Item 7. Management’s Discussion and Analysis
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following discussion and analysis contains forward-looking statements about our plans and expectations of what may happen in the future. Forward-looking statements are based on a number of assumptions and estimates that are inherently subject to significant risks and uncertainties, and our results could differ materially from the results anticipated by our forward-looking statements as a result of many known or unknown factors, including, but not limited to, those factors discussed in “Risk Factors.” See also the “Special Cautionary Notice Regarding Forward-Looking Statements” set forth at the beginning of this report.
You should read the following discussion and analysis in conjunction with “Item 8. Financial Statements and Supplementary Data,” and our consolidated financial statements beginning on page F-1 of this report.
Overview
TG Therapeutics is a fully-integrated, commercial stage biopharmaceutical company focused on the acquisition, development and commercialization of novel treatments for B-cell malignancies and autoimmune diseases. In addition to an active research pipeline including five investigational medicines across these therapeutic areas, we have received accelerated approval from the U.S. Food and Drug Administration (FDA) for UKONIQ (umbralisib), for the treatment of adult patients with relapsed or refractory marginal zone lymphoma who have received at least one prior anti-CD20-based regimen and relapsed or refractory follicular lymphoma who have received at least three prior lines of systemic therapies. Currently, we have two programs in Phase 3 development for the treatment of patients with relapsing forms of multiple sclerosis (RMS) and patients with chronic lymphocytic leukemia (CLL) and several investigational medicines in Phase 1 clinical development. We also actively evaluate complementary products, technologies and companies for in-licensing, partnership, acquisition and/or investment opportunities.
Our research and development expenses consist primarily of expenses related to in-licensing of new product candidates, fees paid to consultants and outside service providers for clinical and laboratory development, facilities-related and other expenses relating to the design, development, manufacture, testing and enhancement of our drug candidates and technologies. We expense our research and development costs as they are incurred. Research and development expenses for the years ended December 31, 2020, 2019 and 2018 were approximately $151.9 million, $148.4 million and $153.8 million, respectively, excluding noncash compensation expenses related to research and development.
The following table sets forth the research and development expenses per project, exclusive of noncash compensation expenses, for the periods presented.
(in thousands)
2020
2019
2018
Ublituximab
$
72,400
$
93,302
$
105,429
Umbralisib
66,495
46,074
42,852
Early Clinical Pipeline & Pre-Clinical
13,039
8,993
5,512
Total
$
151,934
$
148,369
$
153,793
Our general and administrative expenses consist primarily of expenses related to the US launch of UKONIQ, including salaries and related expenses for our commercialization team and commercial development activities. Other general and administrative expenses consist of executive, finance and other administrative personnel, recruitment expenses, professional fees and other corporate expenses, including investor relations, legal activities and facilities-related expenses.
Our results of operations include noncash compensation expenses as a result of the grants of restricted stock and stock options. Compensation expense for awards of restricted stock and stock options granted to employees and directors represents the fair value of the award recorded over the respective vesting periods of the individual awards. The expense is included in the respective categories of expense in the consolidated statements of operations. We expect to continue to incur significant noncash compensation expenses.
We recognize all share-based payments to employees and non-employee directors (as compensation for service) as noncash compensation expense in the consolidated financial statements based on the fair values of such payments. Stock-based compensation expense recognized each period is based on the value of the portion of share-based payment awards that is ultimately expected to vest during the period. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.
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In addition, some of the restricted stock and stock options issued to employees, consultants and other third parties vest upon achievement of certain milestones, and accordingly, the total expense is uncertain. Compensation expense for such awards is recognized when the achievement of such milestones becomes probable.
Our clinical trials will be lengthy and expensive. In addition, we expect losses to continue as we fund in-licensing and development of new drug candidates. As we further our development efforts, we may enter into additional third-party collaborative agreements and incur additional expenses, such as licensing fees and milestone payments. In addition, we will need to maintain and expand our commercial infrastructure for the manufacturing, marketing and selling of UKONIQ and our drug candidates following approval, if any, by the FDA or a foreign health authority, which would result in incurring significant additional expenses. As a result, our annual results may fluctuate and a year-by-year comparison of our operating results may not be a meaningful indication of our future performance.
RESULTS OF OPERATIONS
Years Ended December 31, 2020, 2019 and 2018
Years Ended December 31,
(in thousands)
2020
2019
2018
License revenue
$
152
$
152
$
152
Costs and expenses:
Research and development:
Noncash stock expense associated with in-licensing agreements
—
100
4,000
Noncash compensation
13,962
5,811
5,598
Other research and development
151,934
148,269
149,793
Total research and development
165,896
154,180
159,391
General and administrative:
Noncash compensation
66,327
5,523
7,288
Other general and administrative
41,523
9,504
7,873
Total general and administrative
107,850
15,027
15,161
Total costs and expenses
273,746
169,207
174,552
Operating loss
(273,594)
(169,055)
(174,400)
Other (income) expense, net
5,787
3,816
(918)
Net loss
$
(279,381)
$
(172,871)
$
(173,482)
Years Ended December 31, 2020 and 2019
License Revenue. License revenue was approximately $152,000 for each of the years ended December 31, 2020 and 2019. License revenue is related to the amortization of an upfront payment of $2.0 million associated with our license agreement with Ildong. The upfront payment from Ildong will be recognized as license revenue on a straight-line basis through December 2025, which represents the estimated period over which we will have certain ongoing responsibilities under the sublicense agreement.
Noncash Stock Expense Associated with In-Licensing Agreement (Research and Development). Noncash stock expense associated with in-licensing agreement (research and development) amounted to zero for the year ended December 31, 2020, as compared to $0.1 million during the comparable period in 2019.
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Noncash Compensation Expense (Research and Development). Noncash compensation expense (research and development) related to equity incentive grants totaled $14.0 million for the year ended December 31, 2020, as compared to $5.8 million during the comparable period in 2019. The increase in noncash compensation expense was primarily due to an increase in research and development personnel and a higher stock price during the year ended December 31, 2020.
Other Research and Development Expenses . Other research and development expenses increased by $3.6 million from $148.3 million for the year ended December 31, 2019 to $151.9 million for the year ended December 31, 2020. The increase in R&D expense is primarily attributable to the achievement of various milestones, offset by a decrease in manufacturing expense during the year ended December 31, 2020. We expect our other research and development costs to remain at consistent levels throughout 2021.
Noncash Compensation Expense (General and Administrative). Noncash compensation expense (general and administrative) related to equity incentive grants increased by $60.8 million from $5.5 million for the year ended December 31, 2019 to $66.3 million during the year ended December 31, 2020. The increase in noncash compensation expense was primarily related to more milestone-based vesting of restricted stock granted to executive personnel during the year ended December 31, 2020.
Other General and Administrative Expenses . Other general and administrative expenses increased by $32.0 million from $9.5 million for the year ended December 31, 2019 to $41.5 million for the year ended December 31, 2020. The increase was due primarily to commercial costs, including personnel, incurred in preparation for the launch of UKONIQ. We expect our other general and administrative expenses to increase modestly during 2021.
Interest Expense . Interest expense increased by $1.0 million to $6.3 million for the year ended December 31, 2020, as compared to expense of $5.3 million for year ended December 31, 2019. The increase is mainly due to interest expense related to administrative fees in connection with contract manufacturing costs during the year ended December 31, 2020.
Other Income. Other income decreased by $1.0 million to $0.5 million for the year ended December 31, 2020, as compared to $1.5 million for the year ended December 31, 2019. The decrease in other income is mainly due to a decrease in interest income during the year ended December 31, 2020. We expect our other income to remain at a comparable level during 2021.
Years Ended December 31, 2019 and 2018
License Revenue. License revenue was approximately $152,000 for each of the years ended December 31, 2019 and 2018. License revenue is related to the amortization of an upfront payment of $2.0 million associated with our license agreement with Ildong. The upfront payment from Ildong will be recognized as license revenue on a straight-line basis through December 2025, which represents the estimated period over which we will have certain ongoing responsibilities under the sublicense agreement.
Noncash Stock Expense Associated with In-Licensing Agreement (Research and Development). Noncash stock expense associated with in-licensing agreement (research and development) amounted to $0.1 million for the year ended December 31, 2019, as compared to $4.0 million during the comparable period in 2018. The expense during the year ended December 31, 2018 was recorded in conjunction with the 333,868 total shares of common stock issued to Novimmune and Jiangsu Hengrui as upfront payments for the licenses to the CD47/CD19 and BTK programs.
Noncash Compensation Expense (Research and Development). Noncash compensation expense (research and development) related to equity incentive grants remained consistent between the two periods totaling $5.8 million for the year ended December 31, 2019, as compared to $5.6 million during the comparable period in 2018.
Other Research and Development Expenses. Other research and development expenses decreased by $1.5 million from $149.8 million for the year ended December 31, 2018 to $148.3 million for the year ended December 31, 2019. The decrease in R&D expense is primarily attributable to the winding down of our late-stage clinical development programs during the year ended December 31, 2019.
Noncash Compensation Expense (General and Administrative). Noncash compensation expense (general and administrative) related to equity incentive grants decreased by $1.8 million from $7.3 million for the year ended December 31, 2018 to $5.5 million during the year ended December 31, 2019. The decrease in noncash compensation expense was primarily related to more vesting of restricted stock granted to executive personnel during the year ended December 31, 2018.
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Other General and Administrative Expenses. Other general and administrative expenses increased by $1.6 million from $7.9 million for the year ended December 31, 2018 to $9.5 million for the year ended December 31, 2019. The increase was due primarily to increased personnel and other general and administrative costs.
Interest Expense. Interest expense increased by $4.4 million to $5.3 million for the year ended December 31, 2019, as compared to expense of $0.9 million for year ended December 31, 2018. The increase is mainly due to the interest expense related to the Hercules financing agreement.
Other Income. Other income decreased by $0.3 million to $1.5 million for the year ended December 31, 2019, as compared to $1.8 million for the year ended December 31, 2018. The decrease in other income is mainly due to a greater change in the fair value of notes payable during the year ended December 31, 2018.
LIQUIDITY AND CAPITAL RESOURCES
Our major sources of cash have been proceeds from the private placement and public offering of equity securities, and in 2019 from our loan and security agreement executed with Hercules Capital, Inc. (“Hercules”) (see Note 7 for more information). As of December 31, 2020 we had not yet generated revenue from drug sales of UKONIQ. UKONIQ first became commercially available in the United States in February of 2021. Even with the commercialization of UKONIQ and the future commercialization of our other drug candidates, we may not become profitable. Our ability to achieve profitability depends on our ability to generate revenue and many other factors, including our ability to obtain regulatory approval for our drug candidates; successfully complete any post-approval regulatory obligations; and successfully commercialize our drug candidates alone or in partnership. We may continue to incur substantial operating losses even if we begin to generate revenues from our drug candidates.
As of December 31, 2020, we had $605.4 million in cash and cash equivalents, and investment securities. We anticipate that our cash and cash equivalents, and investment securities as of December 31, 2020 will provide sufficient liquidity for more than a twelve-month period from the date of filing this Annual Report on Form 10-K. The actual amount of cash that we will need to operate is subject to many factors, including, but not limited to, the timing, design and conduct of clinical trials for our drug candidates. We are dependent upon significant future financing to provide the cash necessary to execute our current operations, including the commercialization of any of our drug candidates.
Cash used in operating activities for the year ended December 31, 2020 was $214.5 million as compared to $132.8 million for the year ended December 31, 2019. The increase in cash used in operating activities was due primarily to increased expenditures associated with our clinical development programs for ublituximab and umbralisib.
For the year ended December 31, 2020, net cash used in investing activities was $24.5 million as compared to cash used in investing activities of $0.7 million for the year ended December 31, 2019. The increase in net cash used in investing activities was primarily due to greater investment in short-term securities during the year ended December 31, 2020.
For the year ended December 31, 2020, net cash provided by financing activities of $679.8 million related to the net proceeds from the issuance of common stock as part of our ATM program and public offerings in May 2020 and December 2020.
ATM Program
In December 2014, we filed a shelf registration statement on Form S-3 (the "2015 S-3"), which was declared effective in January 2015. Under the 2015 S-3, the Company may sell up to a total of $250 million of its securities. In connection with the 2015 S-3, we amended our 2013 At-the-Market Issuance Sales Agreement (the "2015 ATM") with MLV & Co. LLC (“MLV”) such that we were able to issue and sell additional shares of our common stock, having an aggregate offering price of up to $175.0 million, from time to time through MLV and FBR Capital Markets & Co. ("FBR", each of MLV and FBR individually an "Agent" and collectively the "Agents"), acting as the sales agents. Under the 2015 ATM, we paid the Agents a commission rate of up to 3.0% of the gross proceeds from the sale of any shares of common stock sold through the Agents.
During the year ended December 31, 2017, we sold a total of 3,104,253 shares of common stock under the 2015 ATM for aggregate total gross proceeds of approximately $31.6 million at an average selling price of $10.18 per share, resulting in net proceeds of approximately $31.0 million after deducting commissions and other transaction costs.
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In May 2017, we filed a shelf registration statement on Form S-3 (the "2017 S-3"), which was declared effective in June 2017. Under the 2017 S-3, we may sell up to a total of $300 million of securities. In connection with the 2017 S-3, we entered into an At-the-Market Issuance Sales Agreement (the "2017 ATM") with Jefferies LLC, Cantor Fitzgerald & Co., FBR Capital Markets & Co., SunTrust Robinson Humphrey, Inc., Raymond James & Associates, Inc., Ladenburg Thalmann & Co. Inc. and H.C. Wainwright & Co., LLC (each a "2017 Agent" and collectively, the "2017 Agents"), relating to the sale of shares of our common stock. Under the 2017 ATM we paid the 2017 Agents a commission rate of up to 3.0% of the gross proceeds from the sale of any shares of common stock.
During the year ended December 31, 2019, we sold a total of 13,620,165 shares of common stock under the 2017 ATM for aggregate total gross proceeds of approximately $99.3 million at an average selling price of $7.29 per share, resulting in net proceeds of approximately $97.5 million after deducting commissions and other transactions costs.
On September 5, 2019, we filed an automatic “shelf registration” statement on Form S-3 (the “2019 WKSI Shelf”) as a “well-known seasoned issuer” as defined in Rule 405 under the Securities Act, which registered an unlimited and indeterminate amount of debt or equity securities for future issuance and sale. The 2019 WKSI Shelf was declared effective in September 2019. In connection with the 2019 WKSI Shelf, we entered into an At-the-Market Issuance Sales Agreement (the “2020 ATM”) with Jefferies LLC, Cantor Fitzgerald & Co. and B. Riley Securities, Inc. (each a “2020 Agent” and collectively, the “2020 Agents”), relating to the sale of shares of our common stock. Under the 2020 ATM, we paid the 2020 Agents a commission rate of up to 3.0% of the gross proceeds from the sale of any shares of common stock. In November 2020, we entered into an At-the-Market Issuance Sales Agreement (the “2021 ATM”) with the same terms and agents (each a “2021 Agent” and collectively, the “2021 Agents”) as the 2020 ATM.
During the year ended December 31, 2020, we sold a total of 8,528,286 shares of common stock under the 2020 ATM for aggregate total gross proceeds of approximately $187.5 million at an average selling price of $21.99 per share, resulting in net proceeds of approximately $184.2 million after deducting commissions and other transactions costs.
During the year ended December 31, 2020, we sold a total of 804,100 shares of common stock under the 2021 ATM for aggregate total gross proceeds of approximately $33.9 million at an average selling price of $42.18 per share, resulting in net proceeds of approximately $33.3 million after deducting commissions and other transactions costs.
The 2019 WKSI Shelf is currently our only active shelf-registration statement. We may offer any combination of the securities registered under the 2019 WKSI Shelf from time to time in response to market conditions or other circumstances if we believe such a plan of financing is in the best interests of our stockholders. We believe that the 2019 WKSI Shelf provides us with the flexibility to raise additional capital to finance our operations as needed.
Equity Financings
On March 1, 2019, we completed a public offering of 4,100,000 shares of our common stock (plus a 30-day underwriter overallotment option to purchase up to an additional 615,000 shares of common stock, which was exercised) at a price of $5.87 per share. Proceeds from this offering, including the overallotment, after underwriting discounts and offering expenses were approximately $27.5 million.
On December 22, 2019, we completed a securities purchase agreement with an institutional investor in which we agreed to sell 5,434,783 shares of our common stock at a price of $9.20 per share. Net proceeds from this offering were approximately $50.0 million.
In May 2020, we completed an underwritten public offering of 8,500,000 shares of our common stock (plus an underwriter option to purchase up to an additional 1,275,000 shares of common stock, which was exercised) at a price of $18 per share. Net proceeds from this offering, including the overallotment, were approximately $165.1 million, net of underwriting discounts and offering expenses of approximately $10.8 million.
On December 17, 2020, we completed a public offering of 6,320,000 shares of our common stock (plus a 30-day underwriter overallotment option to purchase up to an additional 948,000 shares of common stock, which was exercised) at a price of $43.50 per share. Net proceeds from this offering, including the overallotment, were approximately $297.2 million after underwriting discounts and offering expenses of approximately $19.0 million.
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Debt Financings
On February 28, 2019 (the “Closing Date”), we entered into a term loan facility of up to $60.0 million (“Term Loan”) with Hercules Capital, Inc. (“Hercules”), the proceeds of which will be used research and development programs and for general corporate purposes. The Term Loan is governed by a loan and security agreement, dated February 28, 2019 (the “Loan Agreement”), which provides for up to four separate advances. The first advance of $30.0 million was drawn on the Closing Date. Two additional advances of $10.0 million may be drawn at our option but subject to certain clinical trial milestones, and the fourth advance of $10.0 million, available in minimum increments of $5.0 million, was available through December 15, 2020 subject to the approval of Hercules’ investment committee.
The Term Loan will mature on March 1, 2022 (the “Loan Maturity Date”). Each advance accrues interest at a per annum rate of interest equal to the greater of either (i) the “prime rate” as reported in The Wall Street Journal plus 4.75%, or (ii) 10.25%. The Term Loan provides for interest-only payments until October 1, 2020. The interest-only period may be extended to April 1, 2021 if on or before September 30, 2020, we achieve either the third milestone or we have raised at least $150.0 million in unrestricted net cash proceeds from one or more equity financings, subordinated indebtedness and/or upfront proceeds from business development transactions permitted under the Loan Agreement, in each case after February 7, 2019, and prior to September 30, 2020 (“Milestone IV”). Thereafter, amortization payments will be payable monthly in eighteen installments (or, if the period requiring interest-only payments has been extended to April 1, 2021, in twelve installments) of principal and interest (subject to recalculation upon a change in prime rates). As a result of the Company having raised in excess of $150 million before the required timeline in the Loan Agreement, the interest-only period has been extended to April 1, 2021. At our option upon seven business days’ prior written notice to Hercules, we may prepay all or any portion greater than or equal to $5.0 million of the outstanding advances by paying the entire principal balance (or portion thereof), all accrued and unpaid interest, subject to a prepayment charge of 3.0%, if such advance is prepaid in any of the first twelve months following the Closing Date; 1.5%, if such advance is prepaid after twelve months following the Closing Date but on or prior to twenty-four months following the Closing Date; and 0% thereafter. In addition, a final payment equal to 3.5% of the aggregate principal amount of the loan extended by Hercules is due on the maturity date. Amounts outstanding during an event of default shall be payable on demand and accrue interest at an additional rate of 4.0% per annum of the past due amount outstanding.
The Term Loan is secured by a lien on substantially all of our assets, other than intellectual property, and contains customary covenants and representations, including a liquidity covenant, financial reporting covenant and limitations on dividends, indebtedness, collateral, investments, distributions, transfers, mergers or acquisitions, taxes, corporate changes, deposit accounts, and subsidiaries.
The events of default under the Loan Agreement include, without limitation, and subject to customary grace periods, (1) our failure to make any payments of principal or interest under the Loan Agreement, promissory notes or other loan documents, (2) our breach or default in the performance of any covenant under the Loan Agreement, (3) the occurrence of a material adverse effect, (4) a false or misleading representation or warranty in any material respect, (5) our insolvency or bankruptcy, (6) certain attachments or judgments on the Borrower’s assets, or (7) the occurrence of any material default under certain agreements or obligations involving indebtedness in excess of $750,000. If an event of default occurs, Hercules is entitled to take enforcement action, including acceleration of amounts due under the Loan Agreement.
The Loan Agreement also contains warrant coverage of 2% of the total amount funded. A warrant (the “Hercules Warrant”) was issued to Hercules to purchase 147,058 shares of common stock with an exercise price of $4.08. The Hercules Warrant is exercisable for seven years from the date of issuance. Hercules may exercise the Hercules Warrant either by (a) cash or check or (b) through a net issuance conversion. The shares will be registered and freely tradeable within six months of issuance. We accounted for the Hercules Warrant as an equity instrument since it was indexed to our common shares and met the criteria for classification in shareholders’ equity. The relative fair value of the Hercules Warrant on the date of issuance was approximately $1.0 million and was recorded as debt issuance costs and as an offset to the Term Loan. This amount will be amortized to interest expense using the straight-line method, which approximates the effective interest method, over the life of the Term Loan.
Contract Manufacturer
In 2018, we entered into an agreement with a contract manufacturer for the clinical and potential commercial supply of one of our product candidates. As part of this agreement, the contract manufacturer has agreed to defer payment of certain costs and expenses under the agreement in exchange for the payment of an administrative fee. To date we have incurred expenses related to this agreement of approximately $53.7 million as of December 31, 2020, which include service fees, raw material costs and administrative fees. We have made payments of $37.4 million to the contract manufacturer as of December 31, 2020. Accordingly, as of December 31, 2020, $15.7 million is
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included in current liabilities in the Company’s consolidated balance sheet, of which $4.2 million is due in the first quarter of 2021. We will incur an administrative fee of six percent (6%) per year starting from the date of invoice issuance. For the years ended December 31, 2020, 2019 and 2018, we have accrued $1.2 million, $1.2 million and zero, respectively, in administrative fees in connection with these costs, which has been included in interest expense in the Company’s consolidated statements of operations.
Leases
In October 2014, we entered into an agreement (the “Office Agreement”) with Fortress Biotech, Inc. (“FBIO”) to occupy approximately 45% of the 24,000 square feet of New York City office space leased by FBIO. The Office Agreement requires us to pay our respective share of the average annual rent and other costs of the 15-year lease. We approximate an average annual rental obligation of $1.4 million under the Office Agreement. We began to occupy this new space in April 2016, with rental payments beginning in the third quarter of 2016. At January 1, 2020, we recognized a lease liability and corresponding right of use (“ROU”) asset based on the present value of the remaining lease payments for all of our leased office spaces, the majority of which is comprised of our New York City office space. The present values of our lease liability and corresponding ROU asset are $12.1 million and $9.3 million, respectively, as of December 31, 2020. Our leases have remaining lease terms of 4 months to 11 years. One lease has a renewal option to extend the lease for an additional term of two years.
Under the Office Agreement, we agreed to pay FBIO our portion of the build-out costs, which have been allocated to us at the 45% rate mentioned above. The allocated build-out costs have been recorded in Leasehold Interest, net on the Company’s consolidated balance sheets and will be amortized over the 15-year term of the Office Agreement. The initial commitment period of the 45% rate was for a period of three (3) years. We and FBIO currently determine actual office space utilization annually and if our utilization differs from the amount we have been billed, we will either receive credits or be assessed incremental utilization charges. As of December 31, 2020, the allocation rate is 65% and will be evaluated again in August 2021 for the following rent year. Also, in connection with this lease, in October 2014 we pledged $0.6 million to secure a line of credit as a security deposit for the Office Agreement, which has been recorded as restricted cash in the accompanying consolidated balance sheets. Additional collateral of $0.6 million was pledged in April 2018 to increase the letter of credit for the office space.
In October 2019, we finalized a five-year lease for office space in New Jersey (the “NJ Lease”). We approximate an average annual rental obligation of $0.3 million under the NJ Lease. We took possession of this space in October 2019, with rental payments beginning in November 2019.
Total rental expense was approximately $2.7 million, $2.7 million and $1.4 million for the years ended December 31, 2020, 2019 and 2018, respectively.
Future minimum lease commitments as of December 31, 2020 total, in the aggregate, approximately $19.5 million through December 31, 2031. Our future minimum lease commitments include our office leases in New York, New Jersey, North Carolina and Tennessee as of December 31, 2020.
OFF-BALANCE SHEET ARRANGEMENTS
We have not entered into any transactions with unconsolidated entities whereby we have financial guarantees, subordinated retained interests, derivative instruments or other contingent arrangements that expose us to material continuing risks, contingent liabilities, or any other obligations under a variable interest in an unconsolidated entity that provides us with financing, liquidity, market risk or credit risk support.
CRITICAL ACCOUNTING POLICIES AND SIGNIFICANT JUDGMENTS AND ESTIMATES
The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amount of assets and liabilities and related disclosure of contingent assets and liabilities at the date of our financial statements and the reported amounts of revenues and expenses during the applicable period. Actual results may differ from these estimates under different assumptions or conditions.
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We define critical accounting policies as those that are reflective of significant judgments and uncertainties and which may potentially result in materially different results under different assumptions and conditions. In applying these critical accounting policies, our management uses its judgment to determine the appropriate assumptions to be used in making certain estimates. These estimates are subject to an inherent degree of uncertainty. Our critical accounting policies include the following:
Stock Compensation . We have granted stock options and restricted stock to employees, directors and consultants, as well as warrants to other third parties. For employee, director and consultant grants the value of each option award is estimated on the date of grant using the Black-Scholes option-pricing model. The Black-Scholes model takes into account volatility in the price of our stock, the risk-free interest rate, the estimated life of the option, the closing market price of our stock and the exercise price. We base our estimates of our stock price volatility on the historical volatility of our common stock and our assessment of future volatility; however, these estimates are neither predictive nor indicative of the future performance of our stock. For purposes of the calculation, we assumed that no dividends would be paid during the life of the options and warrants. The estimates utilized in the Black-Scholes calculation involve inherent uncertainties and the application of management judgment. In addition, because some of the options, restricted stock and warrants issued to employees, consultants and other third parties vest upon the achievement of certain milestones, the total expense is uncertain. Compensation expense for such awards that vest upon the achievement of milestones is recognized when the achievement of such milestone becomes probable.
Accrued Research and Development Expenses. As part of the process of preparing our financial statements, we are required to estimate our accrued expenses. This process involves reviewing open contracts, communicating with our personnel to identify services that have been performed on our behalf and estimating the level of service performed and the associated cost incurred for the service when we have not yet been invoiced or otherwise notified of the actual cost. The majority of our service providers invoice us monthly for services performed or when contractual milestones are met. We make estimates of our accrued expenses as of each balance sheet date in our financial statements based on facts and circumstances known to us at that time. We periodically confirm the accuracy of our estimates with the service providers and make adjustments, if necessary. Examples of estimated accrued research and development expenses include:
● fees paid to contract research organizations (CROs) in connection with clinical studies;
● fees paid to contract manufacturing organizations (CMOs);
● fees paid to trial sites in connection with clinical studies; and
● fees paid to vendors associated with licenses/milestones.
We base our expenses related to clinical studies on our estimates of the services received and efforts expended pursuant to contracts with multiple CROs that conduct and manage clinical studies on our behalf. The financial terms of these agreements are subject to an initial negotiation, vary from contract to contract and may result in uneven payment flows. There may be instances in which payments made to our vendors will exceed the level of services provided and result in a prepayment of the clinical expense. Payments under some of these contracts depend on factors such as the successful enrollment of patients and the completion of clinical trial milestones. In accruing certain service fees, we estimate the time period over which services will be performed, enrollment of patients, number of sites activated and the level of effort to be expended in each period. If the actual timing of the performance of services or the level of effort varies from our estimate, we adjust the accrual or prepaid accordingly. Although we do not expect our estimates to be materially different from amounts actually incurred, our understanding of the status and timing of services performed relative to the actual status and timing of services performed may vary and may result in us reporting amounts that are too high or too low in any particular period.
RECENTLY ISSUED ACCOUNTING STANDARDS
In July 2018, the FASB issued Accounting Standards Update (“ASU”) No. 2018-11, “Leases - Targeted Improvements” (“ASU 2018-11”) as an update to ASU 2016-02, Leases (“ASU 2016-02” or “Topic 842”) issued on February 25, 2016. ASU 2016-02 is effective for public business entities for fiscal years beginning January 1, 2019. ASU 2016-02 required companies to adopt the new leases standard at the beginning of the earliest period presented in the financial statements, which is January 1, 2017, using a modified retrospective transition method where lessees must recognize lease assets and liabilities for all leases even though those leases may have expired before the effective date of January 1, 2017. Lessees must also provide the new and enhanced disclosures for each period presented, including the comparative periods.
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ASU 2018-11 provides an entity with an additional (and optional) transition method to adopt the new leases standard. Under this new transition method, an entity initially applies the new lease standard at the adoption date and recognizes a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. Consequently, an entity’s reporting for the comparative periods presented in the financial statements in which it adopts the new lease standard will continue to be in accordance with ASC 840, Leases (“ASC 840”). An entity that elects this additional (and optional) transition method must provide the required ASC 840 disclosures for all periods that continue to be in accordance with ASC 840. The amendments do not change the existing disclosure requirements in ASC 840.
ASU 2018-11 is effective for public business entities for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years, with earlier adoption permitted. The Company adopted ASU 2018-11 on January 1, 2019 using a modified retrospective method and will not restate comparative periods. We elected the package of practical expedients permitted under the transition guidance, which allows us to carryforward our historical lease classification and our assessment on whether a contract is or contains a lease. The adoption of this guidance resulted in the addition of material balances of ROU assets and lease liabilities to our consolidated balance sheets at January 1, 2019, primarily relating to our lease of office space (see Note 8). The impact to our consolidated statements of operations was not material as a result of this standard.
In June 2018, the FASB issued ASU No. 2018-07, “Improvements to Nonemployee Share-Based Payment Accounting” (“ASU 2018-07”). ASU 2018-07 expands the scope of FASB Topic 718, Compensation – Stock Compensation (“Topic 718”) to include share-based payment transactions for acquiring goods and services from nonemployees. An entity should only remeasure equity-classified awards for which a measurement date has not been established through a cumulative-effect adjustment to retained earnings as of the beginning of the fiscal year of adoption. Upon transition, the entity is required to measure these nonemployee awards at fair value as of the adoption date. The entity must not remeasure assets that are completed. Disclosures required at transition include the nature of and reason for the change in accounting principle and, if applicable, quantitative information about the cumulative effect of the change on retained earnings or other components of equity.
ASU 2018-07 is effective for public business entities for fiscal years beginning after December 15, 2018, including interim periods within that fiscal year. Early adoption is permitted, but no earlier than an entity’s adoption date of Topic 606. The Company adopted ASU 2018-07 on January 1, 2019. The adoption of ASU 2018-07 did not have a material effect on our consolidated financial statements as of January 1, 2019. The adoption of ASU 2018-07 had no impact on nonemployee performance awards as they are measured based on the outcome that is probable.
Other pronouncements issued by the FASB or other authoritative accounting standards group with future effective dates are either not applicable or not significant to our consolidated financial statements.
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