Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion and analysis together with the consolidated financial statements and related notes included elsewhere herein.
This report includes forward-looking statements which, although based on assumptions that we consider reasonable, are subject to risks and uncertainties which could cause actual events or conditions to differ materially from those currently anticipated and expressed or implied by such forward-looking statements.
Overview
Arcturus is a global clinical-stage messenger RNA medicines company focused on the development of infectious disease vaccines and significant opportunities within liver and respiratory rare diseases. In addition to our mRNA platform, our proprietary lipid nanoparticle delivery system, LUNAR, has the potential to enable multiple nucleic acid medicines, and our proprietary STARR technology has the potential to provide longer-lasting RNA and sustained protein expression.
Our key proprietary technology has the potential to address the major hurdles in RNA development, namely the effective and safe delivery of RNA therapeutics to disease-relevant target tissues. We believe that the versatility of our platform to target multiple tissues, its compatibility with various nucleic acid therapeutics, and our expertise in developing scalable manufacturing processes put us in a good position to deliver on the next generation of nucleic medicines.
In August 2020, we announced the dosing of all subjects in the first cohort of the Phase 1 clinical study of our LUNAR-COV19 vaccine candidate. The study was conducted with CTI Clinical Trial and Consulting Services, a global CRO, and in collaboration with Duke-NUS Medical School in Singapore. In December 2020, we announced that we received approval from the Singapore HSA to proceed with a Phase 2 clinical study of the LUNAR-COV19 vaccine candidate.
Additionally, in October 2020, we announced the completion of the first three dose escalation cohorts in our ongoing Phase 1 study of ARCT-810, our messenger RNA-based therapeutic candidate for OTC deficiency.
Our activities since inception have consisted principally of performing research and development activities, general and administrative activities and raising capital to fund those efforts. Our activities are subject to significant risks and uncertainties, including failing to secure additional funding before we achieve sustainable revenues and profit from operations. As of December 31, 2020, we had an accumulated deficit of $143.8 million.
Liquidity and Capital Resources
Overview
Since our inception, we have funded our operations principally with proceeds from the sale of capital stock and revenues earned through collaborative agreements. At December 31, 2020, we had $462.9 million in unrestricted cash and cash equivalents.
On October 12, 2018, we entered into a Loan and Security Agreement with Western Alliance Bank whereby we received gross proceeds of $10.0 million under a long-term debt agreement (the “Loan”).
On October 30, 2019, we and the Bank entered into a Third Amendment (the “Third Amendment”) to the Loan and Security Agreement dated as of October 12, 2018 (as amended, the “Loan Agreement”).
Pursuant to the Third Amendment, the Bank agreed to make a term loan to us on October 30, 2019, in the amount of $15.0 million (the “Term Loan”). The resulting net increase in the indebtedness of us was $5.0 million. The Term Loan bears interest at a floating rate ranging from 1.25% to 2.75% above the prime rate. The amendment further provides that the Term Loan has a maturity date of October 30, 2023. We shall make monthly payments of interest only until the interest-only end date of October 1, 2021 and thereafter shall make monthly payments of principal and interest during a 24-month amortization period. Upon maturity or prepayment, we will be required to pay a 2% fee as a result of the FDA’s approval to proceed with the Company’s LUNAR-OTC (ARCT-810) program based on its IND submission.
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On March 4, 2020, we w ere awarded a grant (the “Grant”) from the Singapore E DB to support the co-development of a potential COVID-19 vaccine with the Duke-NUS Medical School. The Grant provides for up to S$ 14.0 million (approximately US$ 10. 0 million using the exchange rate at the time the grant contract was entered into) in grants to support the development of the vaccine. We entered into an amendment to the Grant on September 24, 2020 to update certain delivery and milestone timelines. The Grant has been paid in full by the EDB as a result of the achievement of certain milestones related to the progress of the development of the vaccine, as set forth in the award agreement. The funds received have been recognized as contra research and development expense in proportion to the percentage covered by the E DB of the overall budget. We are liable for certain expenses during the program and are also subject to certain conditions, including (i) completing an external audit within 183 days of the conclusion of the claim period on February 20, 2021, or August 22, 2021, and (ii) delivering 10 grams of LUNAR-COV19 vaccine candidate suitable for use in a phase 3 trial in two shipments with a partial shipment by June 30, 2021 and a remaining shipment by September 30, 2021 . Additionally, we are required to pay an agreed upon royalty rate to Duke-NUS on future net sales of the LUNAR-COV19 vaccine candidate in markets or jurisdictions outside of Singapore .
On October 2, 2020, we were awarded another grant from the Singapore EDB to support the further development of a potential COVID-19 vaccine. The grant provides for up to S$9.3 million (approximately US$6.7 million) to support the development of the vaccine candidate for costs incurred in Singapore subject to certain conditions including (i) completing an external audit within 183 days from March 31, 2021, or September 30, 2021, (ii) delivering 10 grams of LUNAR-COV19 vaccine candidate suitable for use in a phase 3 trial in two shipments with a partial shipment by June 30, 2021 and a remaining shipment by September 30, 2021 and (iii) creating an entity in Singapore which was completed during the fourth quarter of 2020. The grant will be paid in two installments upon the achievement of certain milestones related to the progress of the development of the vaccine candidate. We received the first installment of $3.6 million in the fourth quarter of 2020.
On November 7, 2020, we entered into a Manufacturing Support Agreement (the “Support Agreement”) with the Economic Development Board of the Republic of Singapore (the “EDB”). Pursuant to the Support Agreement, the EDB agreed to make a term loan of up to S$62.1 million , subject to the satisfaction of customary deliveries, to support the manufacture of the LUNAR-COV19 vaccine candidate (the “Singapore Loan”). The Singapore Loan and the related side letter includes certain loan covenants requiring (i) unused funds as of June 30, 2021 to be subsequently returned within thirty days, subject to the agreed upon extension of the reconciliation date, (ii) us to provide a quarterly reconciliation report within forty-five days of each financial quarter end, (iii) an external audit to be completed by September 26, 2021, (iv) us to deliver 10 grams of the LUNAR-COV19 vaccine candidate suitable for use in a phase 3 trial in two shipments with a partial shipment by June 30, 2021 and a remaining shipment by September 30, 2021, and (v) us to provide EDB with a right of first refusal on GMP manufacturing slots of the LUNAR-COV19 vaccine candidate up to an agreed-upon maximum amount. We elected to borrow the full amount available under the Support Agreement of S$62.1 million, or $46.6 million, as a result of applicable exchange rates, on January 29, 2021.
The Singapore Loan accrues interest at a rate of 4% per annum calculated on a daily basis. Subject to certain exceptions, the Singapore Loan is intended to be a limited recourse loan that will be repaid solely through a royalty payment of 10% of net sales proceeds of the LUNAR-COV19 vaccine candidate, up to the amount of the outstanding principal and interest under the Singapore Loan. However, all unpaid principal and interest under the Singapore Loan will be due and payable five years after the borrowing date, if net sales of the LUNAR-COV19 vaccine exceed a certain minimum threshold during this five year period or we obtain clearance to sell the vaccine in specified jurisdictions. Unpaid principal and interest under the Singapore Loan will also become due and payable upon an event of default under the Support Agreement. The first vaccine sales, including the amount of net sales, shall be reported to EDB within 10 days of delivery and quarterly reports of aggregate vaccine sales, including net sales proceeds shall be provided within 30 days after quarter end.
If any portion of the Singapore Loan is required to be forgiven pursuant to the terms of the Support Agreement, the EDB has the right to take ownership of certain raw materials and equipment that were purchased by us with proceeds of the Singapore Loan (the “Specified Assets”). We entered into a security agreement (the “Security Agreement”) for the benefit of the EDB to provide that repayment of the Singapore Loan and related obligations are secured by a lien on the Specified Assets.
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In connection with the entry into the Support Agreement, we entered into a consent agreement with Western Alliance Bank and an amendment to the Loan and Security Agreement, dated as of October 12, 2018, to exclude the Specified Assets from Western Alliance Bank’s lien on certain assets of Arcturus .
A significant portion of our current cash balance of $462.9 million along with the $46.6 million from the Singapore Loan is expected to be utilized during fiscal year 2021 to fund (i) the Phase 2 trial and anticipated Phase 3 trial of our current LUNAR-COV19 vaccine candidate, (ii) the continued Phase 1 trial and anticipated Phase 2 trial of ARCT-810, our LUNAR-OTC candidate, (iii) advancing our new LUNAR-FLU program toward submission of an IND, (iv) and other programs and administrative costs.
The Phase 3 trial of our LUNAR-COV19 vaccine candidate is expected to be funded primarily or exclusively through our cash reserves. If we achieve EUA approval to market our LUNAR-COV19 vaccine candidate, we will need to raise additional funds through equity transactions, additional debt or prepayments from potential customers, among other options, to fund commercialization of LUNAR-COV19.
If we are unable to maintain sufficient financial resources, our business, financial condition and results of operations will be materially and adversely affected. There can be no assurance that we will be able to obtain additional needed financing on acceptable terms or at all. Additionally, equity or debt financings may have a dilutive effect on the holdings of our existing shareholders. Our future capital requirements are difficult to forecast and will depend on many factors.
We expect to continue to incur additional losses for the foreseeable future, and we will need to raise additional debt or equity financing or enter into additional partnerships to fund development. The ability of our Company to transition to profitability is dependent on identifying and developing successful mRNA drug candidates. In the near future, if we are not able to achieve planned milestones, incur costs in excess of our forecasts, or do not meet covenant requirements of our debt, we will need to reduce discretionary spending, discontinue the development of some or all of our products, which will delay part of our development programs, all of which will have a material adverse effect on our ability to achieve our intended business objectives.
The following table shows a summary of our cash flows for the year ended December 31, 2020, 2019 and 2018 (in thousands):
Year Ended December 31,
(Dollars in thousands)
2020
2019
2018
Cash provided by (used in):
Operating activities
$
(42,861
)
$
(6,445
)
$
(20,760
)
Investing activities
(1,742
)
(818
)
22,134
Financing activities
436,145
41,907
10,204
Net increase in cash and restricted cash
$
391,542
$
34,644
$
11,578
Operating Activities
Our primary use of cash is to fund operating expenses, which consist mainly of research and development and general and administrative expenditures. We have incurred significant expenses which have been partially offset by cash collected through our collaboration agreements. Cash collections under the collaboration agreements can vary from year to year depending on the terms of the agreement and work performed. These changes on cash flows primarily relate to the timing of cash receipts for upfront payments, reimbursable expenses and achievement of milestones under these collaborative agreements.
Net cash used in operating activities was $42.9 million on a net loss of $72.1 million for 2020, $6.4 million on a net loss of $26.0 million for 2019 and $20.8 million on a net loss of $21.8 million for 2018. Adjustments for non-cash charges which includes share-based compensation expense and depreciation and amortization were $8.1 million for 2020, $3.6 million for 2019 and $2.2 million for 2018. Changes in working capital resulted in adjustments to operating net cash inflows of $21.2 million for 2020, net cash inflows of $16.0 million for 2019, and net cash outflows of $1.2 million for 2018. The significant adjustments to operating net cash inflows for 2020 were primarily due to the supply agreement with Israeli MOH signed in the third quarter of 2020 along with increased accounts payable and accrued liabilities from LUNAR-COV19 (ARCT-021) and LUNAR-OTC (ARCT-810) clinical trial activities, which expenses were incurred as discussed below .
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Investing Activities
Net cash used in investing activities of $1.7 million for 2020 and $0.8 million for 2019 reflected the acquisition of property and equipment. Net cash provided by investing activities of $22.1 million for 2018 reflected proceeds from the maturities of our short-term investments of $30.2 million, offset by purchases of short-term investments of $6.6 million, and cash used to purchase property and equipment of $1.5 million.
Financing Activities
Net cash provided by financing activities of $436.1 million for 2020 consisted of net proceeds from the issuance of common stock in three underwritten public offerings of $423.8 million, net proceeds of $9.6 million from the issuance of common stock to Ultragenyx upon exercise of its option and proceeds from the exercise of stock options of $2.7 million. Net cash provided by financing activities of $41.9 million for 2019 consisted of net proceeds from the issuance of common stock of $15.5 million to Ultragenyx, net proceeds from the issuance of common stock of $21.3 million related to public offerings, net proceeds from long-term debt of $4.9 million, and proceeds from the exercise of stock options of $0.1 million. Net cash provided by financing activities of $10.2 million for 2018 consisted of net proceeds from the exercise of stock options of $0.3 million and net proceeds from long-term debt of $9.9 million.
Funding Requirements
We anticipate that we will continue to generate annual net losses for the foreseeable future, and we expect the losses to increase as we continue the development of, and seek regulatory approvals for, our product candidates, and begin commercialization of our products. As a result, we will require additional capital to fund our operations in order to support our long-term plans. We believe that our current cash position will be sufficient to meet our anticipated cash requirements through at least the next twelve months , assuming, among other things, no significant unforeseen expenses, continued funding from partners at anticipated levels and our payment obligations under our long-term credit facility referenced in Note 7 to our Consolidated Financial Statements continuing following the current maturity schedule. We intend to seek additional capital through equity and/or debt financings, collaborative or other funding arrangements with partners or through other sources of financing. Should we seek additional financing from outside sources, we may not be able to raise such financing on terms acceptable to us or at all. If we are unable to raise additional capital when required or on acceptable terms, we may be required to scale back or discontinue the advancement of product candidates, reduce headcount, liquidate our assets, file for bankruptcy, reorganize, merge with another entity, or cease operations.
Our future funding requirements are difficult to forecast and will depend on many factors, including the following:
•
the development of ARCT-021, our LUNAR-COV19 vaccine candidate;
•
the achievement of milestones under our strategic alliance agreements;
•
the terms and timing of any other strategic alliance, licensing and other arrangements that we may establish;
•
the initiation, progress, timing and completion of preclinical studies and clinical trials for our product candidates;
•
the number and characteristics of product candidates that we pursue;
•
the outcome, timing and cost of regulatory approvals;
•
delays that may be caused by changing regulatory requirements;
•
the cost and timing of hiring new employees to support our continued growth;
•
the costs involved in filing and prosecuting patent applications and enforcing and defending patent claims;
•
the costs and timing of procuring clinical and commercial supplies of our product candidates;
•
the costs and timing of establishing sales, marketing and distribution capabilities;
•
the costs associated with legal proceedings;
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•
the costs associated with potential litigation related to collaboration agreements; and
•
the extent to which we acquire or invest in businesses, products or technologies.
Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the consolidated financial statements included in this Annual Report. Our historical results of operations and the year-to-year comparisons of our results of operations that follow are not necessarily indicative of future results.
Revenues
We enter into arrangements with pharmaceutical and biotechnology partners and government agencies that may contain upfront payments, license fees for research and development arrangements, research and development funding, milestone payments, option exercise and exclusivity fees and royalties on future sales. The following table summarizes our total revenues for the periods indicated (in thousands):
Year Ended December 31,
(Dollars in thousands)
2020
2019
2018
Collaboration revenue
$
9,539
$
20,789
$
15,753
Collaboration revenue decreased by $11.3 million during the year ended December 31, 2020 as compared to the year ended December 31, 2019. The decrease in collaboration revenue primarily relates to (i) $5.6 million of decreased revenue from reduced reimbursements associated with the CureVac co-development agreement that terminated in the second quarter of 2019, (ii) a decrease in one-time sublicense revenue from Synthetic Genomics as we recognized sublicense revenue of $3.3 million during the second quarter of 2019, (iii) a reduction of $1.9 million in revenue recognized related to the Ultragenyx Agreement, as we recorded a large amount of upfront payment amortization upon the execution of the Ultragenyx Third Amendment during the second quarter of 2019 and also recognized fewer research and development expense reimbursements related to the Ultragenyx Agreement during 2020, and (iv) lower research and development expense reimbursements recognized in 2020 related to other collaboration agreements, including with Providence Therapeutics and Takeda. The decrease in collaboration revenue was partially offset by increased revenue recognition related to the Janssen agreement and other collaboration agreements.
Collaboration revenue increased by $5.0 million during the year ended December 31, 2019 as compared to the year ended December 31, 2018. The increase in revenue during the year was caused by a ramp up in activities on the Janssen collaboration agreement which led to an increase in revenue of $1.7 million. Additionally, an increase of $2.2 million was due to settling the terminated co-development program with CureVac (as discussed in the following paragraph) along with an increase in amortized revenue that was previously deferred. Lastly, there was an increase in revenue from Synthetic Genomics Inc. of $2.1 million due to recognizing revenue related to a sublicense payment during the year. These increases were primarily offset by negligible decreases from various programs and decreased revenue of $0.9 million associated with Ultragenyx as the collaboration agreement had less activity compared to the prior year.
Operating Expenses
Our operating expenses consist of research and development and general and administrative expenses.
Year Ended December 31,
(Dollars in thousands)
2020
2019
2018
Operating expenses:
Research and development, net
$
57,846
$
33,640
$
16,982
General and administrative
23,217
12,662
20,582
Total
$
81,063
$
46,302
$
37,564
75
The following table presents our total research and development expenses by category:
Year Ended December 31,
(Dollars in thousands)
2020
2019
2018
External pipeline development expenses:
LUNAR-OTC (ARCT-810)
$
13,008
$
15,616
$
3,699
LUNAR-CF (ARCT-032), net
4,405
813
337
LUNAR-COV19 (ARCT-021), net
20,896
—
—
Discovery technologies
1,748
3,937
2,943
External platform development expenses:
Partnered discovery technologies
1,515
1,894
1,979
Total development expenses
$
41,572
$
22,260
$
8,958
Personnel related expenses
$
12,824
$
9,005
$
6,533
Facilities and equipment expenses
3,450
2,375
1,491
Total research and development
expenses, net
$
57,846
$
33,640
$
16,982
Research and Development Expenses, net
Our research and development expenses consist primarily of external manufacturing costs, in-vivo research studies performed by contract research organizations, clinical and regulatory consultants, personnel related expenses and laboratory supplies related to conducting research and development activities. Costs to acquire and manufacture pre-launch inventory, mRNA supply for preclinical studies and clinical trials are recognized and included in external pipeline development expenses for the specific program.
The IND for our LUNAR-OTC program was accepted by the FDA in April 2020. However, the ongoing pandemic has delayed patient enrollment, resulting in lower clinical costs. As a result, LUNAR-OTC expenses for the year ended December 31, 2020 decreased by $2.6 million as compared to the year ended December 31, 2019. LUNAR-OTC expenses for the year ended December 31, 2019 increased by $11.9 million as compared to the year ended December 31, 2018. The increase from 2018 to 2019 was due primarily to preparation for an IND application, which was submitted during the first quarter of 2020.
LUNAR-CF expenses were $4.4 million in the year ended December 31, 2020, $0.8 million in the year ended December 31, 2019 and $0.3 million in the year ended December 31, 2018. The increase in LUNAR-CF expenses from 2018 to 2019 and from 2019 to 2020 was due primarily to the amendment to the CFF Agreement executed in July 2019, and we expect that our development efforts and associated costs will increase over the next several years as the LUNAR-CF program moves toward expected IND submission in 2022. These amounts are net of funds awarded by the CFF.
In March 2020, we signed a contract for approximately $10.0 million (using the exchange rate at the time the grant contract was entered into) with the Singapore Economic Development Board that will fund a portion of the costs incurred in our LUNAR-COV19 program. In October 2020, we entered into an additional grant agreement for approximately $6.7 million (using the exchange rate at the time the grant contract was entered into). We expect that the program costs and pre-launch inventory costs will continue to increase as clinical trials progress and we advance program development. The research and development costs were $20.9 million for the year ended December 31, 2020. There were no comparable costs in 2019 or 2018.
Discovery technologies represents our efforts to expand our product pipeline. Discovery technology expenses were $1.7 million in the year ended December 31, 2020, $3.9 million in the year ended December 31, 2019 and $2.9 million in the year ended December 31, 2018. The decrease in discovery technology expenses from 2019 to 2020 was due to focusing our efforts on the advancement of our LUNAR-OTC and LUNAR-COV19 programs. The increase in discovery technology expenses from 2018 to 2019 was due to additional efforts to add new capabilities necessary to expand our future platform technology and discovery of our next programs. These efforts have resulted in new programs such as STARR technology.
Partnered discovery technologies expenses were $1.5 million in the year ended December 31, 2020, $1.9 million in the year ended December 31, 2019 and $2.0 million in the year ended December 31, 2018. The decrease
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in p artnered discovery technologies expen ses from 2019 to 2020 was primarily caused by a decrease in activity relating to our collaboration with Takeda . We expect partnered discovery technologies expenses to fluctuate based on the needs of our collaboration partners.
Personnel related expenses, net of funds received from CFF and the Singapore EDB, were $12.8 million in the year ended December 31, 2020, $9.0 million in the year ended December 31, 2019 and $6.5 million in the year ended December 31, 2018. The increase in personnel related expenses from 2019 to 2020 was primarily due to (i) increased headcount related to the addition of our LUNAR-COV19 program and (ii) increased share-based compensation expense resulting from our increased stock price in 2020. The increase in personnel related expenses from 2018 to 2019 was due primarily to increased headcount necessary to advance our external pipeline and platform efforts. We expect personnel related expenses to increase in 2021 as we expand our headcount to execute our business plan.
Facilities and equipment expenses were $3.5 million in the year ended December 31, 2020, $2.4 million in the year ended December 31, 2019 and $1.5 million in the year ended December 31, 2018. The increase in facilities and equipment expenses from 2019 to 2020 was primarily due to the lease of a second building entered into in early 2020. The increase in facilities and equipment expenses from 2018 to 2019 was due primarily to higher rent and related costs associated with our headquarter lease.
General and Administrative Expenses
General and administrative expenses consist primarily of salaries and related benefits for our executive, administrative and accounting functions and professional service fees for legal and accounting services as well as other general and administrative expenses.
General and administrative expenses were $23.2 million in the year ended December 31, 2020, $12.7 million in the year ended December 31, 2019 and $20.6 million in the year ended December 31, 2018. The increase in general and administrative expenses from 2019 to 2020 was primarily caused by (i) a $5.9 million increase in personnel related expenses due to increased headcount and increased share-based compensation, (ii) a $1.6 million increase in facilities and insurance expenses due to the execution of a new lease agreement and (iii) a $2.3 million increase in professional fees due to a $2.4 million insurance settlement received in 2019 relating to the proxy matter that was recorded as contra-general and administrative expense. The decrease in general and administrative expenses from 2018 to 2019 was primarily due to (i) non-recurring proxy, legal and related costs incurred in 2018 of $7.3 million, which did not recur in 2019, and (ii) the insurance settlement of $2.4 million relating to the proxy matter that was recorded as contra-G&A expense when it was received in 2019, offset by increases in personnel costs of $1.1 million, public company related expenses of $0.4 million, and facilities and other costs of $0.3 million. Without the effect of the one-time proxy costs, general and administrative expenses would have been relatively consistent between 2018 and 2019. We expect general and administrative expenses to increase in 2021 as we expand our headcount, facilities and professional services to execute our business plan.
Finance income (expense), net
Year Ended December 31,
(Dollars in thousands)
2020
2019
2018
Finance income (expense), net:
Interest income
$
470
$
408
$
514
Interest expense
(831
)
(854
)
$
(186
)
Total
$
(361
)
$
(446
)
$
328
Interest income is generated on cash and cash equivalents. For the year ended December 31, 2020, the increase in interest income compared to the year ended December 31, 2019 resulted from increased interest on bank deposits due to higher cash balances, partially offset by lower interest rates earned. For the year ended December 31, 2019, the decrease in interest income compared to the year ended December 31, 2018 resulted from decreased investments.
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Interest expense relates to the long-term debt with Western Alliance Bank. Interest expense was relatively flat for the year ended 20 20 as compared to 201 9 . The increase in i nterest expense for the year ended 2019 as compared to 2018 was due to an entire year of interest incurred during 2019 versus one quarter of interest incurred during the fourth quarter of 2018.
Critical Accounting Policies and Estimates
We prepare our consolidated financial statements in conformity with accounting principles generally accepted in the United States (“U.S. GAAP”). As such, we make certain estimates, judgments and assumptions that we believe are reasonable, based upon information available to us. These judgments involve making estimates about the effect of matters that are inherently uncertain and may significantly impact our results of operations and financial condition. We describe our significant accounting policies more fully in Note 2 to our consolidated financial statements for the year ended December 31, 2020. In the following paragraphs, we describe the specific risks associated with these critical accounting policies and we caution that future events may not reflect exactly as one may expect, and that best estimates may require adjustment.
The following are our significant accounting policies which we believe are the most critical to aid in fully understanding and evaluating our reported financial results.
Revenue Recognition
Research and development revenue under collaborative agreements
We recognize R&D revenue from several collaboration agreements. Our collaboration agreements typically contain promised goods and services, including technology licenses or options to obtain technology licenses, R&D services, and manufacturing services. Upon entering into a collaboration agreement, we are required to make the following judgments:
Identifying the performance obligations contained in the agreement
Our assessment of what constitutes a separate performance obligation requires us to apply judgment. Specifically, we are required to identify which goods and services we are required to provide under the contract are distinct, if any.
Determining the transaction price, including any variable consideration
To determine the transaction price, we review the amount of consideration we are eligible to earn under the agreement. We do not typically include any payments we may receive in the future in our initial transaction price since the payments are typically not probable because they are contingent upon certain future events.
We are required to reassess the total transaction price at each reporting period to determine if we should include additional payments that have become probable in the transaction price.
Allocating the transaction price to each of our performance obligations
If we were to allocate the transaction price to more than one performance obligation, we would make estimates of the relative stand-alone selling price of each performance obligation, as it is not typical for us to sell our goods or services on a stand-alone basis. The estimate of the relative stand-alone selling price would require us to make significant judgments. To date, we have not entered into a collaboration agreement with more than one performance obligation.
The R&D revenue we recognize each period is comprised of several types of revenue, including amortization from upfront payments, milestone payments, option exclusivity fees and other services. Each of these types of revenue require us to make various judgments and estimates.
Amortization from Upfront Payments
For certain agreements, we recognize revenue from the amortization of upfront payments as we perform R&D services. We use an input method to estimate the amount of revenue to recognize each period. This method requires us to make estimates of the total costs we expect to incur in order to complete our promised R&D services or the total length of time it will take us to complete our promised R&D services. If we change our estimates, we may have to adjust our revenue.
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Milestone Payments
When recognizing revenue related to milestone payments, we typically judge and estimate whether the milestone payment is probable (discussed in detail above under “Determining the transaction price, including any variable consideration”).
Research and Development Expenses, Including Clinical Trial Accruals/Expenses
Research and development costs consist of salaries and benefits, including related stock-based compensation, laboratory supplies and facility costs, as well as fees paid to other entities that conduct certain research and development activities on our behalf, such as clinical research organizations, or CROs, and contract manufacturing organizations, or CMOs. Research and development costs are expensed as incurred.
Clinical trial expenses are a significant component of research and development expenses, and we outsource a significant portion of these clinical trial activities to third parties. Third-party clinical trial expenses include investigator fees, site and patient costs, CRO costs, and costs for central laboratory testing and data management. The accrual for site and patient costs includes inputs such as estimates of patient enrollment, patient cycles incurred, clinical site activations, and other pass-through costs. These inputs are required to be estimated due to a lag in receiving the actual clinical information from third parties. Payments for these activities are based on the terms of the individual arrangements, which may differ from the pattern of costs incurred, and are reflected on the balance sheets as prepaid assets or accrued expenses. These third-party agreements are generally cancelable, and related costs are recorded as research and development expenses as incurred. Non-refundable advance clinical payments for goods or services that will be used or rendered for future research and development activities are recorded as a prepaid asset and recognized as expense as the related goods are delivered or the related services are performed. When evaluating the adequacy of the accrued expenses, we analyze progress of the studies, including the phase or completion of events, invoices received and contracted costs. Significant judgments and estimates may be made in determining the accrued balances at the end of any reporting period. Actual results could differ from the estimates made. Our historical clinical accrual estimates have not been materially different from our actual costs.
Off-balance sheet arrangements
None.