Arcus Biosciences, Inc. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations. You should read the following discussion and analysis of our financial condition and results of operations together with our unaudited condensed consolidated financial statements and notes thereto in Part I, Item 1 of this Quarterly Report on Form 10-Q and with our audited consolidated financial statements and notes thereto for the year ended December 31, 2020, included in our Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission (SEC) on February 25, 2021. This discussion and other parts of this report contain forward-looking statements that involve risk and uncertainties, such as statements of our plans, objectives, expectations, and intentions. Further, statements that “we believe” and similar statements reflect our beliefs and opinions on the relevant subject. These statements are based upon information available to us as of the date of this Quarterly Report on Form 10-Q, and while we believe such information forms a reasonable basis for such statements, such information may be limited or incomplete, and our statements should not be read to indicate that we have conducted an exhaustive inquiry into, or review of, all potentially available relevant information. Our actual results could differ materially from those discussed in these forward-looking and other statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in the section of this report entitled “Risk Factors.” Overview We are a clinical-stage biopharmaceutical company focused on creating best-in-class cancer therapies. Our initial focus has been on well-characterized biological pathways with significant scientific data supporting their importance. We have built a robust and highly efficient drug discovery capability to create highly differentiated small molecules, which we have the ability to develop in combinations with our monoclonal antibodies through rationally designed, indication-specific clinical trial designs. Our vision is to create, develop and commercialize highly differentiated combination cancer therapies. We currently have five investigational products in clinical development. In 2020, we entered into an Option, License and Collaboration Agreement (Gilead Collaboration Agreement) with Gilead Sciences, Inc. (Gilead), whereby Gilead obtained rights to zimberelimab and a time-limited exclusive option to all of our current and future programs during the 10-year collaboration term. For each program to which Gilead exercises their option, the parties will co-develop globally and co-commercialize in the U.S., subject to certain exceptions, and Gilead will have the right to commercialize the program outside of the United States, subject to the rights of our existing partners to certain territories. In 2017, we entered into an Option and License Agreement (Taiho Agreement) with Taiho Pharmaceutical Co., Ltd. (Taiho) pursuant to which Taiho has a time-limited option to exclusively license the development and commercialization rights to each of our programs for Japan and certain other territories in Asia (excluding China). To date, Taiho has exercised their option rights to our adenosine receptor antagonist program (including etrumadenant) and our anti-PD-1 program (including zimberelimab). Domvanalimab (formerly referred to as AB154), our anti-TIGIT monoclonal antibody, is being evaluated in combination with zimberelimab with or without etrumadenant vs. zimberelimab monotherapy in ARC-7, our randomized Phase 2 trial in first-line metastatic PD-L1 ≥ 50% non-small cell lung cancer. In February 2021, we initiated ARC-10, our first registrational trial evaluating domvanalimab in combination with zimberelimab and zimberelimab monotherapy vs. chemotherapy in this same setting. Etrumadenant (formerly referred to as AB928), our small molecule dual A 2a /A 2b adenosine receptor antagonist, is being evaluated by us in several randomized or Phase 2 trials across major tumor types, including in our ARC-4, ARC-6, ARC-7, and ARC-9 studies, as well as in two randomized Phase 1b/2 trials being conducted by Genentech (the Morpheus trials). AB680, our small-molecule CD73 inhibitor, is being evaluated in a Phase 1/1b study for the treatment of first-line metastatic pancreatic cancer (ARC-8) as well as late-line metastatic prostate cancer (ARC-6). Zimberelimab (formerly referred to as AB122), our anti-PD-1 monoclonal antibody, is the cornerstone of our combination strategy. We are currently evaluating zimberelimab, either alone or in combination with other agents across several tumor types, including non-small cell lung cancer in ARC-7, our Phase 2 trial, and ARC-10, our recently initiated registrational trial which is designed to support the approval of zimberelimab. AB308, our Fc-enabled anti-TIGIT monoclonal antibody, is being evaluated in a dose escalation study designed to expeditiously identify an every three week and an every four week dose for AB308 in combination with zimberelimab. The dose escalation study will further evaluate the safety, pharmacokinetics and pharmacodynamics of AB308 in combination with zimberelimab. Gilead Collaboration On May 27, 2020, we entered into the Gilead Collaboration Agreement, a Common Stock Purchase Agreement (the Stock Purchase Agreement), and an Investor Rights Agreement, (collectively, the Gilead Agreements), each with Gilead. The transaction closed on July 13, 2020 following expiration of the antitrust waiting period. Upon closing, Gilead made an upfront payment of $175 million pursuant to the Gilead Collaboration Agreement, and Gilead made an equity investment of approximately $200 million in us by purchasing 5,963,029 shares of our common stock at a per share price of $33.54 pursuant to the Stock Purchase Agreement. Gilead made an additional equity investment in us of approximately $56.7 million, net of offering costs, by purchasing 2,200,000 shares of 17 our common stock at a per share price of $27.50 in our May 2020 Public Offering. Pursuant to the Investor Rights Agreement, w e also appointed Gilead’s designee s , Merdad Parsey , M.D., Ph.D. and Michael Quigley, Ph.D., to our Board of Directors. Pursuant to the terms of the Gilead Collaboration Agreement, Gilead has an exclusive license to develop and commercialize zimberelimab in certain markets and obtained exclusive options to acquire an exclusive license to develop and commercialize all of our current and future clinical programs during the 10-year collaboration term, contingent upon Gilead’s payment of $400 million, with the first payment of $100 million in 2022 and an additional $100 million payment due at Gilead’s option on each of the fourth, sixth, and eighth anniversaries of the agreement. For those programs that enter clinical development prior to the end of the collaboration term, Gilead’s option rights will extend for up to an additional three years thereafter. Gilead may exercise its option, on a program-by-program basis, upon payment of an option fee that ranges from $200 million to $275 million per program for our clinical programs in existence at the date of the agreement, and $150 million per program for all other programs that enter clinical development thereafter. If Gilead exercises its option with respect to our TIGIT program, we are also eligible to receive up to $500 million in potential U.S. regulatory approval milestones with respect to domvanalimab. Upon Gilead’s exercise of its option to a program, the two companies will co-develop and equally share global development costs, subject to certain of our opt-out rights, and expense caps on our spending and related subsequent adjustments. For each optioned program, provided we have not exercised our opt-out rights, we have an option to co-promote in the United States with equal sharing of related profits and losses. Gilead has the right to exclusively commercialize any optioned programs outside of the U.S., subject to the rights of our existing partners to any territories, and Gilead will pay to us tiered royalties as a percentage of revenues ranging from the high teens to the low twenties. Pursuant to the Stock Purchase Agreement and the Investor Rights Agreement, Gilead has the right, at its option, to purchase additional shares from us, up to a maximum ownership of 35% of our then-outstanding voting common stock, from time to time over a five year period, at a purchase price equal to the greater of a 20% premium to market (based on a trailing five-day average closing price) at the time Gilead exercises such option, and the $33.54 initial purchase price. The Investor Rights Agreement also includes a three-year standstill and a two-year lockup and provides Gilead with registration rights commencing at the end of the lockup period, pro rata participation rights in certain future financings and the right to designate two individuals to be appointed to our Board of Directors. On January 31, 2021, we and Gilead entered into an Amended and Restated Common Stock Purchase Agreement, which amended and restated in its entirety the Common Stock Purchase Agreement, pursuant to which Gilead purchased from us 5,650,000 shares of our common stock at a purchase price of $39.00 per share, for gross proceeds of $220.4 million. All other terms of the original Common Stock Purchase Agreement, including Gilead’s option to purchase additional shares from us, up to a maximum ownership of 35% of our then-outstanding common stock, remain unchanged. COVID-19 Pandemic The degree to which COVID-19 impacts our business operations, research and development programs and financial condition will depend on future developments, including the ultimate duration and/or severity of the outbreak, the impact of any resurgences and new strains that emerge, actions by government authorities to contain the spread of the virus, the timing, availability and effectiveness of any vaccines, and when and to what extent normal economic and operating conditions can resume. Our management continues to actively monitor this health crisis and its effects on our operations, key vendors and workforce. We conduct our clinical trials in the U.S. and internationally in geographic regions that are impacted by COVID-19 to varying degrees. While we have seen relatively robust enrollment across our ongoing Arcus-sponsored studies, we expect to see volatility as local governments respond to resurgences and the emergence of new strains, each of which may result in the prolonged reinstitution, extension or enhancement of shelter-in-place measures. The American Cancer Society has also reported that the pandemic has led to declines in screening, diagnosis and treatment for cancer patients, which will impact the enrollment of patients in clinical trials targeting early stage cancers and retention of patients overall in our trials. Patient safety remains our paramount concern and we continue to collaborate with our existing and with new investigational sites to implement measures to minimize disruptions to patients and ensure continued access to treatment, in accordance with health authority guidance. We are unable to predict the ultimate impact of this pandemic on our ongoing and planned clinical programs. With respect to manufacturing and supply, we believe we currently have sufficient drug supply for our ongoing clinical studies. Our third-party contract manufacturers continue to operate at or near normal levels and, at this time and subject to further COVID-19 implications, we do not anticipate any disruptions to our drug supply chain. Our discovery programs are impacted by reduced operating capacity in our laboratories due to employee safety measures, such as social distancing requirements and shift work. This has slowed the pace of our discovery efforts, and our HIF-2α program is now expected to enter clinical development in the second half of 2021. The full impact of the COVID-19 outbreak remains highly uncertain and subject to change. The safety, health and well-being of our employees remains a primary concern, and we instituted remote work arrangements for our office-based employees and regular 18 COVID-19 testing services for our laboratory-based employees in order to reduce the risk of exposure to COVID-19 among our employees. These actions have increased our operating costs, whjch together with the absence of any furlough or measures to reduce personnel costs despite reduced laboratory capacity, will have a negative impact on our operations and financial condition. We do not expect the forward impact will be material due to adjustments in operations that we have made. However, there are many uncertainties around the COVID pandemic and future developments, which are unpredictable, may result in a material, negative impact to our operations and financial condition. Components of Operating Results Collaboration and License Revenue Our collaboration and license revenue consists of revenue recognized from the upfront and periodic payments received from Taiho and Gilead, for research and development services performed by us to develop our investigational products under the terms of our collaboration agreements, and from any option exercise payments. Operating Expenses Research and Development Expenses Our research and development expenses consist of expenses incurred in connection with the research and development of our pipeline programs. These expenses include pre-clinical and clinical expenses, payroll and personnel expenses, including stock-based compensation for our employees, laboratory supplies, product licenses, consulting costs, contract research, and depreciation. Shared facility expenses are allocated to functional groups proportionally based on usage. Under certain collaboration agreements we agree to share research and development expenses with our partners or to reimburse our partners for qualified expenses. We expense both internal and external research and development costs as they are incurred. We record advance payments for services that will be used or rendered for future research and development activities as prepaid expenses and recognize them as an expense as the related services are performed. We do not allocate our costs by investigational product, as a significant amount of research and development expenses include internal costs, such as payroll and other personnel expenses, and certain external costs that are not recorded at the investigational product level. In particular, with respect to internal costs, several of our departments support multiple research and development programs, and we do not allocate those costs by investigational product. We expect our research and development expenses to increase substantially during the next few years due to our Gilead collaboration and as we seek to complete existing clinical trials and advance our programs into later-stage clinical trials, pursue regulatory approval for our investigational products, and advance other programs into the clinic. Later-stage clinical trials typically include a larger number of subjects, are of a longer duration and include more geographic regions. As we advance our clinical-stage programs and prepare to seek regulatory approval, we will also need to conduct certain validation activities with respect to our manufacturing processes for the investigational products in each program. Moreover, in order to maximize the potential of our collaboration with Gilead, we believe it will be important to grow our discovery capabilities and pipeline. As a result, we expect our preclinical, clinical, and contract manufacturing expenses to increase significantly relative to what we have incurred to date. The level of our future research and development investment will depend on a number of factors and uncertainties, including clinical outcomes from our ongoing clinical trials, whether our collaborators opt into any of our programs, the amount of opt-in and milestone payments we receive from our collaborators, and the breadth of any joint development program agreed to with Gilead for programs they opt into. In addition, under our license agreements with WuXi Biologics and Abmuno, and our co-development and collaboration agreements with Strata, and AstraZeneca, we may be required to pay additional clinical and regulatory milestone payments based on the development progress of our investigational products. Therefore, we are unable to predict the timing or the final cost to complete our clinical programs or validation of our manufacturing and supply processes and delays may occur due to numerous factors. Factors that could cause or contribute to delays or additional costs include, but are not limited to, those discussed in “Item 1A. Risk Factors.” General and Administrative Expenses General and administrative expenses consist principally of personnel-related costs including payroll and stock-based compensation for personnel in executive, finance, human resources, information technology, business and corporate development, and other administrative functions. Shared facility expenses are allocated to functional groups proportionally based on usage. Our general and administrative expenses also include professional fees for legal, consulting, and accounting services, rent and other facilities costs, fixed asset depreciation, and other general operating expenses not otherwise classified as research and development expenses. 19 We anticipate that our general and administrative expenses will increase substantially during the next few years as we support our growing research and development activities, including staff expansion, additional occupancy costs, and other costs associated with increased infrastructure needs. Other Non-Operating Income, net Other non-operating income, net consists primarily of interest earned on our investments in fixed-income marketable securities as well as activity related to our equity method investment in PACT Pharma, Inc (PACT Pharma). To date, gains have consisted of gains on dilution of our investment in PACT Pharma, typically occurring upon PACT Pharma’s new issuances of equity securities. Losses associated with the investment consist of our share of PACT Pharma’s net losses. Critical Accounting Policies, Significant Judgments and Use of Estimates Our condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP). The preparation of these condensed consolidated 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 condensed consolidated financial statements, as well as the reported revenue and 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 from these estimates under different assumptions or conditions. We believe that the accounting policies relating to revenue recognition, clinical trial accruals and stock-based compensation reflect the more significant estimates and assumptions used in the preparation of our condensed consolidated financial statements. There have been no significant changes in our critical accounting policies and estimates during the three months ended March 31, 2021, as compared to the critical accounting policies and estimates disclosed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our Annual Report on Form 10-K for the year ended December 31, 2020 and more fully described in Note 2 of the accompanying condensed consolidated financial statements. Results of Operations Three Months Ended March 31, 2021 and 2020 The following table summarizes our results of operations for the three months ended March 31, 2021 and 2020 (in thousands): Three Months Ended March 31, Change 2021 2020 $ % Revenues: Collaboration revenue 9,461 1,750 7,711 * Total collaboration and license revenue 9,461 1,750 7,711 * Operating expenses: Research and development 66,387 23,142 43,245 187 % General and administrative 15,821 7,008 8,813 126 % Total operating expenses 82,208 30,150 52,058 173 % Loss from operations (72,747 ) (28,400 ) (44,347 ) 156 % Non-operating income, net 154 647 (493 ) -76 % Net loss $ (72,593 ) $ (27,753 ) $ (44,840 ) 162 % * Not meaningful Collaboration and License Revenue Collaboration and license revenue increased $7.7 million, from $1.8 million for the three months ended March 31, 2020 to $9.5 million for the three months ended March 31, 2021. In the three months ended March 31, 2021, we recognized $7.7 million in collaboration revenues related to Gilead’s ongoing rights to access our intellectual property in accordance with the Gilead Collaboration Agreement, as well as $1.8 million under the Taiho Agreement. In the three months ended March 31, 2020, we recognized $1.8 million under the Taiho Agreement. 20 Research and Development Expenses Research and development expenses increased $43.3 million, or 187%, from $23.1 million for the three months ended March 31, 2020 to $66.4 million for the three months ended March 31, 2021. The increase in research and development expenses included $15.0 million in development milestone expenses incurred, consisting of a $10.0 million milestone payment due to WuXi Biologics pertaining to zimberelimab and a $5.0 million milestone payment due to Abmuno pertaining to domvanalimab, with no similar expense in the same quarter in the prior year. There was also an increase of $10.5 million in employee compensation costs, approximately $4.4 million of which consists of non-cash stock-based compensation. This increase is driven by our growing headcount as well as our 2021 stock awards. Manufacturing costs and clinical costs for our ongoing studies increased $9.9 million and $9.0 million, respectively, as a result of the increased number of programs and clinical trials compared to the same quarter in the prior year. Office and facilities expense increased as we continued to grow. The overall increase in research and development expense is partially offset by a $4.9 million reimbursement by Gilead of certain applicable costs of developing zimberelimab, including $4.0 million of cost sharing reimbursement related to milestone expense incurred, in accordance with the Gilead Collaboration Agreement. General and Administrative Expenses General and administrative expenses increased $8.8 million, or 126%, from $7.0 million for the three months ended March 31, 2020 to $15.8 million for the three months ended March 31, 2021. The increase in general and administrative expenses was primarily due to $6.8 million in employee compensation costs, approximately $4.9 million of which consists of non-cash stock-based compensation. This increase is driven by our growing headcount as well as our 2021 stock awards. Additional increases in finance and legal expenses were largely driven by costs incurred to support our growth and ongoing compliance with public company requirements. We also incurred additional facilities expense due to our expanding headcount and office space. Non-Operating Income, Net Non-operating income, net decreased $0.4 million or 76%, from $0.6 million for the three months ended March 31, 2020 to $0.2 million for the three months ended March 31, 2021. The decrease was primarily due to lower interest income resulting from lower investment yields on our portfolio of marketable fixed-income securities during the quarter ended March 31, 2021 as compared to the same period in the prior year. Liquidity and Capital Resources To date, we have financed our operations primarily through net proceeds of approximately $677.1 million from equity offerings and proceeds of approximately $641.4 million from our collaboration and stock purchase agreements, including $220.4 million gross proceeds raised in February 2021 from the sale to Gilead of 5,650,000 shares of our common stock. As of March 31, 2021, we had $884.9 million of cash, cash equivalents, and investments in marketable securities, compared to $735.1 million as of December 31, 2020. Our cash and investments are held in a variety of interest-bearing instruments, including money market funds, U.S. government treasury obligations, U.S. government agency securities, and investments in corporate securities. Based on our existing business plan, we believe that our existing cash, cash equivalents, and investments will be sufficient to fund our planned level of operations at least through 2023. We may require additional capital to complete the development and any commercialization of our investigational products. Our future capital requirements will depend on many factors, including: • the scope, rate of progress and costs of clinical trials for our investigational products as well as drug discovery, preclinical development activities, and laboratory testing; • the number and scope of clinical programs we decide to pursue; • the scope and costs of manufacturing development and commercial manufacturing activities; • the timing and amount of expense related to our current and future clinical programs, subject to the rights of our existing partners, and the costs associated with our share of the global development plan for such programs; • the timing and amount of milestone payments we receive under the Taiho Agreement and Gilead Collaboration Agreement, and option fees under the Gilead Collaboration Agreement; • the extent to which we acquire or in-license other investigational products and technologies; • the cost, timing and outcome of regulatory review of our investigational products; • the cost and timing of establishing sales and marketing capabilities, if any of our investigational products receive marketing approval; 21 • 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 investigational products; • the costs associated with being a public company; and • the cost associated with commercializing our investigational products, if they receive marketing approval. 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 and 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. If we are unable to raise additional funds when needed, we may be required to delay, reduce, or terminate some or all of our development programs and clinical trials. We may also be required to sell or license to others rights to our investigational products in certain territories or indications that we would prefer to develop and commercialize ourselves. See “Risk Factors” for additional risks associated with our substantial capital requirements. Summary Condensed Consolidated 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 (in thousands): Three Months Ended March 31, Net cash (used in) provided by: 2021 2020 Operating activities $ (66,316 ) $ (31,277 ) Investing activities 62,826 40,056 Financing activities 222,120 610 Net increase in cash, cash equivalents and restricted cash $ 218,630 $ 9,389 Cash Used in Operating Activities Net cash used in operating activities was $66.3 million for the three months ended March 31, 2021, as compared to $31.3 million for the same period in the prior year. The change in cash flow from operating activities is primarily due to the $44.8 million increase in our net loss to $72.6 million. The change in our net loss is primarily a result of our expanded clinical development activities and general and administrative costs incurred to support our operations. The overall increase in cash used is partially offset by year-over-year changes in non-cash items, including $9.3 million of increased expense from stock-based compensation, and changes in our asset and liability balances due to the timing of payments to or from our vendors and collaborators. Cash Provided by Investing Activities Cash provided by investing activities was a $62.8 million for the three months ended March 31, 2021 compared to $40.1 million for the same period in the prior year. The change in cash flow from investing activities was primarily due to net maturities of our investments in fixed-income marketable securities. Cash Provided by Financing Activities Cash provided by financing activities was $222.1 million for the three months ended March 31, 2021 compared to $0.6 million in the same period in the prior year. The increase in cash provided is primarily due to cash received from Gilead in February 2021 pursuant to the terms of the Amended and Restated Stock Purchase Agreement, as well as funds received during the three months ended March 31, 2021 for issuance of common stock pursuant to equity award plans. Contractual Obligations and Commitments There have been no material changes to our contractual obligations outside the ordinary course of business during the three months ended March 31, 2021, as compared to those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2020. 22 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.