our product candidates, should any of our product candidates receive marketing approval;

•the achievement of milestones or occurrence of other developments that trigger payments under any collaboration agreements we might have at such time;

•the extent to which we acquire or in-license other product candidates and technologies;

•the costs of preparing, filing and prosecuting patent applications, maintaining and enforcing our intellectual property rights and defending intellectual property-related claims;

•our ability to establish and maintain collaborations on favorable terms, if at all;

•our efforts to enhance operational systems and our ability to attract, hire and retain qualified personnel, including personnel to support the development of our product candidates and, ultimately, the sale of our products, following FDA approval;

•our implementation of various computerized information systems;

•impact of COVID-19 on our clinical development or operations; and

•the costs associated with being a public company.

A change in the outcome of any of these or other variables with respect to the development of any of our product candidates could significantly change the costs and timing associated with the development of that product candidate. Furthermore, our operating plans may change in the future, and we will continue to require additional capital to meet operational needs and capital requirements associated with such operating plans. If we raise additional funds by issuing equity securities, our stockholders may experience dilution. Any future debt financing into which we enter may impose upon us additional covenants that restrict our operations, including limitations on our ability to incur liens or additional debt, pay dividends, repurchase our common stock, make certain investments or engage in certain merger, consolidation or asset sale transactions. Any debt financing or additional equity that we raise may contain terms that are not favorable to us or our stockholders.

Adequate funding may not be available to us on acceptable terms or at all. Our potential inability to raise capital when needed could have a negative impact on our financial condition and our ability to pursue our business strategies. If we are unable to raise additional funds as required, we may need to delay, reduce, or terminate some or all development programs and clinical trials. We may also be required to sell or license our rights to product candidates in certain territories or indications that we would otherwise prefer to develop and commercialize ourselves. If we are required to enter into collaborations and other arrangements to address our liquidity needs, we may have to give up certain rights that limit our ability to develop and commercialize our product candidates or may have other terms that are not favorable to us or our stockholders, which could materially and adversely affect our business and financial prospects. See the section of this Annual Report on 10-K titled “Risk Factors” for additional risks associated with our substantial capital requirements.

Convertible Notes

From May 2019 through October 2019, we issued convertible promissory notes with an aggregate principal amount of $2.0 million. These notes were all converted into an aggregate of 268,056 shares of Series B preferred stock in December 2019 (see Note 4).

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Summary Statement of Cash Flows

The following table sets forth the primary sources and uses of cash, cash equivalents and restricted cash for each of the periods presented below:

Year EndedDecember 31,

(in thousands)

Net cash (used in) provided by:

Investing activities (456) (175)

Net increase in cash, cash equivalents and restricted cash $ 110,177 $ 55,597

Net Cash Used in Operating Activities

Net cash used in operating activities was $21.1 million for the year ended December 31, 2020, which was primarily attributable to our net loss of $26.8 million, partially offset by non-cash items (i.e., accounting for stock-issuance costs at IPO and stock-based compensation) totaling $4.2 million, and a net increase in liabilities of $1.5 million associated with accounts payable and accrued bonuses.

Net cash used in operating activities was $3.7 million for the year ended December 31, 2019, which primarily attributable to our net loss of $4.7 million, partially offset by non-cash items totaling $0.5 million and a net increase in liabilities of $0.5 million associated with accounts payable and accrued bonuses.

Net Cash Used in Investing Activities

Net cash used in investing activities was $0.5 million for the year ended December 31, 2020, which consisted of property and equipment purchases and tenant improvements to our leased laboratory and administrative offices.

Net cash used in investing activities was $0.2 million for the year ended December 31, 2019, which consisted of property and equipment purchases and tenant improvements to our leased laboratory and administrative offices.

Net Cash Provided by Financing Activities

Net cash provided by financing activities was $131.8 million for the year ended December 31, 2020 due to our issuance of Series C preferred stock for net proceeds of $39.8 million and net proceeds from the IPO of $91.7 million.

Net cash provided by financing activities was $59.4 million for the year ended December 31, 2019 due to our issuance of Series B preferred stock for net proceeds of $57.5 million and issuance of convertible promissory notes for proceeds of $2.0 million.

Contractual Obligations and Commitments

The following table summarizes our contractual obligations as of December 31, 2020:

Payments Due by Period

Total Lessthan1 year 1 to 3years 3 to 5years Morethan5 years

(in thousands)

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(1)The operating lease obligations are related to facility leases for our corporate headquarters and research and development facilities in Irvine, California, expiring April 30, 2022 and January 31, 2024.

(2)Milestone obligations are contingent upon our achievement of specified development, regulatory and sales milestones. Given the unpredictability of the drug development process, and the impossibility of predicting the success of current and future clinical trials and the timing of achievement (if at all) of sales milestones, these values assume that all development, regulatory, and sales milestones under our in-license agreement with Elanco, as amended, are successfully met. These values in each column represent the composite best estimates for each achievement date. If any or all milestones are met, we believe that the corresponding increase in value from the related drug program will exceed the amount of our milestone obligation.

(3)Purchase obligations represent the amount of open purchase orders and contractual commitments to vendors for products and services that have not been delivered or rendered, as of December 31, 2020. We enter contracts in the normal course of business with clinical research organizations and clinical sites and with contract manufacturers for pre-clinical and clinical drug supply, as well as with various other vendors in operating our business. These contracts generally provide for termination provisions with notice. The values in each column represent the obligations that are non-cancelable as of December 31, 2020.

We enter into contracts in the normal course of business with (i) clinical research organizations and clinical sites, (ii) contract manufacturers for pre-clinical and clinical drug supply, (iii) regulatory consultants and (iv) various other vendors in operating our business. These contracts generally provide for termination provisions with notice, and therefore we believe that our non-cancelable obligations under these agreements were not material as of December 31, 2020.

Critical Accounting Policies, Significant Judgments and Use of Estimates

Our management’s discussion and analysis of financial condition and results of operations is based on our financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles ("GAAP"). The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported expenses incurred during the reporting periods. Our estimates are based on our historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ materially from these estimates under different assumptions or conditions.

While our significant accounting policies are described in the notes to our financial statements also included in this Annual Report on Form 10-K, we believe these critical accounting policies are the most important to understanding and evaluating our reported financial results.

Research and Development Expenses

Research and development costs are expensed as incurred or as certain upfront or milestone payments become contractually due to licensors upon the achievement of clinical or regulatory events. These expenses also include internal costs directly attributable to in-development programs, including cost of certain salaries, payroll taxes, employee benefits, and stock-based compensation expense, as well as laboratory and clinical supplies, pre-clinical and clinical trial related expenses, and the cost of services provided by outside contractors.

We have entered, and may continue to enter into, license agreements to access and utilize certain technology. In each case, we evaluate if the assets acquired in a transaction represent the acquisition of an asset or a business, as defined under applicable GAAP. Our only executed in-license agreement was evaluated and determined to represent an asset acquisition. Because this asset had not yet received regulatory approval and has no alternative future use, its fair value was immediately recognized as research and development expense.

We make research and development expense accrual estimates as of each balance sheet date, based on facts known to us at that time. This process involves reviewing open contracts and purchase orders, communicating with our personnel to identify services that have been performed on our behalf, and estimating the level of service performed and the associated cost incurred for the service when we have not yet been invoiced or otherwise notified of the actual cost. We periodically confirm the accuracy of our estimates with the service providers, including CROs, and record adjustments, if necessary. To date, there have been no material differences between our estimates of such expenses and the amounts actually incurred.

Stock-Based Compensation

We measure and recognize compensation expense for all stock options based on the estimated fair value of the award on the grant date. We use the Black-Scholes option-pricing model to estimate the fair value of awarded stock options. The fair value is recognized as expense on a straight-line or ratable basis over the requisite or implicit service period.

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The determination of the grant date fair value of our issued stock options is affected principally by our model assumptions, including (a) the expected term of the stock option until its exercise by the recipient, (b) our assumed stock price volatility through a designated peer group of publicly-traded companies for a period equal to the expected option term, (c) the prevailing risk-free interest rate over the expected term, and (d) any expected dividend payments over the expected term. If any of these assumptions change, our stock-based compensation expense for future grants could materially differ.

Stock-based compensation expense for equity awards granted to our employees and members of our Board of Directors is recognized on a straight-line basis over each award’s vesting period. We account for forfeitures as they occur. We use the Black-Scholes option pricing model to determine the fair value of stock options (as of the date of grant).

The recognition of stock-based compensation expense and the initial calculation of stock option fair value requires uncertain assumptions, including (a) the expected term that the stock option will remain outstanding, (b) our stock price volatility over the expected term, and (c) the prevailing risk-free interest rate for the period matching the expected term.

Expected Term – The expected term is calculated using the simplified method which is used when there is insufficient historical data about exercise patterns and post-vesting employment termination behavior. The simplified method is based on the vesting period and the contractual term for each grant, or for each vesting-tranche for awards with graded vesting. The mid-point between the vesting date and the maximum contractual expiration date is used as the expected term under this method. For awards with multiple vesting-tranches, the times from grant until the mid-points for each of the tranches may be averaged to provide an overall expected term.

Expected Volatility –We estimate the volatility of our common stock on the date of grant based on our designated peer group of publicly-traded companies for a period equal to the expected option term.

Expected Dividend Rate – We have not paid and do not anticipate paying any dividends in the near future. Accordingly, we estimate the dividend yield to be zero.

Risk-Free Interest Rate – We estimate the risk-free interest rate based upon the U.S. Department of the Treasury yields in effect at award grant for a period equaling the expected term of the stock option.

Common Stock Valuations prior to our IPO

Prior to the IPO our valuations of our common stock were determined in accordance with the guidelines outlined in the American Institute of Certified Public Accountants Practice Aid, Valuation of Privately-Held-Company Equity Securities Issued as Compensation, or the Practice Aid. The assumptions underlying these valuations represented management’s best estimate, which involved inherent uncertainties and the application of management’s judgment. As a result, if we had used different assumptions or estimates, the fair value of our common stock and our stock-based compensation expense could have been materially different.

Common Stock Valuations following our IPO

Subsequent to the IPO, the fair value of our common stock is based on the closing quoted market price of our common stock as reported by the Nasdaq Global Select Market on the date of grant.

Recent Accounting Pronouncements

A description of recent accounting pronouncements that may potentially impact our financial position, results of operations or cash flows is disclosed in the notes to which they relate within our financial statements.

Off-Balance Sheet Arrangements

Since our inception, we have not engaged in any off-balance sheet arrangements, as defined in the rules and regulations of the SEC.

Indemnification Agreements

As permitted under Delaware law and in accordance with our bylaws, we indemnify our officers and directors for certain events or occurrences while the officer or director is or was serving in such capacity. We are also party to indemnification agreements with our officers and directors. We believe the fair value of the indemnification rights and

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agreements is minimal. Accordingly, we have not recorded any liabilities for these indemnification rights and agreements as of December 31, 2020.

JOBS Act Accounting Election

The JOBS Act permits an “emerging growth company” such as us to take advantage of an extended transition period to comply with new or revised accounting standards applicable to public companies. We have irrevocably elected to opt out of this provision and, as a result, we will comply with new or revised accounting standards as required when they are adopted.

We will remain an emerging growth company until the earliest of (1) the last day of our first fiscal year (a) following the fifth anniversary of the completion of our IPO, (b) in which we have total annual gross revenues of at least $1.07 billion or (c) in which we are deemed to be a large accelerated filer, which means the market value of our common stock that is held by non-affiliates exceeds $700 million of the prior June 30th and (2) the date on which we have issued more than $1.0 billion in non-convertible debt securities during the prior three-year period.

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Item 8. Financial Statements and Supplementary Data

TARSUS PHARMACEUTICALS, INC.

INDEX TO THE FINANCIAL STATEMENTS

Pages

Report of Independent Registered Public Accounting Firm 117

Balance Sheets 118

Statements of Operations and Comprehensive Loss 119

Statements of Preferred and Common Stock and Stockholders’ Equity (Deficit) 120

Statements of Cash Flows 121

Notes to Financial Statements 122

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Stockholders and the Board of Directors of Tarsus Pharmaceuticals, Inc.

Opinion on the Financial Statements

We have audited the accompanying balance sheets of Tarsus Pharmaceuticals, Inc. (the Company) as of December 31, 2020 and 2019, the related statements of operations and comprehensive loss, preferred and common stock and stockholders’ equity (deficit) and cash flows for the years then ended, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2020 and 2019, and the results of its operations and its cash flows for the years then ended in conformity with U.S. generally accepted accounting principles.

Basis for Opinion

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion.

Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

/s/ Ernst & Young LLP

We have served as the Company’s auditor since 2020.

Irvine, California

March 31, 2021

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TARSUS PHARMACEUTICALS, INC.

BALANCE SHEETS

(In thousands, except share and par value amounts)

December 31,

ASSETS

Current assets:

Restricted cash 20 20

Other receivables 20 36

Property and equipment, net 548 154

Operating lease right-of-use assets 688 126

Other assets 81 6

LIABILITIES, PREFERRED STOCK AND STOCKHOLDERS’ EQUITY (DEFICIT)

Current liabilities:

Accounts payable and other accrued liabilities $ 4,347 $ 520

Accrued payroll and benefits 1,040 299

Other long-term liabilities 605 100

Commitments and contingencies (Note 10)

Stockholders’ equity (deficit):

Total stockholders’ equity (deficit) 165,980 (6,005)

See accompanying notes to these financial statements.

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TARSUS PHARMACEUTICALS, INC.

STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(In thousands, except share and per share amounts)

Year Ended December 31,

Operating expenses:

Other income (expense):

Interest income (expense), net 188 (40)

Loss on extinguishment of convertible notes — (255)

Change in fair value of derivative liabilities — (76)

Total other income (expense) 188 (371)

Provision for income taxes (1) (1)

Net loss and comprehensive loss $ (26,811) $ (4,670)

See accompanying notes to these financial statements.

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TARSUS PHARMACEUTICALS, INC.

STATEMENTS OF PREFERRED AND COMMON STOCK AND STOCKHOLDERS’ EQUITY (DEFICIT)

(In thousands, except share data)

Shares Amount Shares Amount

Recognition of stock-based compensation expense — — — — 9 — 9

Issuance of common stock under stock purchase agreements — — 5,385 — — — —

Vesting of founder shares subject to repurchase — — 538,532 — — — —

Recognition of stock-based compensation expense — — — — 18 — 18

Vesting of founder shares subject to repurchase 493,654 1 — — 1

Recognition of stock-based compensation expense — — — — 839 — 839

See accompanying notes to these financial statements.

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TARSUS PHARMACEUTICALS, INC.

STATEMENTS OF CASH FLOWS

(In thousands)

Year endedDecember 31,

Cash Flows From Operating Activities:

Adjustments to reconcile net loss to net cash used in operating activities:

Depreciation and amortization 96 37

Stock-based compensation (Note 5) 839 18

Amortization of operating lease right-of-use asset (Note 10(a)) 150 37

Impairment of operating lease right-of-use asset 15 —

Change in fair value of derivative liabilities (Note 9) — 76

Stock issued for in-license agreement (Note 9(b)) 3,115 —

Non-cash related party interest expense — 89

Loss on extinguishment of convertible notes (Note 9) — 255

Changes in operating assets and liabilities:

Other receivables 16 (32)

Prepaid expenses and other current assets (2,464) (18)

Other non-current assets (75) (6)

Accounts payable and other accrued liabilities 3,240 245

Accrued payroll and benefits 741 296

Net cash used in operating activities (21,138) (3,673)

Cash Flows From Investing Activities:

Purchases of property and equipment (456) (175)

Cash used in investing activities (456) (175)

Cash Flows From Financing Activities:

Proceeds from early exercise of stock options 360 —

Net cash provided by financing activities 131,771 59,445

Net increase in cash, cash equivalents and restricted cash 110,177 55,597

Cash, cash equivalents, and restricted cash — beginning of year 57,972 2,375

Cash, cash equivalents, and restricted cash — end of year $ 168,149 $ 57,972

Reconciliation of cash, cash equivalents and restricted cash

Restricted cash 20 20

Cash, cash equivalents and restricted cash $ 168,149 $ 57,972

Supplemental Disclosures Noncash Investing and Financing Activities:

Stock issued for in-license agreement $ 3,115 $ —

Conversion of convertible notes to Series B Preferred Stock (Note 8) $ — $ 2,410

See accompanying notes to these financial statements.

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TARSUS PHARMACEUTICALS, INC.

NOTES TO THE FINANCIAL STATEMENTS

1. DESCRIPTION OF BUSINESS AND PRESENTATION OF FINANCIAL STATEMENTS

(a) Description of Business

Tarsus Pharmaceuticals, Inc. (“Tarsus” or the “Company”) is a late clinical-stage biopharmaceutical company focused on the development and commercialization of novel therapeutic candidates to address large market opportunities initially in ophthalmic conditions where there are limited treatment alternatives.

(b) Initial Public Offering and Reverse Stock Split

On October 20, 2020, the Company completed its initial public offering "IPO" through an underwritten sale of 5,500,000 shares of its common stock at a price of $16.00 per share. The aggregate net proceeds received by the Company from the IPO, inclusive of an additional 825,000 common shares sold upon the full exercise of the underwriters’ purchase option totaled $91.7 million, after deducting underwriting discounts and commissions and other offering expenses.

Concurrent with the closing of the Company's IPO, all then-outstanding shares of its convertible preferred stock (see Note 4) were automatically converted into an aggregate of 11,107,018 common shares.

On October 8, 2020, the Company's Board of Directors approved a 1-for-7.4276 reverse stock split and a certificate of amendment was filed to restate the Company's certificate of incorporation to effect this reverse stock split. The par value was not adjusted as a result of the reverse stock split. All share and per share information included in the accompanying financial statements give retroactive effect to the reverse stock split for all periods presented.

(c) Liquidity Risks

The Company has no revenue and incurred losses and negative cash flows from operations since inception, resulting in an accumulated deficit of $32.8 million as of December 31, 2020, and the income potential of the Company's business and market are unproven. The Company’s cash and cash equivalents was $168.1 million and $58.0 million as of December 31, 2020 and December 31, 2019, respectively. The Company expects to continue to incur operating losses and negative cash flows and has historically financed its operations primarily through equity capital raises.

The Company believes that existing capital resources, including the net proceeds from the IPO in October 2020, will be sufficient to meet projected operating requirements for at least 12 months from the date of issuance of the accompanying financial statements.

The financial statements have been prepared on a going concern basis, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might result from the outcome of this uncertainty. Management expects to continue to incur additional substantial losses in the foreseeable future as a result of the Company’s research and development activities.

The Company’s operations have consisted primarily of its organization, securing financing, in-licensing intellectual property, and conducting preclinical and clinical studies. The Company faces risks associated with early-stage biotechnology companies whose product candidates are in development that require significant additional research and development efforts, including extensive preclinical and clinical testing and regulatory approval prior to commercialization. These efforts require the Company to expend large amounts of additional capital to complete research and development, achieve research and development objectives, defend intellectual property rights, and recruit and retain skilled personnel, including key members of management.

The Company will be required to raise additional capital to fund future operations, however, no assurance can be given as to whether additional needed financing will be available on terms acceptable to the Company, if at all.

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TARSUS PHARMACEUTICALS, INC.

NOTES TO THE FINANCIAL STATEMENTS

If the Company raises additional funds by issuing equity securities, its stockholders may experience dilution. Any future debt financing into which the Company enters may impose additional covenants that restrict operations, including limitations on its ability to incur liens or additional debt, pay dividends, repurchase common stock, make certain investments or engage in certain merger, consolidation or asset sale transactions. Any debt financing or additional equity raise may contain terms that are not favorable to the Company or its stockholders. Further, adequate funding may not be available on acceptable terms, or at all. The Company’s potential inability to raise capital when needed could have a negative impact on its financial condition and ability to pursue planned business strategies. If the Company is unable to raise additional funds as required, it may need to delay, reduce, or terminate some or all its development programs and clinical trials. The Company may also be required to sell or license its rights to product candidates in certain territories or indications that it would otherwise prefer to develop and commercialize on its own. If the Company is required to enter into collaborations and other arrangements to address its liquidity needs, it may have to give up certain rights that limit its ability to develop and commercialize product candidates or may have other terms that are not favorable to the Company or its stockholders, which could materially and adversely affect its business and financial prospects. These factors may adversely impact the Company's ability to achieve its business objectives and would likely have an adverse effect on its future business prospects, or even its ability to remain a going concern.

(d) Operating Segment

To date, the Company has operated and managed its business and financial information on an aggregate basis for the purposes of evaluating financial performance and the allocation of resources. Accordingly, the Company’s management determined that it operates one reportable operating segment that is focused exclusively on developing pharmaceutical products for commercialization.

(e) Emerging Growth Company Status

The Company is an emerging growth company, as defined in the Jumpstart Our Business Startups Act of 2012 (the "JOBS Act"). Under the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards issued subsequent to the enactment of the JOBS Act until such time as those standards apply to private companies. The Company has irrevocably elected to not take this exemption and, as a result, will adopt new or revised accounting standards on the relevant effective dates on which adoption of such standards is required for other public companies that are not emerging growth companies.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND USE OF ESTIMATES

(i) Basis of Presentation

The preparation of financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) and with the rules and regulations of the Securities and Exchange Commission (“SEC”) requires management to make informed estimates and assumptions that impact the amounts reported in these financial statements and accompanying notes. These amounts may materially differ from the amounts ultimately realized and reported due to the inherent uncertainty of any estimate or assumption. On an on-going basis, management evaluates its most critical estimates and assumptions, including those related to the (i) fair value of stock awards and periodic expense recognition of stock-based compensation, (ii) the realization of income tax assets and estimates of tax liabilities, (iii) expense accruals related to research and development activities, including clinical trials, and, for periods prior to the IPO, (iv) valuation of convertible notes, derivative instruments, and preferred stock.

Accounting policies and estimates that most significantly impact the presented amounts within these financial statements are further described below:

(ii) Cash and Cash Equivalents

Cash and cash equivalents consist of bank deposits and highly liquid investments, including money market fund accounts, with original maturities of three months or less from the purchase date. The carrying amounts reported in the balance

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TARSUS PHARMACEUTICALS, INC.

NOTES TO THE FINANCIAL STATEMENTS

sheets for cash and cash equivalents are valued at cost, which approximate their fair value. Cash equivalents may consist of money market funds.

(iii) Restricted Cash

Restricted cash represents cash held as collateral for the Company’s corporate credit card program. Any cash that is legally or contractually restricted from immediate use is classified as restricted cash.

(iv) Concentration of Credit Risk and Other Risks and Uncertainties

Financial instruments that potentially subject the Company to significant concentrations of credit risk consist primarily of cash and cash equivalents in deposits at financial institutions that exceed federally insured limits.

In March 2020, the World Health Organization declared a pandemic related to the global novel coronavirus disease 2019 (“COVID-19”) outbreak. The Company’s operations have not been significantly impacted by the COVID-19 pandemic. The Company has been carefully monitoring the potential impact COVID-19 may have on the Company’s business. However, the Company cannot at this time predict the specific extent, duration, or full impact that the COVID-19 outbreak will have on its financial condition and operations, including ongoing and planned clinical trials.

The Company’s results of operations involve numerous risks and uncertainties. Factors that could adversely impact the Company’s operating results and business objectives include, but are not limited to, (1) uncertainty of results of clinical trials, (2) uncertainty of regulatory approval of the Company’s potential product candidates, including TP-03 for ophthalmic conditions, TP-04 for treatment of skin conditions and TP-05 for prophylaxis of Lyme and community malaria reduction, (3) uncertainty of market acceptance of its product candidates, (4) competition from substitute products and larger companies, (5) securing and protecting proprietary technology and strategic relationships, and (6) and dependence on key individuals and sole source suppliers.

The Company’s product candidates require approvals from the U.S. Food and Drug Administration (“FDA”) and comparable foreign regulatory agencies prior to commercial sales in their respective jurisdictions. There can be no assurance that any product candidates will receive the necessary approvals. If the Company is denied approval, approval is delayed or the Company is unable to maintain approval for any product candidate, it could have a materially adverse impact on the business.

(v) Property and Equipment

Property and equipment is stated at historical cost and is depreciated on a straight-line basis over an estimated useful life that corresponds with its designated asset category. Leasehold improvements are amortized on a straight-line basis over the shorter of the remaining lease term or the estimated useful lives of related improvements. The Company evaluates the recoverability of “long-lived assets” (which includes property and equipment) whenever events or changes in circumstances in the business indicate that the asset’s carrying amount may not be recoverable. Recoverability of these assets is measured by a comparison of the carrying amounts to the sum of the future undiscounted cash flows the assets are expected to generate over the remaining useful lives of the assets. If a long-lived asset fails a recoverability test, the Company measures the amount by which the carrying value of the asset exceeds its fair value. Other than the right-of-use ("ROU") asset impairment discussed in Note 9, there were no events or changes in business circumstances during the years ended December 31, 2020 and 2019 that indicated the carrying amounts of any long-lived assets were not fully recoverable.

(vi) Derivative Instruments

The convertible notes issued in May 2019, August 2019, and October 2019 contained embedded derivative instruments, representing “contingent redemption options”. The contingent redemption options met the requirements for separate accounting and were accounted for as a single derivative instrument for each tranche of the convertible notes. The derivative instruments were recorded at fair value at inception and were subject to remeasurement to fair value, with any changes in estimated fair value recognized as a component of “other (expense) income” in the Statements of Operations and Comprehensive Loss (see Note 7).

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TARSUS PHARMACEUTICALS, INC.

NOTES TO THE FINANCIAL STATEMENTS

As the Notes were converted in December 2019, no expense related to changes in fair value of derivative liabilities was recorded for the twelve months ended December 31, 2020.

(vii) Research and Development Costs

Research and development costs are expensed as incurred or as certain upfront or milestone payments become contractually due to licensors upon the achievement of clinical or regulatory events. These expenses also include internal costs directly attributable to in-development programs, including cost of certain salaries, payroll taxes, employee benefits, and stock-based compensation expense, as well as laboratory and clinical supplies, pre-clinical and clinical trial related expenses, and the cost of services provided by outside contractors. The Company recognizes expense for pre-clinical studies and clinical trial activities performed by these third parties. This is typically based upon estimates of the proportion of work completed over the term of the individual study or trial, as well as patient enrollment and dosing events in accordance with agreements established with clinical research organizations ("CROs") and clinical trial or pre-clinical study sites.

The Company has entered, and may continue to enter into, license agreements to access and utilize intellectual property for drug development. In each case, the Company evaluates if the assets acquired in a transaction represent the acquisition of an asset or a business, as defined under applicable GAAP. The Company’s only executed in-license agreement (see Note 9(b)) was evaluated and determined to represent an asset acquisition. Because this asset had not yet received regulatory approval and has no alternative future use, its purchase price was immediately recognized as research and development expense. In addition, any future milestone payments made before product regulatory approval (that do not meet the definition of a derivative) will also be immediately recognized as research and development expense when paid or become payable, provided there is no alternative future use of the rights in other research and development projects.

(viii) Deferred Offering Costs

Costs directly related to the Company’s IPO were deferred for expense recognition and instead capitalized and recorded on the accompanying balance sheets. These costs consisted of legal fees, accounting fees, and other applicable professional services. These deferred offering costs were reclassified to “additional paid in capital” and offset against IPO proceeds, upon closing of the IPO in October 2020. There were no deferred offering costs capitalized as of December 31, 2020 and 2019.

(ix) Stock-Based Compensation

Stock-based compensation expense is recognized for all equity awards granted to employees, consultants, and members of the Company’s Board of Directors and is recognized at fair value. For stock-based awards that vest subject to the satisfaction of a service requirement, the fair value measurement date is the date of grant and the related expense is recognized on a straight-line basis over each award’s actual or implied vesting period. For stock-based awards that vest subject to a performance condition, the Company recognizes compensation cost if and when it concludes that it is probable that the performance condition will be achieved and the related expense is recognized on an accelerated attribution method. As applicable, the Company reverses previously recognized expense for forfeitures of unvested awards in the period of occurrence. The Company uses the Black-Scholes option pricing model to estimate the fair value of stock-based awards as of the date of grant.

The measurement of the fair value of stock-based awards and recognition of stock-based compensation expense requires assumptions to be estimated by management that involve inherent uncertainties and the application of management’s judgment, including (a) the fair value of the Company’s common stock on the date of the option grant, (b) the expected term of the stock option until its exercise by the recipient, (c) stock price volatility over the expected term, (d) the prevailing risk-free interest rate over the expected term, and (e) expected dividend payments over the expected term.

Management estimates the expected term of awarded stock options utilizing the “simplified method” for awards as the Company does not yet have sufficient exercise history since its November 2016 formation. Further, prior to the IPO, the Company was privately-held and therefore lacked company-specific historical and implied volatility information of its stock. Accordingly, management estimated this expected volatility based on a designated peer-group of publicly-traded companies for a look-back period, as of the date of grant, that corresponded with the expected term of the awarded stock option.

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NOTES TO THE FINANCIAL STATEMENTS

The Company estimates the risk-free interest rate based upon the U.S. Department of the Treasury yield curve in effect at award grant for time periods that correspond with the expected term of the awarded stock option. The Company’s expected dividend yield is zero because it has never paid cash dividends and does not expect to for the foreseeable future.

Prior to the IPO, given the absence of a public trading market, the Company’s Board of Directors, with input from management, considered numerous objective and subjective factors to determine the fair value of its common stock. The factors included: (i) third-party valuations of the Company’s common stock; (ii) the Company’s stage of development; (iii) the status of research and development efforts; (iv) the rights, preferences and privileges of the Company’s preferred stock relative to common stock; (v) the Company’s operating results and financial condition, including the Company’s levels of available capital resources; (vi) equity market conditions affecting comparable public companies; (vii) general U.S. market conditions; and (viii) the lack of current marketability of the Company’s common stock. Subsequent to the IPO, the fair value of the Company’s common stock is based on the closing quoted market price of its common stock as reported by the NASDAQ Global Select Market on the date of grant.

All stock-based compensation costs are recorded in the Statements of Operations and Comprehensive Loss based upon the underlying employee's role within the Company.

(x) Income Taxes

Income taxes are accounted for using the asset and liability method. Deferred tax assets and liabilities are recorded based on the estimated future tax effects of temporary differences between the tax basis of assets and liabilities and amounts reported in the financial statements, as well as operating losses and tax credit carry forwards using enacted tax rates and laws that are expected to be in effect when the differences are expected to reverse. Deferred tax assets and liabilities are measured using the 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 on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period of enactment. Realization of deferred tax assets is dependent upon future earnings, the timing and amount of which are uncertain due to the Company’s historical operating performance and recorded cumulative net losses in prior fiscal periods.

A valuation allowance is recorded to reduce deferred tax assets, because based upon a weighting of positive and negative factors, it is more likely than not that these deferred tax assets will not be realized. If/when the Company were to determine that deferred tax assets are realizable, an adjustment to the corresponding valuation allowance would increase the net income in the period that such determination was made.

In the event that the Company is assessed interest and/or penalties from taxing authorities that have not been previously accrued, such amounts would be included as a component of “income tax expense” within the Statements of Operations and Comprehensive Loss in the period the notice was received. To date there have been no interest or penalties charged.

(xi) Preferred Stock

The Company classified preferred stock outside of stockholders’ equity (deficit) on the accompanying balance sheets. The requirements of a deemed liquidation event, as defined within its amended and restated certificate of incorporation filed in September 2020 (the “2020 Amended and Restated Certificate of Incorporation”) were not entirely within the Company’s control. In the event of such a deemed liquidation event, the proceeds from the event are distributed in accordance with the liquidation preferences, provided that the holders of preferred stock have not converted their shares into common stock. The Company recorded the issuance of preferred stock at the issuance price less related issuance costs. As of December 31, 2019, the Company did not adjust the carrying value of outstanding preferred stock to its liquidation preference because a deemed liquidation event was not probable of occurring as of the end of the reporting period. All of the outstanding shares of preferred stock were automatically converted to common stock shares upon the closing of the IPO in October 2020.

(xii) Net Loss per Share Attributable to Common Stockholders

Basic net loss per share attributable to common stockholders is calculated by dividing the net loss by the weighted-average number of shares of common stock outstanding for the period, without consideration for potential dilutive shares of

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TARSUS PHARMACEUTICALS, INC.

NOTES TO THE FINANCIAL STATEMENTS

common stock. Diluted net loss per share is computed by dividing the net loss by the weighted-average number of common share equivalents outstanding for the period determined using the treasury-stock method and if-converted method, as applicable. Basic and diluted net loss per share attributable to common stockholders is presented in conformity with the two-class method required for participating securities. The Company’s participating securities include preferred stock, unvested common stock to founders, and unvested common stock awards issued upon early exercise of certain stock options. The Company’s participating securities do not have a contractual obligation to share in the Company’s losses. As such, the net loss was attributed entirely to common stockholders. Shares of common stock subject to repurchase by the Company are excluded from the weighted-average shares. Due to net losses in all periods presented, all otherwise potentially dilutive securities are antidilutive. Accordingly, basic net loss per share equals diluted net loss per share for all period presented in the accompanying financial statements.

(xiii) Fair Value Measurements

Assets and liabilities recorded at fair value on a recurring basis in the balance sheets are categorized based upon the level of judgment associated with the inputs used to measure their fair values. Fair value is defined as the exchange price that would be received for an asset or an exit price that would be paid to transfer a liability 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. The authoritative guidance on fair value measurements establishes a three-tier fair value hierarchy for disclosure of fair value measurements as follows:

•Level 1: Quoted prices (unadjusted) in active markets for identical assets or liabilities that are publicly accessible at the measurement date.

•Level 2: Observable prices that are based on inputs not quoted on active markets, but that are corroborated by market data. These inputs may include quoted prices for similar assets or liabilities or quoted market prices in markets that are not active to the general public.

•Level 3: Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

The carrying amounts for financial instruments consisting of cash and cash equivalents, accounts payable and accrued liabilities approximate fair value due to their short maturities. Derivative instruments are carried at fair value based on unobservable market inputs.

(xiv) Comprehensive Loss

Comprehensive loss represents all changes in stockholders’ equity (deficit), except those resulting from distributions to stockholders. For all periods presented, comprehensive loss was the same as reported net loss.

(xv) Recently Issued or Effective Accounting Standards

Recently issued or effective accounting pronouncements that impact, or may have an impact, on the Company’s financial statements have been discussed within the footnote to which each relates. Other recent accounting pronouncements not disclosed in these financial statements have been determined by the Company’s management to have no impact, or an immaterial impact, on its current and expected future financial position, results of operations, or cash flows.

3. BALANCE SHEET ACCOUNT DETAIL

The composition of select financial statement captions that comprise the accompanying balance sheets are summarized below:

(a) Property and Equipment, net of Accumulated Depreciation

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NOTES TO THE FINANCIAL STATEMENTS

“Property and equipment, net” consists of the following:

December 31,

Furniture and fixtures $ 294 $ 5

Office equipment 74 26

Leasehold improvements 141 69

Property and equipment, at cost 682 192

(Less): Accumulated depreciation and amortization 134 38

Property and equipment, net of accumulated depreciation $ 548 $ 154

Depreciation expense (included within “total operating expenses” in the accompanying Statements of Operations and Comprehensive Loss) for the years ended December 31, 2020 and 2019 was $0.1 million and $37 thousand, respectively.

(b) Accounts Payable and Other Accrued Liabilities

“Accounts payable and other accrued liabilities” consists of the following:

December 31,

Trade accounts payable and other $ 2,237 $ 456

Operating lease liability, current portion 282 64

Accrued clinical studies 1,524 —

Employee stock option early exercise liability, current portion 304 —

Accounts payable and other accrued liabilities $ 4,347 $ 520

(c) Other Long-Term Liabilities

“Other long-term liabilities” consists of the following:

December 31,

Operating lease liability, non-current portion $ 549 $ 100

Employee stock option early exercise liability, non-current portion 56 —

Other long-term liabilities $ 605 $ 100

4. STOCKHOLDERS’ EQUITY

Authorized Stock

Under the October 2020 Amended and Restated Certificate of Incorporation, the Company is authorized to issue two classes of stock: common and preferred. The total number of shares authorized for issuance is 200.0 million of common shares and 10.0 million of preferred shares.

Preferred Stock Overview

Series A Preferred Stock Issuance

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NOTES TO THE FINANCIAL STATEMENTS

In March and May 2018, the Company executed a private placement Series A Stock Purchase Agreement and issued 1.6 million shares of Series A Preferred Stock at $2.3174 per share for net proceeds of $3.6 million, after issuance costs of $0.1 million.

Series B Preferred Stock Issuance

In December 2019, the Company executed a private placement Series B Stock Purchase Agreement of 6.7 million shares of Series B Preferred Stock at $8.9904 per share for net proceeds of $57.4 million, after issuance costs of $0.2 million. Concurrently, convertible notes issued in May, August, and October 2019 for aggregate proceeds of $2.0 million were converted based on principal and accrued interest, and the Company issued 0.3 million shares of Series B Preferred Stock at its contractual conversion price (see Note 8).

Series C Preferred Stock Issuance

In September 2020, the Company executed a private placement Series C Stock Purchase agreement of 2.9 million shares of Series C Preferred Stock at a purchase price of $14.0003 per share for net proceeds of $39.8 million, after issuance costs of $0.2 million.

On October 20, 2020, upon the closing of the IPO, all outstanding shares of preferred stock were automatically converted into an aggregate 11,107,018 shares of the Company's common stock and $103.2 million of mezzanine equity was reclassified to common stock and additional paid-in capital. As of December 31, 2020, there were no shares of preferred stock issued and outstanding.

The table below includes preferred stock details as of December 31, 2019.

Common Stock Overview and Reserve for Future Issuance

Common stockholders have one vote for each share of common stock held and are entitled to receive any dividends declared by the Company’s Board of Directors when legally available for distribution, subject to the dividend rights of the holders of Series A, Series B, and Series C preferred stock discussed above. For the years ended December 31, 2020 and 2019, no dividends were declared.

As of December 31, 2020 and 2019, the Company had 20.5 million and 2.7 million common shares issued, respectively. At December 31, 2020 and 2019, the Company had 20.3 million and 2.6 million, common shares outstanding, respectively. The following shares of common stock were reserved for issuance:

December 31,

Preferred Stock outstanding — 8,249,939

5. STOCK-BASED COMPENSATION

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2020 Equity Incentive Plan

The Company's Board of Directors and stockholders adopted and approved the Company's 2020 Equity Incentive Plan (the “2020 Plan”) on October 8, 2020. The 2020 Plan replaces the 2016 Plan, however, awards outstanding under the 2016 Plan will continue to be governed by their existing terms. The number of shares of the Company's common stock available for issuance under the 2020 Plan equal the initial sum of 9,000,000 shares plus 2,432,980 shares remaining available for issuance under the 2016 Plan, or issued pursuant to or subject to awards granted under the 2016 Plan. The 2020 Plan provides for the following types of awards: incentive and non-statutory stock options, stock appreciation rights, restricted shares, and restricted stock units.

The number of common shares reserved for issuance under the 2020 Plan are increased automatically on the first business day of each fiscal year, commencing in 2021 and ending in 2030, by a number equal to the lesser of: (i) 4% of the shares of common stock outstanding on the last business day of the prior fiscal year; or (ii) the number of shares determined by the Company's Board of Directors. In general, to the extent that any awards under the 2020 Plan are forfeited, terminate, expire or lapse without the issuance of shares, or if the Company reacquires the shares subject to awards granted under the 2020 Plan, those shares will again become available for issuance under the 2020 Plan, as will shares applied to pay the exercise or purchase price of an award or to satisfy tax withholding obligations related to any award.

Prior to adopting the 2020 Plan, the Company had one active stockholder-approved stock-based compensation plan (the “2016 Plan”), adopted in December 2016, which permitted the grant of incentive stock options, nonqualified stock options, stock awards and certain other awards to its employees, members of its Board of Directors, and consultants.

Stock-based awards are governed by agreements between the Company and the recipients. Incentive stock options and nonqualified stock options may be granted under the 2016 Plan and 2020 Plan at an exercise price of not less than 100% of the fair market value of common stock on the respective date of grant. The grant date is the date the terms of the award are formally approved by the Company’s Board of Directors or its designee.

Through December 31, 2020, all awards issued under the 2016 Plan were in the form of stock options. These option agreements have service and/or performance conditions for vesting, unless immediately vested on the date of grant. Stock options granted typically have one to four-year service conditions for full vesting. The performance conditions for vesting are explicitly stated in each option agreement and are associated with clinical, business development, or operational milestones.

Stock options must generally be exercised, if at all, no later than 10 years from the date of grant. Upon termination of employment, vested stock options may be exercised within 12 months after the date of termination upon death; six months after the date of termination upon disability; and three months after the date of termination for all other separations.

Stock-Based Compensation Summary

Stock-based compensation expense for the years ended December 31, 2020 and 2019 was as follows:

Year EndedDecember 31,

Research and development $ 260 $ 6

General and administrative 579 12

Total stock-based compensation $ 839 $ 18

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Valuation Assumptions of Stock Options

The fair value of granted stock options was estimated as of the date of grant using the Black-Scholes option-pricing model, based on the following inputs:

Year EndedDecember 31,

Expected term (in years) (a) 6.25 5.94 to 6.25

Risk-free interest rate (b) 0.38% to 0.47% 2.4% to 2.5%

Expected dividend yield (d) — —

Weighted-average grant-date fair value per stock option $ 4.16 $ 0.34

(a)Determined using the “simplified method” under applicable GAAP (SAB 107); the maximum contractual term of issued stock options is 10 years.

(b)Based upon the U.S. Treasury yields in effect during the period which the options were granted (for a period equaling the stock options’ expected term).

(c)Measured using the volatility of the stock price for the Company’s designated peer group of publicly-traded companies for a period equal to the expected option term.

(d)Tarsus does not expect to declare any cash dividends in the foreseeable future.

Stock Option Activity

Stock option activity during the years ended December 31, 2020 and 2019 was as follows:

Exercised —

Expired —

____________

(1)Represents the total difference between the estimated stock price fair value as of December 31, 2020 and the stock option exercise price, multiplied by the number of in-the-money options as of December 31, 2020. The amount of any intrinsic value will change in relation to any increases or decreases in the then-determined fair value of the Company’s common stock.

The total grant-date fair value of options that vested during the years ended December 31, 2020 and 2019 was $0.7 million and $33 thousand, respectively.

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The following table summarizes information with respect to stock option grants as of December 31, 2020:

Outstanding Exercisable

As of December 31, 2020, there was unrecognized compensation expense of $6.5 million related to unvested stock options, which the Company expects to recognize over a weighted average period of 2.8 years.

Early Exercise Feature of Certain Stock Options

The 2016 Plan permits certain option holders to exercise awarded options prior to vesting. Upon early exercise, the options become subject to a restricted stock agreement and remain subject to the same vesting provisions in the corresponding stock option award and unvested options are subject to repurchase by the Company upon termination at the same price exercised. These unvested shares are reported as issued, but not outstanding while subject to repurchase by the Company and are also excluded from the basic and diluted net loss per share calculation until the repurchase right lapses upon vesting.

The Company initially records a liability for these early exercises that is subsequently reclassified into stockholders’ equity on a pro rata basis as vesting occurs. As of December 31, 2020 the Company has recorded the unvested portion of the exercise proceeds of $0.4 million as a liability from the early exercise in the accompanying Balance Sheets. During the years ended December 31, 2019, the Company repurchased 26,927 of unvested common stock options from a former consultant in connection with termination of his consulting agreement. As of December 31, 2019, all stock options with early exercise features were either vested or immaterial if early exercised and the Company reported no corresponding liability in the accompanying Balance Sheets.

6. NET LOSS PER SHARE

Net loss per share attributable to common stockholders was computed by dividing net loss by the weighted-average number of common shares outstanding for the years ended December 31, 2020 and 2019:

Year Ended December 31,

The following outstanding potentially dilutive securities were excluded from the calculation of diluted net loss per share attributable to common stockholders because their impact under the “treasury stock method” and “if-converted method” would have been anti-dilutive for the periods presented:

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Year Ended December 31,

Series A and Series B Preferred Stock, outstanding — 1,922,491

Stock options early-exercised and unvested 179,375 4,300

Convertible promissory notes — 93,421

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7. FAIR VALUE MEASUREMENTS

The table below summarizes certain financial instruments measured at fair value that are included within the accompanying balance sheets, and their designation among the three fair value measurement categories (see Note 2(xiii)):

Fair Value Measurements

Level 1 Level 2 Level 3 Total

Assets:

Total assets measured at fair value $ 168,129 $ — $ — $ 168,129

Fair Value Measurements

Level 1 Level 2 Level 3 Total

Assets:

Total assets measured at fair value $ 57,952 $ — $ — $ 57,952

Money Market Funds

Money market fund holdings are included in cash and cash equivalents on the accompanying balance sheets and are classified within Level 1 of the fair value hierarchy because they have readily-available market prices in active markets that are publicly accessible at the measurement date. These money market funds are invested in U.S. Treasury bills and notes, and other obligations issued or guaranteed as to principal and interest by the U.S. Government or its agencies.

Convertible Promissory Notes – Derivative Liabilities

The following table sets forth a summary of the changes in fair value of the bifurcated derivative liability associated with the convertible promissory notes issued and settled during 2019 to certain related parties (see Note 8). The measurement of the derivative liabilities represents a Level 3 financial instrument:

DerivativeLiabilities

Fair value as of December 31, 2018 $ —

Initial fair value of derivative liability upon issuance of May 2019 Notes 28

Initial fair value of derivative liability upon issuance of August 2019 Notes 50

Settlement of derivative liabilities through conversion of all Notes (363)

Fair value as of December 31, 2019 $ —

The fair values of the derivative liabilities presented above were estimated at the date of issuance and at subsequent balance sheet dates using a two-step approach to valuation. Management utilized a probability-weighted valuation method and then compared the instrument’s value with-and-without the derivative features in order to estimate their combined fair value, using unobservable inputs, which are classified as Level 3 within the fair value hierarchy. The significant inputs not included in the market and thus represents a Level 3 measurement in the valuation approach included the probability of achieving a settlement that provides the note holders the rights or the obligations to receive cash or a variable number of shares upon the completion of a then-future capital transaction. The convertible notes were issued and settled in full during the year ended December 31, 2019 (see Note 8).

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8. CONVERTIBLE PROMISSORY NOTES PAYABLE

Overview of Notes and Conversion in December 2019

In May 2019, the Company entered into a Note Purchase Agreement (the “May 2019 Purchase Agreement”) with its co-founders and certain other related parties (the “Note Holders”). Under the terms of the May 2019 Purchase Agreement, the Company received cash proceeds of $0.5 million and issued $0.5 million of convertible promissory notes (the “May 2019 Notes”) with a stated maturity of December 2020. These notes bore interest at a rate of 8.0% per annum, compounded annually, and payable at maturity. In the event of a qualified equity financing, the outstanding principal of the May 2019 Notes plus all accrued and previously unpaid interest would, at the option of the holder, either (i) automatically convert into shares of stock issued in the qualified equity financing based on a conversion price equal to 90% of the issuance price paid by these new investors, or (ii) be repaid in full.

In August 2019, the Company amended and restated the May 2019 Purchase Agreement with the Note Holders and received an additional $0.5 million of proceeds and issued new $0.5 million convertible promissory notes to the same parties (the “August 2019 Notes”) with identical terms.

In October 2019, the Company entered into a new Note Purchase Agreement (the “October 2019 Purchase Agreement”) with the Note Holders. Under the terms of the October 2019 Purchase Agreement, the Company received proceeds of $1.0 million and issued $1.0 million of convertible promissory notes (the “October 2019 Notes,” collectively with the May 2019 Notes and the August 2019 Notes, the “Notes”) with a conversion price equal to 80% of the issuance price in a qualified equity financing.

In December 2019, the Company completed an issuance of Series B Preferred Stock (see Note 5). Upon this issuance, the $2.0 million of Note principal value, along with accrued interest, were converted into 0.3 million shares of Series B Preferred Stock under its contractual terms. The Company recorded “loss on extinguishment of convertible notes” (non-cash) of $0.3 million within “other income (expense)” in the accompanying Statements of Operations and Comprehensive Loss for the year ended December 31, 2019.

Embedded Derivative and its Accounting

The Notes allowed for redemption upon a qualified equity financing that was determined to be a contingent redemption feature that was not closely related to the Notes and was thus was required to be bifurcated as a derivative liability on the balance sheet. Based on the features of this derivative, the Company accounted for it as an implied discount in presenting the carrying value of these Notes. This discount was accreted over the term to maturity of the Notes using the effective interest method, resulting in aggregate interest expense recognition (non-cash) of $0.1 million for the year ended December 31, 2019. As the Notes were converted in December 2019, no interest expense was recorded for the year ended December 31, 2020.

Changes in the embedded derivatives’ fair value at each reporting period were recognized in the accompanying statements of operations and comprehensive loss within “changes in fair value of derivative liabilities,” resulting in incremental “other expense” recognition (non-cash) of $0.1 million for the year ended December 31, 2019. As the Notes were converted in December 2019, no other expense related to changes in fair value of derivative liabilities was recorded for the year ended December 31, 2020.

9. COMMITMENTS & CONTINGENCIES

(a) Facility Leases

Overview

In the ordinary course of business, the Company enters lease agreements with unaffiliated parties for the use of office and laboratory facilities and office equipment. As of December 31, 2019, the Company had one active facility lease in Irvine, California, that commenced on March 1, 2019 and expires April 30, 2022. This lease has a renewal option at the end of term, for which the Company was not reasonably certain to exercise at the lease commencement. As such, the renewal option

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was not included in the lease term used to calculate the right-of-use lease asset and lease liability. Prior to March 1, 2019, the Company did not have any material lease arrangements. As of December 31, 2020, the Company recorded an impairment of the operating lease right-of-use asset for this research and development facility of $15 thousand.

The Company entered into two additional facility leases that commenced on June 1, 2020 for adjacent administrative and laboratory suites in Irvine, California. These leases expire on January 31, 2024. Both of these leases included a renewal option at the end of its term, for which the Company was not reasonably certain to exercise at the lease commencement. As such, the renewal option was not included in the lease term used to calculate the right-of-use lease asset and lease liability. In connection with these two leases the Company capitalized right-of-use assets along with an accompanying lease liability of $0.7 million.

All of the Company’s facility leases have minimum annual rent, payable monthly, and carry fixed annual rent increases. Under the arrangements, real estate taxes, certain operating expenses, and common area maintenance are reimbursable to the lessor. These amounts are expensed as incurred, as they are variable in nature and therefore excluded from the measurement of the reported right-of-use asset and liability discussed below. During the years ended December 31, 2020 and 2019, the Company had no sublease arrangements with it as lessor.

Adoption of New Lease Standard, Topic 842

Beginning January 1, 2019, the Company adopted ASU 2016-02, Leases (“Topic 842”). Under this new lease accounting standard, the Company recognized a right-of-use asset and lease liability on the accompanying Balance Sheets for all material leases. Management elected the “modified retrospective approach” with an effective transition date of January 1, 2018 upon adoption and the available practical expedients. The Company also elected to (1) not separate “lease components” from “non-lease components” in the measurement of minimum payments for its leases and (2) not recognize a lease asset and liability for a term of 12 months or less. Lease expense is recognized on a straight-line basis over the expected term of the lease. In March 2019, the Company capitalized a right-of-use asset of $0.2 million along with an accompanying $0.2 million lease liability.

As part of applying Topic 842, the Company determines if an arrangement is or contains a lease and the classification of that lease at contract execution. The classification of leases as “operating” or “finance” leases along with the initial measurement and recognition of the associated right-of-use assets and lease liabilities is performed at the lease commencement date. The measurement of lease liabilities is based on the present value of future lease payments over the lease term. Since an implicit rate for the operating lease for the Company’s Irvine facility was not determinable and was not implicit in the lease, the Company calculated an estimated incremental borrowing rate based upon what it would have to pay to borrow on a collateralized bases over a similar term and amount equal to the lease payments in a similar economic environment. The right-of-use lease asset is based on the corresponding lease liability and adjusted for (i) applicable payments made at or before the commencement date, (ii) initial direct costs incurred, and (iii) tenant incentives provided by the lessor.

Components of Lease Expense

The liability associated with each lease is amortized over the respective lease term using the effective interest rate method. The Company’s right-of-use assets are amortized over the lease term on a straight-line basis to lease expense, as reported on an allocated basis within “research and development” and “general and administrative” expenses in the accompanying Statements of Operations and Comprehensive Loss. For the years ended December 31, 2020 and 2019 the Company recognized $0.2 million and $0.1 million for lease expense, respectively. The Company had $25 thousand of variable lease payments, including non-lease components such as common area maintenance fees recognized as lease expense for the year ended December 31, 2020. There wereno variable lease payments for the year ended December 31, 2019.

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Weighted-Average Remaining Lease Term and Applied Discount Rate

The Company had three active leases for its Irvine office and laboratory facility, with a remaining lease term of two years and four months as of December 31, 2019 and a remaining lease term of 1 year and 4 months as of December 31, 2020. The Company had two additional facility leases commence on June 1, 2020, with remaining lease terms of 3 years, 1 month as of December 31, 2020. The weighted-average estimated incremental borrowing rate of 10% was utilized to present value future minimum lease payments since an implicit interest rate was not readily determinable for each lease. The weighted average remaining lease term for the Company’s leases as of December 31, 2020 is 2 years, 10 months.

Future Contractual Lease Payments as of December 31, 2020

The below table summarizes the (i) minimum lease payments over the next five years and thereafter, (ii) lease arrangement imputed interest, and (iii) present value of future lease payments:

Operating Leases - future payments December 31, 2020

Total future lease payments, undiscounted $ 953

(Less): Imputed interest (122)

Present value of operating lease payments $ 831

(b) In-License Agreements for Lotilaner

Skin and Eye Disease or Conditions in Humans

In January 2019, the Company entered into a license agreement with Elanco Tiergesundheit AG (“Elanco”), granting it a worldwide license to certain intellectual property for the development and commercialization of lotilaner for the treatment or cure of any eye or skin disease or condition in humans (the "January 2019 Agreement"). The Company has sole responsibility for related development, regulatory, and commercialization activities.

The Company paid a $1.0 million upfront payment at the execution of the January 2019 Agreement, which is reported within “research and development” expense within the accompanying Statements of Operations and Comprehensive Loss for the year ended December 31, 2019. The Company also paid a required $1.0 million clinical milestone payment in the September 2020 as part of an achieved Phase 2b/3 clinical trial milestone for the treatment of Demodex blepharitis; this amount is reported within “research and development” expense within the accompanying Statements of Operations and Comprehensive Loss for year ended December 31, 2020.

The Company will make further payments to Elanco pursuant to the January 2019 Agreement upon achievement of various clinical milestones for an aggregate maximum of $5.0 million and various commercial and sales threshold milestones for an aggregate maximum of $79.0 million. In addition, the Company will be obligated to pay contractual royalties to Elanco in the single digits of its net sales. If the Company receives payments from any sublicensees, it will be obligated to pay Elanco a variable percentage in the low to mid double-digits of such proceeds, except for territories in which the Company achieved applicable regulatory approval prior to sublicense execution.

All Other Disease or Conditions in Humans

In September 2020, the Company executed an expanded license agreement with Elanco, granting it a worldwide license to certain intellectual property for the development and commercialization of lotilaner treatment or cure of all other diseases and conditions in humans – beyond that of the eye or skin (the “September 2020 Agreement”).

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The Company issued Elanco 222,460 shares of its common stock as consideration for the license at the execution of the September 2020 Agreement. The value of these shares was $3.1 million ($14.0003 per share, approximating the Company's Series C preferred stock issuance price – see Note 4) and is reported within “research and development” expense within the accompanying Statements of Operations and Comprehensive Loss for the year ended December 31, 2020. In addition, in March 2021, the Company agreed to issue 187,500 shares of its common stock to Elanco during the second quarter of 2021 to maintain the September 2020 Agreement.

The Company recorded the transaction as an asset acquisition as substantially all of the fair value of the gross assets acquired were concentrated in a group of similar identifiable assets thus satisfying the requirements of the screen test in ASU 2017-01. The assets acquired in the transaction were measured based on the upfront payment to Elanco and the fair value of the common stock shares issued to Elanco, as the fair value of the consideration given was more readily determinable than the fair value of the assets received. Because the assets have not yet received regulatory approval and have no alternative future use, the fair value attributable to these assets were recorded as research and development expenses.

The Company will make further payments to Elanco under the September 2020 Agreement upon achievement of various clinical milestones for an aggregate maximum of $4.5 million, and various commercial and sales threshold milestones for an aggregate maximum of $77.0 million. In addition, the Company will be obligated to pay contractual royalties to Elanco in the single digits of its net sales. If the Company receives payments from any sublicensees, it will be obligated to pay Elanco a variable percentage in the low to mid double-digits of such proceeds, except for territories in which the Company achieved applicable regulatory approval prior to sublicense execution.

(c) Clinical Research Organization and Contract Manufacturer Agreements

We enter into contracts in the normal course of business with clinical research organizations and clinical sites and with contract manufacturers for pre-clinical and clinical drug supply, as well as with various other vendors in operating our business. These contracts generally provide for termination provisions with requisite notice.

(d) Employment Agreements

The Company has entered into employment agreements with four of its named executive officers. These agreements provide for the payment of certain benefits upon separation of employment under specified circumstances, such as in connection with a change in control event or other significant transaction.

(e) Other Contingencies

From time to time, the Company may be subject to various litigation and related matters arising in the ordinary course of business. The Company is currently not aware of any such matters where there is at least a reasonable possibility that a material loss has been or will be incurred for financial statement recognition.

(f) Indemnities and Guarantees

The Company has certain indemnity commitments, under which it may be required to make payments to its officers and directors in relation to certain transactions to the maximum extent permitted under applicable laws. The duration of these indemnities varies, and in certain cases, is indefinite and does not provide for any limitation of maximum payments. The Company has not been obligated to make any such payments to date and no liabilities have been recorded for this contingency in the accompanying balance sheets.

10. INCOME TAXES

A reconciliation of income taxes was computed by applying the federal statutory income tax rate in each period to the pretax loss for the years ended December 31, 2020 and 2019, and adjusted for certain classes of transactions, as summarized below:

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Year EndedDecember 31,

Expected tax benefit at statutory rate $ (5,630) $ (981)

State income tax, net of federal benefit 1 1

Permanent items 5 4