SUTRO BIOPHARMA, INC. 10-Q

Item 1. Financial Statements. Sutro Biopharma, Inc. Condensed Balance Sheets (In thousands, except share and per share amounts) June 30, December 31, 2020 2019 (Unaudited) Assets Current assets: Cash and cash equivalents $ 65,348 $ 4,960 Marketable securities 136,015 112,904 Investment in equity securities 49,094 — Accounts receivable (including amounts from related parties of $ 0 and $ 1,050 as of June 30, 2020 and December 31, 2019, respectively) (1) 5,102 6,298 Prepaid expenses and other current assets 2,931 4,406 Total current assets 258,490 128,568 Property and equipment, net 11,265 9,633 Marketable securities, non-current 5,647 15,609 Other non-current assets 2,121 2,545 Restricted cash 15 15 Total assets $ 277,538 $ 156,370 Liabilities and Stockholders’ Equity Current liabilities: Accounts payable $ 4,901 $ 5,584 Accrued compensation 4,520 6,017 Deferred revenue—current 23,503 19,465 Debt—current — 1,000 Other current liabilities 2,536 901 Total current liabilities 35,460 32,967 Deferred revenue, non-current 10,562 16,195 Deferred rent 330 409 Debt—non-current 24,281 8,876 Other noncurrent liabilities 148 134 Total liabilities 70,781 58,581 Stockholders’ equity: Preferred stock, $ 0.001 par value — 10,000,000 shares authorized as of June 30, 2020 and December 31, 2019; 0 shares issued and outstanding as of June 30, 2020 and December 31, 2019 — — Common stock, $ 0.001 par value — 300,000,000 shares authorized as of June 30, 2020 and December 31, 2019; 35,878,928 and 23,098,969 shares issued and outstanding as of June 30, 2020 and December 31, 2019, respectively 36 23 Additional paid-in-capital 391,791 293,346 Accumulated other comprehensive income 398 165 Accumulated deficit ( 185,468 ) ( 195,745 ) Total stockholders’ equity 206,757 97,789 Total Liabilities and Stockholders’ Equity $ 277,538 $ 156,370 (1) Merck was a related party until the closing of the Company’s public offering on May 14, 2020. Vaxcyte (formerly SutroVax) was a related party until the closing of its initial public offering on June 16, 2020. See accompanying notes to unaudited interim condensed financial statements. 1 Sutro Biopharma, Inc. Condensed Statements of Operations (Unaudited) (In thousands, except share and per share amounts) Three Months Ended Six Months Ended June 30, June 30, 2020 2019 2020 2019 Revenues (including amounts from related parties of $ 0 and $ 2,813 during the three and six months ended June 30, 2020, respectively, and $ 5,497 and $ 10,413 during the three and six months ended June 30, 2019, respectively) (1) (2) $ 9,469 $ 10,525 $ 16,621 $ 19,154 Operating expenses Research and development 17,243 16,143 34,862 31,323 General and administrative 8,643 8,067 17,356 15,782 Total operating expenses 25,886 24,210 52,218 47,105 Loss from operations ( 16,417 ) ( 13,685 ) ( 35,597 ) ( 27,951 ) Interest income 384 1,124 1,025 2,300 Unrealized gain on equity securities 48,860 — 48,860 — Interest and other expense, net ( 2,955 ) ( 1,232 ) ( 4,011 ) ( 2,392 ) Net income (loss) $ 29,872 $ ( 13,793 ) $ 10,277 $ ( 28,043 ) Net income (loss) per share, basic (3) $ 1.00 $ ( 0.60 ) $ 0.39 $ ( 1.22 ) Net income (loss) per share, diluted (3) $ 0.94 $ ( 0.60 ) $ 0.36 $ ( 1.22 ) (1) Includes $ 0 and $ 2.8 million, respectively, for the three months and six months ended June 30, 2020 of related party revenue from Merck. Merck was a related party until the closing of the Company’s public offering on May 14, 2020. (2) Includes $ 0 and $ 36,000 , respectively, for the three months and six months ended June 30, 2020 of related party revenue from Vaxcyte (formerly SutroVax). Vaxcyte was a related party until the closing of its initial public offering on June 16, 2020. (3) See Notes 2 and 10 for an explanation of the calculations of our basic and diluted net income (loss) per share, basic and diluted and the weighted-average number of shares used in the computation of the per share amounts. See accompanying notes to unaudited interim condensed financial statements. 2 Sutro Biopharma, Inc. Condensed Statements of Comprehensive Income (Loss) (Unaudited) (In thousands) Three Months Ended Six Months Ended June 30, June 30, 2020 2019 2020 2019 Net income (loss) $ 29,872 $ ( 13,793 ) $ 10,277 $ ( 28,043 ) Other comprehensive income: Unrealized gain on available-for-sale securities 370 157 233 260 Comprehensive income (loss) $ 30,242 $ ( 13,636 ) $ 10,510 $ ( 27,783 ) See accompanying notes to unaudited interim condensed financial statements. 3 Sutro Biopharma, Inc. Condensed Statements of Stockholders’ Equity (Unaudited) (In thousands, except share amounts) Accumulated Additional Other Total Preferred Stock Common Stock Paid-In- Comprehensive Accumulated Stockholders’ Shares Amount Shares Amount Capital Income (Loss) Deficit Equity Balances at December 31, 2019 — $ — 23,098,969 $ 23 $ 293,346 $ 165 $ ( 195,745 ) $ 97,789 Exercise of common stock options — — 12,937 — 56 — — 56 Issuance of common stock under Employee Stock Purchase Plan — — 74,465 — 646 — — 646 Vesting of restricted stock units — — 41,050 — — — — — Stock-based compensation expense — — — — 2,707 — — 2,707 Issuance of common stock warrants in connection with debt refinancing — — — — 619 — — 619 Net unrealized loss on available-for- sale securities — — — — — ( 137 ) — ( 137 ) Net loss — — — — — — ( 19,595 ) ( 19,595 ) Balances at March 31, 2020 — — 23,227,421 23 297,374 28 ( 215,340 ) 82,085 Exercise of common stock options — — 1,257 — 8 — — 8 Vesting of restricted stock units — — 250 — — — — — Stock-based compensation expense — — — — 3,011 — — 3,011 Issuance of common stock in connection with public offering, net of issuance costs of $ 6,626 — — 12,650,000 13 91,398 — — 91,411 Net unrealized gain on available-for- sale securities — — — — — 370 — 370 Net income — — — — — — 29,872 29,872 Balances at June 30, 2020 — $ — 35,878,928 $ 36 $ 391,791 $ 398 $ ( 185,468 ) $ 206,757 Accumulated Additional Other Total Preferred Stock Common Stock Paid-In- Comprehensive Accumulated Stockholders’ Shares Amount Shares Amount Capital Loss Deficit Equity Balances at December 31, 2018 — $ — 22,848,184 $ 23 $ 281,891 $ ( 47 ) $ ( 150,328 ) $ 131,539 Adoption of Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (Topic 606) — — — — — — 10,327 10,327 Exercise of common stock options — — 8,347 — 42 — — 42 Issuance of common stock under Employee Stock Purchase Plan — — 68,910 — 671 — — 671 Stock-based compensation expense — — — — 2,286 — — 2,286 Net unrealized gain on available-for- sale securities — — — — — 103 — 103 Net loss — — — — — - ( 14,250 ) ( 14,250 ) Balances at March 31, 2019 — — 22,925,441 $ 23 $ 284,890 $ 56 $ ( 154,251 ) $ 130,718 Exercise of common stock options — — 1,762 — 10 — — 10 Stock-based compensation expense — — — — 2,463 — — 2,463 Net unrealized gain on available-for- sale securities — — — — — 157 — 157 Net loss — — — — — — ( 13,793 ) ( 13,793 ) Balances at June 30, 2019 — $ — 22,927,203 $ 23 $ 287,363 $ 213 $ ( 168,044 ) $ 119,555 See accompanying notes to unaudited interim condensed financial statements. 4 Sutro Biopharma, Inc. Condensed Statements of Cash Flows (Unaudited) (In thousands) Six Months Ended June 30, 2020 2019 Operating activities Net income (loss) $ 10,277 $ ( 28,043 ) Adjustments to reconcile net income (loss) to net cash used in operating activities: Depreciation and amortization 2,158 2,329 Amortization of premium (accretion of discount) on marketable securities 54 ( 1,263 ) Stock-based compensation 5,718 4,749 Unrealized gain on equity securities ( 48,860 ) – Remeasurement of liability awards 1,979 28 Other 322 208 Changes in operating assets and liabilities: Accounts receivable 1,196 ( 4,011 ) Prepaid expenses and other assets 1,475 406 Accounts payable ( 1,969 ) 1,309 Accrued compensation ( 1,497 ) ( 2,652 ) Other liabilities ( 413 ) 103 Deferred rent ( 79 ) ( 20 ) Deferred revenue ( 1,595 ) ( 8,889 ) Net cash used in operating activities ( 31,234 ) ( 35,746 ) Investing activities Purchases of marketable securities ( 91,270 ) ( 147,370 ) Maturities of marketable securities 63,800 72,250 Sales of marketable securities 14,500 7,000 Purchases of equipment and leasehold improvements ( 2,529 ) ( 765 ) Net cash used in investing activities ( 15,499 ) ( 68,885 ) Financing activities Proceeds from public offering, net of issuance costs 91,411 – Proceeds from debt refinancing 25,000 – Payments of debt ( 10,000 ) ( 2,000 ) Proceeds from exercise of common stock options 64 52 Proceeds from employee stock purchase plan 646 671 Net cash provided by (used in) financing activities 107,121 ( 1,277 ) Net increase (decrease) in cash, cash equivalents and restricted cash 60,388 ( 105,908 ) Cash, cash equivalents and restricted cash at beginning of period 4,975 125,313 Cash, cash equivalents and restricted cash at end of period $ 65,363 $ 19,405 Supplemental disclosure of cash flow information: Cash paid for interest $ 649 $ 633 Supplemental disclosure of non-cash investing and financing information: Purchases of equipment included in accounts payable $ 1,286 $ 146 Embedded interest associated with program fees $ 1,128 $ 1,717 Warrants issued to lenders $ 619 $ – See accompanying notes to unaudited interim condensed financial statements. 5 Sutro Biopharma, I nc. Notes to Unaudited Interim Condensed Financial Statements 1. Organization and Principal Activities Description of Business Sutro Biopharma, Inc. (the “Company”), is a clinical stage drug discovery, development and manufacturing company focused on deploying its proprietary integrated cell-free protein synthesis platform, XpressCF®, to create a broad variety of optimally designed, next-generation protein therapeutics initially for cancer and autoimmune disorders. The Company was incorporated on April 21, 2003 and is headquartered in South San Francisco , California . The Company operates in one business segment, the development of biopharmaceutical products. May 2020 Public Offering On May 14, 2020, the Company closed a public offering of 12,650,000 shares of its common stock at a public offering price of $ 7.75 per share, which included the exercise in full of the underwriters’ option to purchase 1,650,000 shares of common stock. The gross proceeds from this offering were approximately $ 98.0 million, before deducting approximately $ 6.6 million of underwriting discounts and commissions and other offering expenses, resulting in net proceeds of approximately $ 91.4 M to the Company. Vaxcyte Equity Ownership In June 2020, Vaxcyte, formerly known as SutroVax, Inc, closed its initial public offering (“IPO”) of its common stock at a price per share of $ 16.00 . As of June 30, 2020, the Company held 1,634,005 shares of Vaxcyte common stock, which are subject to a lock-up agreement that expires in December 2020 . The Vaxcyte common stock held by the Company will be measured at fair value at each reporting period based on the closing price of Vaxcyte’s common stock on the last trading day of each reporting period, adjusted for a discount for lack of marketability (DLOM) due to the lock-up agreement, with any unrealized gains and losses recorded in the Company’s statements of operations. As of June 30, 2020, the estimated fair value of the Vaxcyte common stock held by the Company was $ 49.1 million. The Company recognized an unrealized gain related to Vaxcyte common stock of $ 48.9 million for the three and six months ended June 30, 2020, of which $ 49.1 million was from the estimated fair value of Vaxcyte common stock, offset by a $ 0.2 million adjustment related to a revaluation of a prior preferred stock warrant converted to common stock. See Note 2—“Investment in Equity Securities,” Note 3—“Fair Value Disclosures,” Note 4 — “Cash and Marketable Securities”, and Note 7—“Related Party Transactions”. Liquidity The Company has incurred significant losses and has negative cash flows from operations. As of June 30, 2020, the Company had an accumulated deficit of $ 185.5 million. Management expects to incur additional substantial losses in the foreseeable future as a result of the Company’s research and development activities and costs to operate as a public company. As of June 30, 2020, the Company had unrestricted cash, cash equivalents and marketable securities of $ 207.0 million, which are available to fund future operations. The Company believes that its unrestricted cash, cash equivalents and marketable securities as of June 30, 2020 will be sufficient for the Company to continue for at least one year from the issuance date of its unaudited interim condensed financial statements. The Company will need to raise additional capital to support the completion of its research and development activities and its operations. 2. Summary of Significant Accounting Policies Basis of Presentation and Use of Estimates The accompanying interim condensed financial statements of the Company are unaudited. These interim condensed financial statements have been prepared in accordance with generally accepted accounting principles in the United States of 6 America ( “ U.S. GAAP ” ) and the applicable rules and regulations of the Securities and Exchange Commission ( “ SEC ” ) for interim financial information. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. The December 31, 201 9 condensed balance sheet was derived from the audited financial statements as of that date but does not include all of the information and footnotes required by U.S. GAAP for complete financial statements. The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. The Company bases its estimates on historical experience and market-specific or other relevant assumptions that it believes are reasonable under the circumstances. The amounts of assets and liabilities reported in the Company’s balance sheets and the amount of expenses and income reported for each of the periods presented are affected by estimates and assumptions, which are used for, but are not limited to, determining research and development periods under multiple element arrangements, stock-based compensation expense, income taxes and certain accrued liabilities. An estimated DLOM to determine the fair value of the Company’s investment in equity securities and related liabilities was also used due to the existence of a lock-up agreement that expires in December 2020. The full extent to which the COVID-19 pandemic will directly or indirectly impact the Company’s business, results of operations and financial condition, including revenue, expenses, manufacturing, clinical trials, research and development costs and employee-related amounts, will depend on future developments that are highly uncertain, including as a result of new information that may emerge concerning COVID-19 and the actions taken to contain it or treat COVID-19, as well as the economic impact on local, regional, national and international customers and markets. We have made estimates of the impact of COVID-19 within our financial statements and there may be changes to those estimates in future periods. Actual results could differ from such estimates or assumptions. The accompanying unaudited interim condensed financial statements have been prepared on the same basis as the audited financial statements and, in the opinion of management, reflect all adjustments of a normal recurring nature considered necessary to state fairly the Company's financial position, results of operations, comprehensive income (loss), and cash flows for the interim periods. The interim results for the three and six months ended June 30, 2020 are not necessarily indicative of the results that may be expected for the year ending December 31, 2020, or for any other future annual or interim period. The information included in this Quarterly Report on Form 10-Q should be read in conjunction with the Company's audited financial statements included in the Annual Report on Form 10-K pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, for the year ended December 31, 2019. Change in Estimate In the quarter ended March 31, 2020, the Company recorded an adjustment to revenue related to a change in estimate in connection with its Exclusive Patent License and Research Collaboration Agreement (the “2018 Merck Agreement”) with Merck, a related party of the Company. The 2018 Merck Agreement provides for the joint development of up to three research programs focusing on cytokine derivatives for cancer and autoimmune disorders. Under the 2018 Merck Agreement, the Company received from Merck a non-refundable, non-creditable, upfront payment of $ 60.0 million in August 2018 for access to the Company’s technology and the identification and preclinical research and development of two target programs. Under ASC 606, the Company identified five performance obligations under the 2018 Merck Agreement, two of which relate to the performance of services for 1) the first target program and 2) the second target program. At the inception of the 2018 Merck Agreement, the transaction price of $ 60.0 million was allocated among the performance obligations using the Company’s best estimate of standalone selling price (“SSP”) for each of the associated performance obligations. Revenue allocated to the first and second target programs, which totaled $ 47.1 million is being recognized on a proportion of performance basis, using the full-time equivalent (“FTE”) cost as the basis of measurement, with such performance expected to occur over an estimated service period of three years for each target program. In March 2020, the Company adjusted revenue recognized for the first and second target programs as the parties determined additional resources should be assigned to the first target program with a reduction of resources attributed to the second target program. This resulted in a decrease in the measure of proportional performance for the first target program and an increase in the measure of proportional performance for the second target program. These adjustments collectively decreased the Company’s revenues by $ 3.6 million, net income by $ 3.6 million and basic and diluted net income per share by $ 0.14 and $ 0.13 , respectively, for the six months ended June 30, 2020. 7 Adoption of New Accounting Principles In December 2019, as part of its initiative to reduce complexity in the accounting standards, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes (“ASU 2019-12”), which eliminates certain exceptions related to the approach for intra-period tax allocation, the methodology for calculating income taxes in an interim period and the recognition of deferred tax liabilities for outside basis differences. ASU 2019-12 also clarifies and simplifies other aspects of the accounting for income taxes. The standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020, with early adoption permitted. The Company early adopted ASU 2019-12 on January 1, 2020, and this adoption had no material impact on the Company’s financial position or results of operations. In August 2018, the FASB issued ASU 2018-13 (Topic 820), Fair Value Measurement: Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement, reducing certain disclosures concerning the fair value hierarchy. The guidance was effective for the Company effective January 1, 2020 and did not have a material impact on the Company’s financial statements. Recently Issued Accounting Pronouncements In June 2016, the FASB issued ASU 2016-13 (Topic 326), Financial Instruments Credit Losses, which requires consideration of a broader range of reasonable and supportable information to developing credit loss estimates. For public entities, ASU 2016-13 is effective for fiscal years beginning after December 15, 2019, including all interim periods within those years. As a result of the Company having elected the extended transition period for complying with new or revised accounting standards pursuant to Section 107(b) of the JOBS Act, ASU 2016-13 is effective for the Company for the fiscal years beginning after December 15, 2020, including all interim periods within those years. Early adoption is permitted. The Company is currently assessing the impact that the adoption of ASU 2016-13 will have on its financial statements and related disclosures. In February 2016, the FASB issued ASU 2016-02 (Topic 842), Leases (“ASC 842”). ASC 842 supersedes the lease recognition requirements in ASC 840, Leases. ASC 842 clarifies the definition of a lease and requires lessees to recognize right-of-use assets and lease liabilities for all leases, including those classified as operating leases under previous lease accounting guidance. For public entities, ASU 2016-02 was effective for fiscal years beginning after December 15, 2018, including all interim periods within that year. As a result of the Company having elected the extended transition period for complying with new or revised accounting standards pursuant to Section 107(b) of the JOBS Act, ASC842 will be effective for the Company on January 1, 2022. Originally, entities were required to adopt ASC 842 using a modified retrospective transition method. However, in July 2018, the FASB issued ASU 2018-11 (Topic 842), Leases: Targeted Improvements, which provides entities with an additional transition method. Under ASU 2018-11, entities have the option of initially applying ASC 842 at the adoption date, rather than at the beginning of the earliest period presented, and recognizing the cumulative effect of applying the new standard as an adjustment to beginning retained earnings in the year of adoption while continuing to present all prior periods under previous lease accounting guidance. The Company is currently evaluating the impact of adopting this guidance on the Company’s financial statements. The Company currently expects that its operating lease commitments will be subject to the new standard and recognized as right-of-use assets and operating lease liabilities upon adoption of this standard, which will increase the total assets and total liabilities that it reports relative to such amounts presented prior to adoption. Cash, Cash Equivalents and Restricted Cash The following table provides a reconciliation of cash, cash equivalents and restricted cash reported within the balance sheets that sum to the total of the same amounts shown in the statements of cash flows. June 30, 2020 2019 (in thousands) Cash and cash equivalents $ 65,348 $ 19,390 Restricted cash 15 15 Total cash, cash equivalents, and restricted cash shown in the statements of cash flows $ 65,363 $ 19,405 8 Investments in Equity Securities Subsequent to the closing of the Vaxcyte IPO in June 2020 (see Note 1), the fair value of Vaxcyte’s common stock became readily determinable. As a result, beginning June 2020, the Company accounted for its investment in Vaxcyte’s common stock at an estimated fair value. At each reporting period, the equity securities will be remeasured to fair value with any unrealized gains or losses being recorded through the statements of operations. Fair Value Measurements Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability, or an exit price, in the principal or most advantageous market for that asset or liability in an orderly transaction between market participants on the measurement date, and establishes a fair value hierarchy that requires an entity to maximize the use of observable inputs, where available, and minimizes the use of unobservable inputs when measuring fair value. The Company determined the fair value of financial assets and liabilities using the fair value hierarchy that describes three levels of inputs that may be used to measure fair value, as follows: Level 1—Quoted prices in active markets for identical assets and liabilities; Level 2—Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and 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 of accounts receivable, prepaid expenses, accounts payable, accrued liabilities and accrued compensation approximate fair value due to the short-term nature of these items. The fair value of the Company’s outstanding loan (See Note 6) is estimated using the net present value of the payments, discounted at an interest rate that is consistent with market interest rate, which is a Level 2 input. The estimated fair value of the Company’s outstanding loan approximates the carrying amount, as the loan bears a floating rate that approximates the market interest rate. The Company’s investments in equity securities are classified as Level 2 within the fair value hierarchy while subject to a lock-up agreement that expires in December 2020. As a result of the lock up, and upon the closing of Vaxcyte IPO, the Company has applied an estimated DLOM of 5.4 %, which is a Level 2 input. Revenue Recognition The Company has no products approved for commercial sale and has not generated any revenue from commercial product sales. The total revenue to date has been generated principally from collaboration and license agreements and to a lesser extent, from manufacturing, supply and services and products the Company provides to its collaboration partners. Collaboration revenue The Company derives revenue from collaboration arrangements, under which the Company may grant licenses to its collaboration partners to further develop and commercialize its proprietary product candidates. The Company may also perform research and development activities under the collaboration agreements. Consideration under these contracts generally includes a nonrefundable upfront payment, development, regulatory and commercial milestones and other contingent payments, and royalties based on net sales of approved products. Additionally, the collaborations may provide options for the customer to acquire from the Company materials and reagents, clinical product supply or additional research and development services under separate agreements. The Company assesses which activities in the collaboration agreements are considered distinct performance obligations that should be accounted for separately. The Company develops assumptions that require judgement to determine whether the license to the Company’s intellectual property is distinct from the research and development services or participation in activities under the collaboration agreements. 9 At the inception of each agreement, the Company determines the arrangement transaction price, which includes variable consideration, based on the assessment of the probability of achievement of future milestones and contingent payments and other potential consideration. For arrangements that include multiple performance obligations, the Company allocates the transaction price to the identified performance obligations based on SSP of each distinct performance obligation. In instances where SSP is not directly observable, the Company develops assumptions that require judgment to determine the SSP for each performance obligation identified in the contract. These key assumptions may include FTE, personnel effort, estimated costs, discount rates and probabilities of clinical development and regulatory success. Upfront Payments : For collaboration arrangements that include a nonrefundable upfront payment, if the license fee and research and development services cannot be accounted for as separate performance obligations, the transaction price is deferred and recognized as revenue over the expected period of performance using a cost-based input methodology. The Company uses judgement to assess the pattern of delivery of the performance obligation. In addition, amounts paid in advance of services being rendered may result in an associated financing component to the upfront payment. Accordingly, the interest on such borrowing cost component will be recorded as interest expense and revenue, based on an appropriate borrowing rate applied to the value of services to be performed by the Company over the estimated service performance period. License Grants: For collaboration arrangements that include a grant of a license to the Company’s intellectual property, the Company considers whether the license grant is distinct from the other performance obligations included in the arrangement. For licenses that are distinct, the Company recognizes revenues from nonrefundable, upfront payments and other consideration allocated to the license when the license term has begun and the Company has provided all necessary information regarding the underlying intellectual property to the customer, which generally occurs at or near the inception of the arrangement. Milestone and Contingent Payments : At the inception of the arrangement and at each reporting date thereafter, the Company assesses whether it should include any milestone and contingent payments or other forms of variable consideration in the transaction price using the most likely amount method. If it is probable that a significant reversal of cumulative revenue would not occur upon resolution of the uncertainty, the associated milestone value is included in the transaction price. At the end of each subsequent reporting period, the Company re-evaluates the probability of achievement of each such milestone and any related constraint and, if necessary, adjusts its estimate of the overall transaction price. Since milestone and contingent payments may become payable to the Company upon the initiation of a clinical study or filing for or receipt of regulatory approval, the Company reviews the relevant facts and circumstances to determine when the Company should update the transaction price, which may occur before the triggering event. When the Company updates the transaction price for milestone and contingent payments, the Company allocates the changes in the total transaction price to each performance obligation in the agreement on the same basis as the initial allocation. Any such adjustments are recorded on a cumulative catch-up basis in the period of adjustment, which may result in recognizing revenue for previously satisfied performance obligations in such period. The Company’s collaborators generally pay milestones and contingent payments subsequent to achievement of the triggering event. Research and Development Services : For amounts allocated to the Company’s research and development obligations in a collaboration arrangement, the Company recognizes revenue over time using a cost-based input methodology, representing the transfer of goods or services as activities are performed over the term of the agreement. Materials Supply: The Company provides materials and reagents, clinical materials and services to certain of its collaborators under separate agreements. The consideration for such services is generally based on FTE personnel effort used to manufacture those materials reimbursed at an agreed upon rate in addition to agreed-upon pricing for the provided materials. The amounts billed are recognized as revenue as the performance obligations are met by the Company. 10 3. Fair Value Measurements The following table sets forth the fair value of the Company’s financial assets and liabilities measured on a recurring basis by level within the fair value hierarchy: June 30, 2020 Total Level 1 Level 2 Level 3 (in thousands) Assets: Money market funds $ 63,229 $ 63,229 $ – $ – Commercial paper 34,901 – 34,901 – Corporate debt securities 61,284 – 61,284 – Equity securities 49,094 – 49,094 – Asset-backed securities 16,217 – 16,217 – U.S. government agency securities 29,260 – 29,260 – Total $ 253,985 $ 63,229 $ 190,756 $ – December 31, 2019 Total Level 1 Level 2 Level 3 (in thousands) Assets: Money market funds $ 3,151 $ 3,151 $ – $ – Commercial paper 4,952 – 4,952 – Corporate debt securities 69,499 – 69,499 – Asset-backed securities 27,055 – 27,055 – U.S. government agency securities 27,007 – 27,007 – Total $ 131,664 $ 3,151 $ 128,513 $ – Where applicable, the Company uses quoted market prices in active markets for identical assets to determine fair value. This pricing methodology applies to Level 1 investments, which are comprised of money market funds. If quoted prices in active markets for identical assets are not available, then the Company uses quoted prices for similar assets or inputs other than quoted prices that are observable, either directly or indirectly. These investments are included in Level 2 and consist of commercial paper, corporate debt securities, asset-backed securities and U.S. government agency securities. These assets are valued using market prices when available, adjusting for accretion of the purchase price to face value at maturity. The Company’s equity securities represent Vaxcyte common stock shares and are classified as Level 2 while subject to certain restrictions on sale. These assets are valued using market prices with a DLOM being applied, which is a Level 2 input. A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires management to make judgments and consider factors specific to the asset or liability. In certain cases where there is limited activity or less transparency around inputs to valuation, securities are classified as Level 3 within the valuation hierarchy. 11 4. Cash Equivalents and Marketable Securities Cash equivalents and marketable securities consisted of the following: June 30, 2020 Amortized Cost Basis Unrealized Gains Unrealized (Losses) Fair Value (in thousands) Money market funds $ 63,229 $ – $ – $ 63,229 Commercial paper 34,901 – – 34,901 Corporate debt securities 61,118 170 ( 4 ) 61,284 Asset-based securities 16,096 121 – 16,217 U.S. government agencies 29,149 111 – 29,260 Total 204,493 402 ( 4 ) 204,891 Less amounts classified as cash equivalents ( 63,229 ) – – ( 63,229 ) Total marketable securities $ 141,264 $ 402 $ ( 4 ) $ 141,662 December 31, 2019 Amortized Cost Basis Unrealized Gains Unrealized (Losses) Fair Value (in thousands) Money market funds $ 3,151 $ – $ – $ 3,151 Commercial paper 4,952 – – 4,952 Corporate debt securities 69,423 79 ( 3 ) 69,499 Asset-based securities 27,005 50 – 27,055 U.S. government agencies 26,968 39 – 27,007 Total 131,499 168 ( 3 ) 131,664 Less amounts classified as cash equivalents ( 3,151 ) – – ( 3,151 ) Total marketable securities $ 128,348 $ 168 $ ( 3 ) $ 128,513 As of June 30, 2020 and December 31, 2019, $ 5.6 million and $ 15.6 million, respectively, of marketable securities had maturities of more than one year and are classified as long-term assets. There were $ 25.0 million and $ 4.5 million of investments in an unrealized loss position of $ 4,000 and $ 3,000 as of June 30, 2020 and December 31, 2019, respectively. During the three and six months ended June 30, 2020 and 2019, the Company did no t record any other-than-temporary impairment charges on its available-for-sale securities. Based upon the Company’s impairment review, the Company determined that the unrealized losses were not attributed to credit risk but were primarily associated with changes in interest rates. Based on the scheduled maturities of the investments, the Company was more likely than not to hold these investments for a period of time sufficient for a recovery of the Company’s cost basis. As such, the Company concluded that the unrealized losses in the investment securities were not other-than-temporary. 12 5. Collaboration and License Agreements and Supply Agreements The Company has entered into collaboration and license agreements with various pharmaceutical and biotechnology companies. In accordance with the collaboration agreements, the Company recognized revenue as follows: Three Months Ended Six Months Ended June 30, June 30, 2020 2019 2020 2019 (in thousands) (in thousands) Bristol Myers Squibb Company ("BMS") (1) $ 1,509 $ 1,670 $ 3,554 $ 3,245 Merck Sharp & Dohme Corporation (“Merck”) (2) 7,005 5,497 9,782 10,132 Merck KGaA, Darmstadt, Germany (operating in the United States and Canada under the name “EMD Serono”) 855 3,358 3,149 5,496 Vaxcyte (3) 100 - 136 281 Total revenue $ 9,469 $ 10,525 $ 16,621 $ 19,154 (1) In January 2019, BMS announced the entry into a definitive agreement to acquire Celgene and the transaction was completed in November 2019. (2) Merck was a related party until the closing of the Company’s public offering on May 14, 2020. (3) Vaxcyte was a related party until the closing of its initial public offering on June 16, 2020. The following table presents the changes in the Company’s deferred revenue balance from collaboration agreements during the six months ended June 30, 2020: Six Months Ended June 30, 2020 (in thousands) Deferred revenue—December 31, 2019 $ 35,660 Additions to deferred revenue 7,272 Recognition of revenue in current period ( 8,867 ) Deferred revenue—June 30, 2020 $ 34,065 The Company’s balance of deferred revenue contains the transaction price from collaboration agreements allocated to performance obligations which are partially unsatisfied, including the $ 5.0 million received from Merck to extend the research term of the collaboration’s first cytokine-derivative program by one year , which payment was earned in March 2020 and received in April 2020, and a $ 2.3 million upfront fee billed to BMS in consideration for the Company’s performance of certain development and manufacturing services, which amount may be recognized as revenue in future periods, upon completion of the earning process for such collaboration activities. The Company expects to recognize approximately $ 23.5 million of deferred revenue over the next twelve months . There have been no material changes to the Company’s collaboration agreements in the six months ended June 30, 2020, except as described below. Collaborations with Celgene In November 2019, BMS acquired Celgene, and Celgene became a wholly owned subsidiary of BMS. In connection with such acquisition, BMS assumed the rights and obligations of the 2014 Celgene Agreement, 2017 Celgene Agreement and 2018 Celgene Master Services Agreement. However, except for the presentation in the tables, the Company will continue to refer to its agreements with Celgene throughout this Form 10-Q as being with Celgene. Celgene Agreement In September 2014, the Company signed a Collaboration and License Agreement with Celgene to discover and develop bispecific antibodies and/or antibody-drug conjugates (“ADCs”), focused primarily on the field of immuno-oncology, using the Company’s proprietary integrated cell-free protein synthesis platform, XpressCF ® . 13 Upon signing the Celgene Agreement, the Company received an upfront, nonrefundable payment totaling $ 83.1 million. In March 2015, the Company received a $ 15.0 million contingent payment (“March 2015 payment”) from Celgene that provided Celgene a right to access certain of the Company’s technology for use in conjunction with certain Celgene intellectual property. In June 2016, the Company received a $ 25.0 million milestone (“June 2016 payment”) upon completion of certain preclinical activities. Additionally, in June 2016, the Company earned a $ 10.0 million substantive milestone for certain manufacturing accomplishments. In August 2017, the Company received an option fee payment of $ 12.5 million. In September 2017, the Company earned a $ 10.0 million milestone for certain manufacturing accomplishments, which payment was received from Celgene in October 2017. In December 2018, the Company earned a $ 10.0 million milestone for certain manufacturing accomplishments, which payment was received from Celgene in the same month. In August 2017, the Company entered into an amended and restated collaboration and license agreement with Celgene to refocus the collaboration on four programs that were advancing through preclinical development, including an ADC program targeting B cell maturation antigen (“BCMA ADC”). In May 2019, the U.S. Food and Drug Administration cleared the investigational new drug (“IND”) application for the BCMA ADC, which was discovered and manufactured by the Company and is the first collaboration program IND. Celgene has worldwide development and commercialization rights with respect to the BCMA ADC. The Company will continue to be responsible for clinical supply manufacturing and certain development services for the BCMA ADC and is eligible to receive from Celgene aggregate development and regulatory contingent payments of up to $ 275.0 million, if approved in multiple indications, and tiered royalties ranging from mid to high single digit percentages on worldwide sales of any resulting commercial products. With respect to the remaining three collaboration programs (BCMA-CD3, PD1-LAG3 and PD1-TIM3), during the second quarter of 2019 Celgene notified the Company that it decided not to exercise the option to acquire U.S. clinical development and commercialization rights to a second collaboration program. Therefore, Celgene was not required to pay the Company the $ 12.5 million option maintenance fee that would have been due upon IND clearance for the first collaboration program, as described above. Consequently, the U.S. clinical development and commercialization rights to the other three collaboration programs remain owned by the Company, without any further option to Celgene. For any products resulting from these three collaboration programs, Celgene will own ex-U.S. development and commercialization rights and will be obligated to pay the Company development and regulatory contingent payments and tiered royalties ranging from mid to high single digit percentages. The contingent payments under the Celgene Agreement are not considered to be substantive milestones because the receipt of such payments is based solely on the performance of Celgene. The Company has received and will be eligible to receive financial support for research and development services assigned to the Company by Celgene, based on an agreed-upon level of FTE personnel effort and related reimbursement rate, which will be recognized as revenue as the related reimbursable activities approved by Celgene and the Company are performed by the Company. Celgene may terminate the Celgene Agreement at any time with 120 days’ prior written notice. Either the Company or Celgene has the right to terminate the Celgene Agreement based on the other party’s uncured material breach, challenge of the validity and enforceability of intellectual property, or bankruptcy. In accounting for this arrangement under ASC 606, applying the practical expedients, the Celgene Agreement was treated as a single arrangement that had been modified in 2017, in the form it was last modified prior to the adoption of ASC 606. Given the modification of the Celgene Agreement in 2017, the Company determined that the remaining deferred revenue balance of $ 8.2 million as of the date of the modification, related to certain prior Celgene payments to the Company, together with the $ 12.5 million option fee payment received in August 2017, would comprise the transaction price of $ 20.7 million to be allocated on a relative basis among the Company’s performance obligations based on the Company’s best estimate of each SSP or fair value. The Company identified the three performance obligations relating to the Celgene Agreement as: (1) access by Celgene to worldwide development and commercialization rights on the first collaboration program to achieve IND clearance; (2) the Company’s estimated future services on the collaboration Joint Steering Committee (“JSC”); and (3) Celgene’s use of certain technology and the option to acquire worldwide development and commercialization rights to a second collaboration program. 14 Based on its estimated SSP, relative to the total estimated SSP values of all identified performance obligations, the portion of the transaction price allocated to the first performance obligation was $ 8.2 million, which performance obligation was satisfied as of the modification date of the Celgene Agreement, as the BCMA ADC program was the most advanced of the four collaboration programs and estimated by the Company to be the one for which Celgene would first achieve IND clearance and gain worldwide development and commercialization rights. The second and third performance obligations identified above were unsatisfied as of the modification date of the Celgene Agreement. The Company determined the portion of the transaction price to be allocated to the JSC performance obligation was $ 0.2 million. Revenue related to such performance obligation will be recognized by the Company over the estimated period during which it will perform its JSC services. The Company determined that the portion of the transaction price to be allocated to the third performance obligation, which provided Celgene with an option to acquire worldwide development and commercialization rights to a second collaboration program, was $ 12.3 million. Although Celgene decided not to exercise this option, the Company still has the continuing performance obligation to provide Celgene access to the Company’s technology. As such, the Company’s revenue related to such performance obligation will continue to be recognized over the period from August 2017 through September 2020, the estimated term of the use of the technology. Upon the adoption of ASC 606 on January 1, 2019, the Company recorded a $ 4.5 million adjustment to decrease its deferred revenue for performance obligations that were satisfied in prior periods, with the corresponding adjustment being a reduction to the Company’s accumulated deficit. For the three and six months ended June 30, 2020, the Company recognized $ 1.0 million and $ 2.0 million, respectively, of revenue associated with the Company’s ongoing performance related to partially unsatisfied performance obligations, and $ 0.3 million and $ 0.4 million, respectively, from research and development services. For the three and six months ended June 30, 2019, the Company recognized $ 1.0 million and $ 1.9 million, respectively, of revenue associated with the Company’s ongoing performance related to partially unsatisfied performance obligations, and $ 0.1 million and $ 0.3 million, respectively, from research and development services. As of June 30, 2020 and December 31, 2019, there was $ 3.3 million and $ 3.0 million, respectively, of deferred revenue related to payments received by the Company under the Celgene Agreement. 2018 Celgene Master Services Agreement In March 2018, the Company entered into a Master Development and Clinical Manufacturing Services Agreement (the “2018 Celgene Master Services Agreement”) with Celgene, wherein Celgene requested the Company to provide development, manufacturing and supply chain management services, including clinical product supply. The consideration for the services is based on an agreed-upon level of FTE personnel effort and related reimbursement rate in addition to agreed-upon pricing for the clinical product supply. Upon adoption of ASC 606 on January 1, 2019, this was deemed a modification of the arrangement and the consideration terms were at fair value and materials are to be provided on an as agreed upon basis. Accordingly, the Company will recognize revenue upon the performance of such services. For the three and six months ended June 30, 2020, the Company earned $ 0.3 million and $ 1.2 million, respectively, under the 2018 Celgene Master Services Agreement. For the three and six months ended June 30, 2019, the Company earned $ 0.5 million and $ 1.0 million, respectively, under the 2018 Celgene Master Services Agreement. 2018 Merck Agreement In July 2018, the Company entered into the 2018 Merck Agreement with Merck to jointly develop up to three research programs focusing on cytokine derivatives for cancer and autoimmune disorders. Under the 2018 Merck Agreement, the Company received from Merck a non-refundable, non-creditable, upfront payment of $ 60.0 million in August 2018 for access to the Company’s technology and the identification and preclinical research and development of two target programs, with an option for Merck to engage the Company to continue these activities for a third program upon the payment of an additional amount. Under ASC 606, the Company identified the five performance obligations under the 2018 Merck Agreement as: (1) access to certain intellectual property rights; (2) performance of services related to the first target program; (3) performance of services related to the second target program; (4) the Company’s estimated future services on the collaboration JSC; and (5) a material right pertaining to the performance of services related to a contingent third target program upon the payment of an additional amount. The transaction price of $60.0 million was allocated among the performance obligations using the Company’s best estimate of SSP for each of the associated performance obligations. Based on its estimated SSP, relative to the estimated total SSP values of all identified performance obligations, the portion of the transaction price allocated to the first performance 15 obligation was $ 7.3 million. It was determined that such performance obligation was satisfied as of the effective date of the 2018 Merck Agreement, and accordingly revenue associated with this performance obligation would, pursuant to ASC 606, have been recorded on the effective date of the Merck Agreement. Revenue allocated to the first and second target programs, which totaled $ 47.1 million was being recognized on a proportion of performance basis, using the FTE cost as the basis of measurement, with such performance expected to occur over an estimated service period of three years for each target program. As it pertains to the JSC performance obligation, the revenue allocated to such performance obligation was $ 0.7 million, which was being recognized as revenue on a proportion of performance basis using FTE cost as the basis, and such effort is expected to be incurred on a relatively consistent basis throughout the term of the 2018 Merck Agreement. The Company allocated $ 4.9 million of the transaction price to the material right associated with the contingent third program. Recognition of the $4.9 million as revenue will begin upon commencement of the third program or upon the determination that the contingent third target program is no longer a performance obligation. Additionally, under ASC 606, the Company determined there was a financing component associated with the $ 60.0 million upfront payment, and has calculated total interest expense of $ 7.4 million as of June 30, 2020 on the unearned revenue portion beyond one year from the effective date of the agreement, which amount is expected to be recognized as revenue over the estimated service period for the first and second target programs. Upon adoption of ASC 606 on January 1, 2019, the Company recorded a $ 6.3 million adjustment to decrease its deferred revenue for performance obligations that were satisfied in prior periods, with the corresponding adjustment being a reduction to the Company’s accumulated deficit. In March 2020, the Company adjusted revenue recognized for the first and second target programs as the parties determined additional resources should be assigned to the first target program with a reduction of resources attributed to the second target program . This resulted in a decrease in the measure of proportional performance for the first target program by $ 6.2 million and an increase in the measure of proportional performance for the second target program of $ 1.1 million for a collective decrease in revenue of $ 5.1 million. See Note 2 above for further explanation. Also, in March 2020, Merck exercised its option to extend the research term of the collaboration’s first cytokine-derivative program by one year , which, pursuant to the terms of the 2018 Merck Agreement, triggered a payment of $ 5.0 million. The $ 5 million was, in prior periods, considered to be a fully constrained variable consideration. Removal of the constraint on this variable consideration resulted in a change to the total transaction price, from $ 60.0 million to $ 65.0 million. The Company allocated the updated transaction price to all identified performance obligations on the same basis as the initial allocation upon inception of the 2018 Merck Agreement, with any adjustments recorded as a cumulative catch-up in the current period. Based upon the adjusted transaction price, revenue allocated to the access to intellectual property rights was $ 7.8 million and incremental revenue of $ 0.5 million was recognized in the period as this performance obligation was previously completed. Revenue allocated to the first and second target programs totaled $ 50.5 million, to be recognized on a proportion of performance basis, using the FTE cost as the basis of measurement, with such performance expected to occur over an estimated service period of three years for each target program. Incremental revenue of $ 1.5 million was recognized in the period. The Company allocated $5.9 million of the adjusted transaction price to the material right associated with the contingent third program. No revenue for this performance obligation has been recognized and recognition of the $ 5.9 million as revenue will begin upon the earlier of (i) the commencement of the third program; or (ii) upon the determination that the contingent third target program is no longer a performance obligation. As it pertains to the JSC performance obligation, the incremental transaction price allocation was immaterial. As a result of the change in transaction price, the Company recorded a $ 2.0 million cumulative catch-up in revenue in the quarter ended March 31, 2020. During the three and six months ended June 30, 2020, the Company recognized revenue of $ 5.2 million and $ 6.1 million, respectively, associated with the Company’s ongoing performance related to the partially unsatisfied performance obligations, $ 0.5 million and $ 1.1 million, respectively, related to the interest component described above, and $ 1.2 million and $ 2.5 million, respectively, for FTE funding provided by Merck. During the three and six months ended June 30, 2019, the Company recognized revenue of $ 3.7 million and $ 6.7 million, respectively, associated with the Company’s ongoing performance related to the partially unsatisfied performance obligations, $ 0.8 million and $ 1.7 million, respectively, related to the interest component described above, and $ 0.9 million and $ 1.7 million, respectively, for FTE funding provided by Merck. As of June 30, 2020 and December 31, 2019, there was $ 30.8 million and $ 31.9 million, respectively, of deferred revenue related to the transaction price under the 2018 Merck Agreement. 16 The Company is also eligible to receive aggregate milestone payments of up to $ 1.6 billion, assuming the development and sale of all therapeutic candidates and all possible indications identified under the collaboration. If one or more products from each of the target programs are developed for non-oncology or a single indication, the Company will be eligible for reduced aggregate milestone payments. In addition, the Company is eligible to receive tiered royalties ranging from mid-single digit to low teen percentages on the worldwide sales of any commercial products that may result from the collaboration. Merck may terminate the 2018 Merck Agreement at any time with 60 days’ prior written notice. Either the Company or Merck has the right to terminate the 2018 Merck Agreement based on the other party’s uncured material breach or bankruptcy. EMD Serono Agreement The Company signed a Collaboration Agreement and a License Agreement with EMD Serono in May 2014 and September 2014, respectively, which were entered into in contemplation of each other and therefore treated as a single agreement for accounting purposes. The Collaboration Agreement was subsumed into the License Agreement (the “MDA Agreement”), which agreement is to develop ADCs for multiple cancer targets. Upon signing the Collaboration Agreement, the Company received an upfront, nonrefundable, non-creditable payment totaling $ 10.0 million. Upon signing the MDA Agreement, the Company received an additional upfront, nonrefundable payment totaling $ 10.0 million and will receive financial support for research and development services to be provided by the Company, based on an agreed-upon level of FTE personnel effort and related reimbursement rate. The Company is eligible to receive up to $ 52.5 million for each product developed under the MDA Agreement, primarily from pre-commercial contingent payments. In addition, the Company is eligible to receive tiered royalties ranging from low-to-mid single digit percentages, along with certain additional one-time royalties, on worldwide sales of any commercial products that may result from the MDA Agreement. The MDA Agreement term expires on a product-by-product and country-by-country basis. Upon expiration, EMD Serono will have a fully paid-up, royalty-free, perpetual, and irrevocable non-exclusive license, with the right to grant sublicenses, under certain Company intellectual property rights. EMD Serono may terminate the MDA Agreement at any time with 90 days’ prior written notice or upon the inability of the Company to provide EMD Serono access to a specified number of cancer drug targets. Either the Company or EMD Serono has the right to terminate the MDA Agreement based on the other party’s uncured material breach or bankruptcy. Upon adoption of ASC 606 on January 1, 2019, the Company identified a single performance obligation under the MDA Agreement, which consists of the technology license, research and development activities and JSC participation over the estimated period of the agreement, as each are interrelated and not distinct within the overall context of the agreement. The transaction price of $ 20.0 million was being recognized on a proportion of performance basis, using the FTE cost as the basis of measurement, with such performance occurring over the estimated service period of the agreement, from June 2014 through May 2019. The Company recorded a $ 0.6 million adjustment to increase its deferred revenue for performance obligations that were unsatisfied in prior periods, with the corresponding adjustment being an increase to the Company’s accumulated deficit. For the three and six months ended June 30, 2020, the Company earned $ 0.3 million and $ 2.3 million, respectively, from a supply agreement, and $ 0.5 million and $ 0.8 million, respectively, from research and development services. For the three and six months ended June 30, 2019, the Company earned $ 1.5 million and $ 1.5 million, respectively, from a supply agreement, $ 0.9 million and $ 1.7 million, respectively, from research and development services, and $ 1.0 million and $ 2.3 million, respectively, associated with the Company’s ongoing performance related to partially unsatisfied performance obligations. Such ongoing performance obligations were fully satisfied in Q3 2019. As of June 30, 2020 and December 31, 2019, there was zero and $ 0.8 million, respectively, of deferred revenue related to payments received by the Company under the MDA Agreement. Vaxcyte, Inc. Supply Agreement In May 2018, the Company entered into a Supply Agreement (the “Supply Agreement”) with Vaxcyte, wherein Vaxcyte engaged the Company to supply extracts and custom reagents, as requested by Vaxcyte. The pricing is based on an agreed upon cost plus arrangement. For the three and six months ended June 30, 2020, the Company recognized revenue of $ 0.1 million under the Supply Agreement. For the three and six months ended June 30, 2019, the Company recognized revenue of zero and $ 0.3 million, respectively, under the Supply Agreement. As the Company has a right to consideration from Vaxcyte in an amount that corresponds directly with the value of the Company’s supplied extracts and custom reagents, the Company’s sales of extracts and custom reagents in discrete 17 unit form are recognized as revenue at the time when such supplies are shipped to Vaxcyte , in line with the “right to invoice” practical expedient in ASC 606. The Company has not received any returns to date and believes that returns of its products will continue to be minimal. As such, the Company does not record any reserve for the returns but will continue to evaluate the need for a reserve each reporting period. The Leukemia & Lymphoma Society, Inc. In August 2018, the Company entered into a Research, Development and Commercialization Agreement (the “LLS Agreement”) with The Leukemia & Lymphoma Society (“LLS”), under which LLS has agreed to contribute up to $ 6.0 million in clinical development funding for STRO-001, the Company’s CD74-targeting ADC to treat relapsed and/or refractory multiple myeloma and non-Hodgkin lymphoma. The funding will be provided in installments based upon the achievement of funding milestones, with any excess funding above actual expenditures refundable to LLS. The initial payment of $ 0.5 million was received by the Company upon execution of the LLS Agreement. To date, the Company has received total payments from LLS of $ 1.0 million. In consideration for the funding to the Company under the LLS Agreement, the Company may be required in the future to make payments to LLS, contingent upon reaching certain pre-specified late-stage clinical development, regulatory and commercialization milestones and should the Company enter into certain transactions relating to STRO-001 with a third party, which payments in the aggregate could total up to a maximum of $ 19.5 million, assuming receipt by the Company from LLS of the entire $ 6.0 million in clinical development funding for STRO-001. As of June 30, 2020, no events have occurred that would require such payments to LLS. The LLS Agreement terminates upon the earlier of (a) fulfillment of all payment obligations by both parties or (b) 12 years after the effective date. LLS may terminate the LLS Agreement at any time with 60 days’ prior written notice. Either the Company or LLS has the right to terminate the LLS Agreement based on the other party’s uncured material breach. The Company concluded that the contingent payments were an embedded derivative and recorded a related liability of approximately $ 0.1 million as a part of other noncurrent liabilities as of both June 30, 2020 and December 31, 2019, with the corresponding amount recorded in the statements of operations as interest and other expense, net. The value of the embedded derivative was estimated based on the probability-adjusted and discounted value of future payments. 6. Loan and Security Agreement In August 2017, the Company entered into a loan and security agreement with Oxford Finance LLC (“Oxford”) and Silicon Valley Bank (“SVB”) under which it borrowed $ 15.0 million (the “August 2017 Loan”). The loan was due in 30 monthly installments from March 2019 through its repayment in August 2021 , with interest-only monthly payments until March 2019 . The Company commenced repayment of the loan in March 2019. The interest charges on the loan were based on a floating rate that equaled the greater of 7.39 % or the sum of the 30-day U.S. Dollar London Interbank Offered Rate (“LIBOR”) plus 6.40 %. In connection with the August 2017 Loan, the Company issued to Oxford and SVB a warrant to purchase the Company’s Series D-2 redeemable convertible preferred stock (the “2017 Warrant”). The 2017 Warrants were later converted into warrants to purchase Series E redeemable convertible preferred stock in May and July 2018, and upon the Company’s IPO on October 1, 2018, all Series E redeemable convertible preferred stock warrants were converted to warrants to purchase 46,359 shares of common stock. The estimated fair value upon issuance of the 2017 Warrant of $ 0.3 million was recorded as a debt discount on the associated borrowings on the Company’s balance sheet. The debt discount was amortized to interest expense over the expected repayment period of the loan using the effective-interest method. As of December 31, 2019, the outstanding principal on the August 2017 Loan was $ 10.0 million. On February 28, 2020, (the “Effective Date”), the Company entered into a loan and security agreement (the “Loan and Security Agreement”) with Oxford as the collateral agent and a lender, and SVB as a lender (together with Oxford, the “Lenders”), pursuant to which the Lenders agreed to lend the Company up to an aggregate of $ 25.0 million in a series of term loans (the “Term A Loan”). Upon entering into the Loan and Security Agreement, the Company borrowed $ 25.0 million from the Lenders, with approximately $ 9.6 million of such amount applied to the repayment of the outstanding principal, interest and final payment fees owed pursuant to the August 2017 Loan. As such, the August 2017 Loan has been paid in full. The Company accounted for the issuance of the Loan and Security Agreement and repayment of the August 2017 Loan as a debt modification. The associated unamortized debt discount on the August 2017 Loan and new lender fees from the debt issuance will be amortized as interest expense using the effective interest method until the maturity date of the Term A Loan. 18 Under the terms of the Loan and Security Agreement, the Company may, at its sole discretion, borrow from the Lenders up to an additional $ 5.0 million (the “Term B Loan” and together with the Term A Loan, the “Term Loans”) upon the Company closing of a new collaboration agreement that includes an upfront payment of at least $ 50.0 million to the Company, as determined by Oxford in its sole and absolute discretion (the “Term B Milestone Event”). The Company may draw the Term B Loan during the period commencing on the date of the occurrence of the Term B Milestone Event and ending on the earliest of (i) December 31, 2020, (ii) the thirtieth (30th) day following the occurrence of the Term B Milestone Event, and (iii) the occurrence of an event of default by the Company. The Company’s obligations under the Loan and Security Agreement are secured by all assets of the Company, other than its intellectual property. The Company has also agreed not to encumber its intellectual property assets, except as permitted by the Loan and Security Agreement. The Term Loans mature on March 1, 2024 (the “Maturity Date”) and will be interest-only through March 1, 2022 , followed by 24 equal monthly payments of principal and interest. The Term Loans will bear interest at a floating per annum rate equal to the greater of (i) 8.07 % or (ii) the sum of (a) the greater of (1) the thirty (30) day U.S. LIBOR rate reported in the Wall Street Journal on the last business day of the month that immediately precedes the month in which the interest will accrue or (2) 1.67 %, plus (b) 6.40 %. The Company will be required to make a final payment of 3.83 % of the original principal amount of the Term Loans drawn, or $ 1.0 million, payable on the earlier of (i) the Maturity Date, (ii) the acceleration of any Term Loans, or (iii) the prepayment of the Term Loans (the “Final Payment”). The final payment amount is accreted as interest expense until the Maturity Date using the effective interest method. The Company may prepay all, but not less than all, of the Term Loans upon 30 days’ advance written notice to Oxford, provided that the Company will be obligated to pay a prepayment fee equal to (i) 3.00 % of the principal amount of the applicable Term Loan prepaid on or before the first anniversary of the applicable funding date, or (ii) 2.00 % of the principal amount of the applicable Term Loan prepaid between the first and second anniversary of the applicable funding date, or (iii) 1.00 % of the principal amount of the applicable Term Loan prepaid thereafter, and prior to the Maturity Date (each, a “Prepayment Fee”). The Loan and Security Agreement contains customary affirmative and restrictive covenants, including covenants regarding incurrence of additional indebtedness or liens, investments, transactions with affiliates, delivery of financial statements, maintenance of inventory, payment of taxes, maintenance of insurance, protection of intellectual property rights, dispositions of property, business combinations or acquisitions, among other customary covenants. The Company is also restricted from paying dividends or making other distributions or payments on its capital stock, subject to limited exceptions. The Loan and Security Agreement provides that an event of default will occur if, among other triggers, there occurs any circumstances that could reasonably be expected to result in a material adverse change in the business, or operations or condition (financial or otherwise) of the Company or a material impairment of the prospect of the Company to repay any portion of its obligations under the Agreement. The Agreement also includes customary representations and warranties, other events of default and termination provisions. In connection with entering into the Loan and Security Agreement, the Company issued to the Lenders warrants exercisable for 81,257 shares of the Company’s common stock (the “2020 Warrants”). The 2020 Warrants are exercisable in whole or in part, immediately, and have a per share exercise price of $ 9.23 , which is the closing price of the Company’s common stock reported on the Nasdaq Global Market on the day prior to the Effective Date. The 2020 Warrants will terminate on the earlier of February 28, 2030 or the closing of certain merger or consolidation transactions. The estimated fair value upon issuance of the Warrants of $ 0.6 million is recorded as a debt discount on the associated borrowings on the Company’s balance sheet. The debt discount is being amortized to interest expense over the expected repayment period of the loan using the effective-interest method. As of June 30, 2020, the Company has classified the outstanding debt balance of $ 25.0 million as non-current, which reflects the scheduled repayment terms under the Loan and Security Agreement. As of June 30, 2020 and December 31, 2019, accrued interest expense was $ 0.2 million and $ 0.4 million, respectively. 19 During the three and six months ended June 30, 2020, the Company recorded interest expense related to loans outstanding of $ 0.6 million and $ 1.0 million, respectively, with average interest rates of 8.07 % and 8.08 %, respectively, and interest related to the accretion of debt discount of $ 0.1 million and $ 0.2 million, respectively. During the three and six months ended June 30, 2019, the Company recorded interest expense related to loans outstanding of $ 0.3 million and $ 0.6 million, respectively, with average interest rates of 8.87 % and 8.88 %, respectively, and interest related to the accretion of debt discount of $ 85,000 and $ 175,000 , respectively. 7. Related-Party Transactions Upon the Company’s public offering on May 14, 2020, Merck’s ownership of the Company’s outstanding equity interest decreased to less than 10 %. As a result, starting May 14, 2020, the Company ceased to reflect balances and transactions associated with Merck as being with a related party in its financial statements. Transactions with Merck for the three months and six months ended June 30, 2020 and June 30, 2019 are described in Note 5. As discussed in Note 1, Vaxcyte closed its IPO of its common stock on June 16, 2020, resulting in the Company’s ownership of Vaxcyte’s outstanding equity interest to less than 4.0 %. As a result, starting on June 16, 2020, the Company ceased to reflect any balances and transactions associated with Vaxcyte being a related party on its financial statements. Transactions with Vaxcyte for the three months and six months ended June 30, 2020 and 2019 are described in Note 5. 8. Stockholders’ Equity Common Stock Holders of common stock are entitled to one vote per share on all matters to be voted upon by the stockholders of the Company. The Company had reserved common stock, on an if-converted basis, for issuance as follows: June 30, December 31, 2020 2019 Common stock options issued and outstanding 5,309,239 3,872,664 Restricted common stock units issued and outstanding 774,991 335,799 Remaining shares reserved for issuance under 2004 and 2018 Equity Incentive Plan 1,970,938 2,750,416 Shares reserved for issuance under 2018 Employee Stock Purchase Plan 483,066 326,542 Warrants to purchase common stock 153,070 71,813 Total 8,691,304 7,357,234 20 Preferred Stock Effective October 30, 2018, the Company had 10,000,000 shares of preferred stock authorized with a par value of $ 0.001 . No shares of preferred stock were outstanding as of June 30, 2020 and December 31, 2019. Warrants During the period from 2008 to 2012, the Company issued various warrants for the purchase of redeemable convertible preferred stock in connection with debt financings and the issuance of redeemable convertible preferred stock. In August 2017, the Company issued warrants to Oxford and SVB to purchase an aggregate of 682,230 shares of Series D-2 redeemable convertible preferred stock at an exercise price of $ 0.6596 per share in connection with the issuance of the August 2017 Loan. If there was a subsequent convertible preferred stock or other senior equity securities financing with a per share price less than the Series D-2 redeemable convertible preferred per share price, then the warrant would automatically convert to a warrant to purchase such class of shares, based on the per share price of such equity. Given that the price per share of the Series E redeemable convertible preferred stock was less than the price per share of the Series D-2 redeemable convertible preferred stock, the 2017 Warrant converted into a warrant to purchase a total of 1,682,871 shares of Series E redeemable convertible preferred stock at an exercise price of $ 0.2674 per share. The warrant is exercisable from the original date of issuance and has a 10 -year term. The Company adjusted the warrant liability for changes in fair value until the completion of its IPO on October 1, 2018, at which time certain convertible preferred stock warrants were converted into warrants for the purchase of common stock and the related convertible preferred stock warrant liability was reclassified to additional paid-in capital and others expired. On October 1, 2018, 1,232,220 shares of the Series C redeemable convertible preferred warrants were canceled, and the remaining 687,928 shares were converted on a 1-for-0.0370 basis to warrants to purchase 25,454 shares of common stock. All Series E redeemable convertible preferred warrants were converted on a 1-for-0.0275 basis to warrants to purchase 46,359 shares of common stock. In February 2020, in connection with entering into the Loan and Security Agreement, the Company issued to Oxford and SVB the 2020 Warrants, which are exercisable for 54,171 shares and 27,086 shares, respectively, of the Company’s common stock. The 2020 Warrants are exercisable in whole or in part, immediately, and have a per share exercise price of $ 9.23 , which is the closing price of the Company’s common stock reported on the Nasdaq Global Market on the day prior to the Effective Date. The 2020 Warrants will terminate on the earlier of February 28, 2030 or the closing of certain merger or consolidation transactions. 21 9. Equity Incentive Plans, Employee Stock Purchase Plan and Stock-Based Compensation 2004 Equity Incentive Plan and 2018 Equity Incentive Plan In September 2018, the Company adopted the 2018 Equity Incentive Plan (“2018 Plan”), which became effective on September 25, 2018. As a result, the Company will not grant any additional awards under the 2004 Equity Incentive Plan (“2004 Plan”). The terms of the 2004 Plan and applicable award agreements will continue to govern any outstanding awards thereunder. In addition to the shares of common stock reserved for future issuance under the 2004 Plan that were added to the 2018 Plan upon its effective date, the Company initially reserved 2,300,000 shares of common stock for issuance under the 2018 Plan. In addition, the number of shares of common stock reserved for issuance under the 2018 Plan will automatically increase on the first day of January for a period of up to ten years , commencing on January 1, 2019, in an amount equal to 5 % of the total number of shares of the Company’s capital stock outstanding on the last day of the preceding year, or a lesser number of shares determined by the Company’s board of directors. As a result, common stock reserved for issuance under the 2018 Plan was increased by 1,154,948 shares on January 1, 2020. As of June 30, 2020, the Company had 1,970,938 shares available for grant under the 2018 Plan. The following table summarizes option activity under the Company’s 2004 Plan and 2018 Plan: Shares Weighted- Average Exercise Price Weighted- Average Remaining Contract Term (Years) Aggregate Intrinsic Value (in thousands) Stock options outstanding at December 31, 2019 3,872,664 $ 12.89 7.88 $ 2,119 Granted 1,496,806 $ 8.88 Exercised ( 14,194 ) $ 4.50 Canceled and forfeited ( 46,037 ) $ 10.58 Stock options outstanding at June 30, 2020 5,309,239 $ 11.80 8.03 $ 1,286 Stock options exercisable at June 30, 2020 2,226,316 $ 12.53 6.74 $ 630 The aggregate intrinsic value was calculated as the difference between the exercise prices of the underlying stock option awards and the estimated fair value of the Company’s common stock on the date of exercise. For the three and six months ended June 30, 2020, the aggregate intrinsic value of stock options exercised was $ 5,000 and $ 81,000 , respectively, determined at the date of the option exercise. For the three and six months ended June 30, 2019, the aggregate intrinsic value of stock options exercised was $ 9,000 and $ 55,000 , respectively, determined at the date of the option exercise. Employee Stock Options Valuation For determining stock-based compensation expense, the fair-value-based measurement of each employee stock option was estimated as of the date of grant using the Black-Scholes option-pricing model with assumptions as follows: Six Months Ended June 30, 2020 2019 Expected term (in years) 2.84-7.01 5.03-7.01 Expected volatility 73.15%-83.96% 72.89%-74.89% Risk-free interest rate 0.16%-1.62% 1.85%-2.55% Expected dividend – – Using the Black-Scholes option-valuation model, the weighted-average estimated grant-date fair value of employee stock options granted during the three and six months ended June 30, 2020 was $ 5.60 and $ 5.03 per share, respectively, and during the three and six months ended June 30, 2019 was $ 6.79 and $ 6.97 per share, respectively. 22 Restricted Stock Units During the six months ended June 30, 2020, the Company granted 497,250 shares of restricted common stock units, or RSUs, to certain employees. These RSUs will become fully vested over four years in May 2024 . A summary of the status and activity of non-vested RSUs at June 30, 2020 is as follows: Number of shares Weighted Average Grant-Date Fair Value Non-vested December 31, 2019 335,799 $ 13.49 Granted 497,250 $ 8.19 Vested and released ( 41,300 ) $ 11.44 Canceled and forfeited ( 16,758 ) $ 9.64 Non-vested June 30, 2020 774,991 $ 10.28 2018 Employee Stock Purchase Plan In September 2018, the Company adopted the 2018 Employee Stock Purchase Plan (“ESPP”), which became effective on September 26, 2018, in order to enable eligible employees to purchase shares of the Company’s common stock. The Company initially reserved 230,000 shares of common stock for sale under the ESPP. The aggregate number of shares reserved for sale under the ESPP will increase automatically on January 1st of each of the first ten calendar years after the effective date by the number of shares equal to the lesser of 1 % of the total outstanding shares of the Company’s common stock as of the immediately preceding December 31 (rounded to the nearest whole share) or a number of shares as may be determined by the Company’s board of directors. As a result, common stock reserved for issuance under the ESPP was increased by 230,989 shares on January 1, 2020. The aggregate number of shares issued over the term of the Company’s ESPP, subject to stock-splits, recapitalizations or similar events, may not exceed 2,300,000 shares of the Company’s common stock. The fair value of the ESPP shares is estimated using the Black-Scholes option pricing model. For the six months ended June 30 , 2020, the fair value of ESPP shares was estimated using the following assumptions: Six Months Ended June 30, 2020 2019 Expected term (in years) 0.5 0.5 Expected volatility 63.04 % 74.41 % Risk-free interest rate 1.92 % 2.09 % Expected dividend – – As of June 30 , 2020, 206,404 shares had been purchased and 483,066 shares were available for future issuance under the ESPP. 23 Stock-Based Compensation Expense The Company believes that the fair value of the stock options, RSUs and ESPP shares is more reliably measurable than the fair value of services received. Total stock-based compensation expense recognized was as follows: Three Months Ended Six Months Ended June 30, June 30, 2020 2019 2020 2019 (in thousands) (in thousands) Research and development expense: Stock options $ 340 $ 246 $ 584 $ 474 Restricted stock units 243 196 407 303 ESPP 113 - 220 76 Subtotal 696 442 1,211 853 General and administrative expense: Stock options 1,756 1,654 3,458 3,154 Restricted stock units 528 367 989 714 ESPP 31 - 60 28 Subtotal 2,315 2,021 4,507 3,896 Total $ 3,011 $ 2,463 $ 5,718 $ 4,749 As of June 30 , 2020, unrecognized stock-based compensation expense related to the unvested stock options and RSUs granted was $ 20.1 million and $ 6.2 million, respectively. The remaining unrecognized compensation cost is expected to be recognized over a weighted-average period of 2.6 years and 2.8 years, respectively. As of June 30 , 2020, there is $ 0.1 million of unrecognized stock-based compensation expense related to the ESPP. As of June 30, 2019, unrecognized stock-based compensation expense related to the unvested stock options and RSUs granted was $ 21.4 million and $ 1.5 million, respectively. The remaining unrecognized compensation cost is expected to be recognized over a weighted-average period of 3.1 years and 2.4 years, respectively. As of June 30, 2019, there is no unrecognized stock-based compensation expense related to the ESPP. Non-Employee Stock-Based Compensation Expense The fair value of options granted to non-employees was estimated using the Black-Scholes method. The stock-based compensation expense related to non-employees for the three and six months ended June 30, 2020 and 2019 was immaterial. Call Option Plan In February 2017, the Company adopted a Call Option Plan to grant selected employees, officers, directors and consultants (collectively, the “Participants”) options to purchase shares of the common stock of Vaxcyte. As of June 30, 2020, the Company has reserved 266,740 shares of Vaxcyte common stock for issuance under the program, under which call options covering 248,960 and 17,780 shares were granted in February 2017 and August 2019, respectively. The call options granted in February 2017 vest 25 % on each of January 1, 2017, 2018, 2019, and 2020, and expire one year from the vesting date. The call options granted in August 2019 vest 25 % on each of January 1, 2019, 2020, 2021, and 2022, and expire one year from the vesting date. The call options were measured at fair value on grant date and at each reporting period prior to their vesting, with cost recognized over the requisite service period as compensation cost. Any changes in the fair value subsequent to the vesting date are recognized in interest and other expense, net in the statements of operations. Call options covering 248,960 and 17,780 shares have been granted with an exercise price of $ 1.28 per share and $ 2.04 per share, respectively. 24 A summary of the status of the call options at June 30, 2020 and at December 31, 2019 is as follows: June 30, December 31, 2020 2019 Shares Shares Options vested and exercised 191,165 191,165 Options vested and outstanding 66,685 - Options unvested and outstanding 8,890 75,475 Total options granted 266,740 266,640 The amounts recognized as compensation expense related to the Call Option Plan for the three and six months ended June 30, 2020 were $ 64,000 and $ 68,000 , respectively. The amounts recognized as compensation expense related to the Call Option Plan for the three and six months ended June 30, 2019 were $ 17,000 and $ 35,000 , respectively. The amounts recognized as other expense related to the remeasurement of the vested call options for the three and six months ended June 30, 2020 were $ 1.8 million and $ 2.0 million, respectively. The amounts recognized as other expense related to the remeasurement of the vested call options for the three and six months ended June 30, 2019 were $ 3,000 and 7,000 , respectively. As of June 30, 2020 and December 31, 2019, liability attributable to the Call Option Plan was $ 2.1 million and $ 76,000 , respectively. 10. Net Income (Loss) Per Share The following table sets forth the computation of the Company’s basic and diluted net loss per share. Three Months Ended Six Months Ended June 30, June 30, 2020 2019 2020 2019 Numerator: Net income (loss), basic and diluted $ 29,872 $ ( 13,793 ) $ 10,277 $ ( 28,043 ) Denominator: Weighted-average shares used to compute basic EPS 29,900,913 22,926,390 26,510,873 22,895,902 Dilutive effect of common stock options 1,020,799 – 1,124,799 – Dilutive effect of restricted stock units 774,991 – 774,991 – Dilutive effect of warrants to purchase common stock 81,257 – 127,616 – Weighted-average shares used to compute diluted EPS 31,777,960 22,926,390 28,538,279 22,895,902 Net income (loss) earnings per share: Basic $ 1.00 $ ( 0.60 ) $ 0.39 $ ( 1.22 ) Diluted $ 0.94 $ ( 0.60 ) $ 0.36 $ ( 1.22 ) The following common stock equivalents were excluded from the computation of diluted net loss per share for the periods ended June 30, 2019, because including them would have been antidilutive: As of June 30, 2019 Common stock options issued and outstanding 3,903,653 Restricted stock units issued and outstanding 458,190 Warrants to purchase common stock 71,813 Total 4,433,656 25