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 should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. This discussion and analysis contains forward-looking statements based upon current beliefs, plans and expectations that involve risks, uncertainties and assumptions, such as statements regarding our plans, objectives, expectations, intentions and projections. Our actual results and the timing of selected events could differ materially from those anticipated in these forward-looking statements as a result of several factors, including those set forth in Part I, Item 1A, “Risk Factors” in this Annual Report on Form 10-K. See the sections entitled “Risk Factors” and “Cautionary Note Regarding Forward-Looking Statements.”
Company Overview
We are a clinical stage pharmaceutical company focused on treating metabolic and inflammatory diseases to minimize their long-term complications and improve the lives of patients. We have an innovative pipeline of first-in-class small molecule clinical and preclinical drug candidates. Our lead program is cadisegliatin (TTP399) , an orally administered, small molecule, liver-selective glucokinase activator (“GKA”) as an adjunctive therapy to insulin for the treatment of type 1 diabetes ("T1D").
Recent Developments
Private Placement of Class A Common Shares and Pre-Funded Warrants
On February 27, 2024, we entered into a securities purchase agreement (the “Securities Purchase Agreement”) with certain institutional accredited investors (the “Private Placement Investors”), pursuant to which we agreed to issue and sell to the Private Placement Investors in a private placement (the “Private Placement”) (i) an aggregate of 464,377 shares (the “Private Placement Shares”) of our Class A common stock, at a purchase price of $11.81 per share, and (ii) pre-funded warrants (the “Private Placement Pre-Funded Warrants”) to purchase up to an aggregate of 3,853,997 shares of our Class A common stock (the “Private Placement Warrant Shares”) at a purchase price of $11.80 per Private Placement Pre-Funded Warrant (representing the $11.81 per Private Placement Share purchase price less the exercise price of $0.01 per Private Placement Warrant Share). We received aggregate gross proceeds from the Private Placement of approximately $51.0 million, before deducting offering expenses payable by us. The Private Placement Pre-Funded Warrants are exercisable at any time after their original issuance and will not expire.
ATM
On February 28, 2024, we entered into a sales agreement (the “TD Cowen Sales Agreement”) with Cowen and Company, LLC (“TD Cowen”), pursuant to which we may offer and sell, from time to time, through or to TD Cowen, as sales agent or principal, shares of our Class A common stock, having an aggregate offering price of up to $50.0 million (the “TD Cowen ATM Offering”). Pursuant to General Instruction I.B.6 of Form S-3, in no event will we sell securities registered on the registration statement relating to the TD Cowen ATM Offering with a value exceeding more than one-third of our public float in any 12-month period so long as our public float remains below $75.0 million. Under the terms of the TD Cowen Sales Agreement, we will pay TD Cowen a commission of 3% of the aggregate proceeds from the sale of shares and reimburse certain legal fees or other disbursements
Reverse Stock Split
On November 20, 2023, we filed a Certificate of Amendment to the Company’s amended and restated certificate of incorporation, as amended, with the Secretary of State of the State of Delaware, which effected a reverse stock split at a ratio of 1-for-40, such that every 40 shares of our Class A common stock, combined into one issued and outstanding share of Class A common stock, and every 40 shares of our Class B common stock, combined into one issued and outstanding share of Class B Common Stock (the "Reverse Stock Split"). No fractional shares were issued in connection with the Reverse Stock Split. Any fractional shares of Class A common stock and Class B common stock to which a stockholder was entitled resulting from the Reverse Stock Split were rounded up to the nearest whole share. The Class A common stock began trading on a reverse split-adjusted basis on the Nasdaq on November 21, 2023. Our Class A common stock will continue trading under the symbol “VTVT,” and the new CUSIP number for the Class A common stock following the Reverse Stock Split is 91835204.
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Our Product Pipeline
The following table summarizes our drug candidates, their partnership status and their respective stages of development:
Our Type 1 Diabetes Program – Cadisegliatin (TTP399)
The U.S. Food and Drug Administration (FDA) granted Breakthrough Therapy designation in 2021 for cadisegliatin as an adjunctive therapy to insulin for the treatment of type 1 diabetes ("T1D"). The Breakthrough Therapy designation provides a sponsor with added support and the potential to expedite development and review timelines for a promising new investigational medicine. The Breakthrough Therapy designation for cadisegliatin in T1D was supported by the positive results from the Phase 2 SimpliciT-1 Study, a multi-center, randomized, double-blind, adaptive study assessing the safety and efficacy of cadisegliatin as an adjunct to insulin therapy in adults with T1D. In this trial, treatment with cadisegliatin resulted in a statistically significant improvement in HbA1c relative to placebo and a clinically meaningful decrease (40%) in the frequency of severe and symptomatic hypoglycemia. Cadisegliatin demonstrated a favorable safety profile, in which abnormal levels of serum or urine ketones were detected less frequently in patients taking cadisegliatin than those taking placebo.
In May of 2023, the FDA issued new draft guidance on "Diabetes Mellitus: Efficacy Endpoints for Clinical Trials Investigating Antidiabetic Drugs and Biological Products" which, for the first time, permitted the use of hypoglycemia as an endpoint to support a label claim. Consistent with this guidance and with input from the FDA, we have initiated a Phase 3 double-blind controlled trial to assess the effect of cadisegliatin on reducing the frequency of Level 2 hypoglycemia (blood glucose levels are less than 54 mg/dL or 3 mmol/L, regardless of symptoms) and Level 3 hypoglycemia ("severe" hypoglycemia e.g., requiring assistance of another person) in 150 patients with type 1 diabetes. Participants in the trial will be randomized to two doses of cadisegliatin or placebo. Reduction in glycated hemoglobin (HbA1c), a traditional efficacy endpoint in diabetes trials, is a key secondary endpoint to assess the potential of cadisegliatin to reduce hyperglycemia, Following the initial assessment of efficacy after six months of treatment, participants will remain on trial for another six months to assess the durability of potential beneficial effects and safety. The study protocol was submitted to the FDA on February 29, 2024. The trial will be conducted in the U.S. only and is expected to complete enrollment by the fourth quarter in 2024 providing top line 1-year data by the first quarter in 2026.
Concurrently, we will be working on the design for two international registrational studies for cadisegliatin in type 1 diabetes, which we expect to start in 2026.
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In addition, we continue to work with our partner, G42 Investments AI Holding RSC Ltd. (“G42”), to initiate a double-blind, randomized, controlled Phase 2 trial in the Middle East region in 450 insulin-using patients with type 2 diabetes. We expect that trial to begin in 2024.
Holding Company Structure
vTv Therapeutics Inc. is a holding company and its principal asset is a controlling equity interest in vTv Therapeutics LLC (“vTv LLC”), the principal operating subsidiary. We have determined that vTv LLC is a variable-interest entity (“VIE”) for accounting purposes and that vTv Therapeutics Inc. is the primary beneficiary of vTv LLC because (through its managing member interest in vTv LLC and the fact that the senior management of vTv Therapeutics Inc. is also the senior management of vTv LLC) it has the power to direct all of the activities of vTv LLC, which include those that most significantly impact vTv LLC’s economic performance. vTv Therapeutics Inc. has therefore consolidated vTv LLC’s results under the VIE accounting model in its consolidated financial statements.
Financial Overview
Revenue
To date, we have not generated any revenue from drug sales. Our revenue has been primarily derived from milestone payments, up-front proceeds and research fees under collaboration and license agreements.
In the future, we may generate revenue from a combination of product sales, license fees, milestone payments and royalties from the sales of products developed under licenses of our intellectual property. We expect that any revenue we generate will fluctuate from quarter to quarter as a result of the timing and amount of license fees, milestone and other payments, and the amount and timing of payments that we receive upon the sale of our products, to the extent any are successfully commercialized. If we fail to complete the development of our drug candidates in a timely manner or obtain regulatory approval for them, our ability to generate future revenue and our results of operations and financial position will be materially adversely affected.
Research and Development Expenses
Since our inception, we have focused our resources on our research and development activities, including conducting preclinical studies and clinical trials, manufacturing development efforts and activities related to regulatory filings for our drug candidates. We recognize research and development expenses as they are incurred. Our direct research and development expenses consist primarily of external costs such as fees paid to investigators, consultants, central laboratories and clinical research organizations in connection with our clinical trials, and costs related to acquiring and manufacturing clinical trial materials. Our indirect research and development costs consist primarily of cash and share-based compensation costs, the cost of employee benefits and related overhead expenses for personnel in research and development functions. Since we typically use our employee and infrastructure resources across multiple research and development programs such costs are not allocated to the individual projects.
Our research and development expenses by project for the years ended December 31, 2023, 2022 and 2021 were as follows (in thousands):
Years Ended December 31,
2023 2022 2021
Direct research and development expense:
Cadisegliatin $ 10,182 $ 9,611 $ 2,608
HPP737 — — 2,762
Azeliragon — — 822
Other projects 676 563 717
Indirect research and development expense 2,737 2,183 6,415
Total research and development expense $ 13,595 $ 12,357 $ 13,324
We plan to continue to incur significant research and development expenses for the foreseeable future as we continue the development of cadisegliatin and further advance the development of our other drug candidates, subject to the availability of additional funding.
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The successful development of our clinical and preclinical drug candidates is highly uncertain. At this time, we cannot reasonably estimate the nature, timing or costs of the efforts that will be necessary to complete the remainder of the development of any of our clinical or preclinical drug candidates or the period, if any, in which material net cash inflows from these drug candidates may commence. This is due to the numerous risks and uncertainties associated with the development of our drug candidates, including:
• the uncertainty of the scope, rate of progress and expense of our ongoing, as well as any additional, clinical trials and other research and development activities;
• the potential benefits of our candidates over other therapies;
• our ability to market, commercialize and achieve market acceptance for any of our drug candidates that we are developing or may develop in the future;
• future clinical trial results;
• our ability to enroll patients in our clinical trials;
• the timing and receipt of any regulatory approvals;
• our ability to secure sufficient capital and cash resources, including access to available debt and equity financing and revenues from operations, to satisfy all of our short-term and longer-term cash requirements and other cash needs, at the times and in the amounts needed;
• legislation and regulatory actions and changes in laws or regulations; and
• the filing, prosecuting, defending and enforcing of patent claims and other intellectual property rights, and the expense of doing so.
A change in the outcome of any of these variables with respect to the development of a drug candidate could mean a significant change in the costs and timing associated with the development of that drug candidate. For example, if the FDA or another regulatory authority were to require us to conduct clinical trials beyond those that we currently anticipate will be required for the completion of clinical development of a drug candidate, or if we experience significant delays in enrollment in any of our clinical trials, we could be required to expend significant additional financial resources and time with respect to the development of that drug candidate.
General and Administrative Expenses
General and administrative expenses consist primarily of salaries, benefits and related costs for employees in executive, finance, corporate development, human resources and administrative support functions. Other significant general and administrative expenses include accounting and legal services, expenses associated with obtaining and maintaining patents, cost of various consultants, occupancy costs and information systems.
Interest Income
Interest income represents noncash interest income related to the imputed interest from the G42 Promissory Note receivable using the effective interest method and cash interest income from dividends and interest from our money market account, all of which are recognized in our Consolidated Statement of Operations .
Interest Expense
The Company’s interest expense is immaterial.
Other Expense, Net
Other expense primarily consists of unrealized gains or losses attributable to the changes in fair value of the equity investment held, the recognition of changes in fair value of the warrants to purchase shares of our Class A common stock held by related parties, the loss from the G42 Promissory Note early redemption on February 28, 2023, the impairment charge from Anteris Bio, Inc. (“Anteris”) liquidation and dissolution and the Common Stock Repurchase Agreement (the "Repurchase Agreement") with Reneo Pharmaceuticals, Inc ("Reneo").
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Results of Operations
In this section, we discuss the results of our operations for the year ended December 31, 2023 compared to the year ended December 31, 2022. For a discussion of the year ended December 31, 2022 compared to the year ended December 31, 2021, please refer to Part II, Item 7, “Management's Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2022.
Comparison of the years ended December 31, 2023 and 2022
The following table sets forth certain information concerning our results of operations for the periods shown:
(dollars in thousands) Year Ended
Statement of operations data: 2023 2022 Change
Revenue $ — $ 2,018 $ (2,018)
Operating expenses:
Research and development 13,595 12,357 1,238
General and administrative 11,907 12,201 (294)
Total operating expenses 25,502 24,558 944
Operating loss (25,502) (22,540) (2,962)
Interest income 472 352 120
Interest expense (13) (15) 2
Other expense, net (923) (2,670) 1,747
Loss before income taxes and noncontrolling interest (25,966) (24,873) (1,093)
Income tax provision — 200 (200)
Net loss before noncontrolling interest (25,966) (25,073) (893)
Less: Net loss attributable to noncontrolling interest (5,716) (5,909) 193
Net loss attributable to vTv Therapeutics Inc. $ (20,250) $ (19,164) $ (1,086)
Revenue
There was no revenue for the year ended December 31, 2023. Revenue was $2.0 million for the year ended December 31, 2022. The revenue recognized in 2022 related to the increase to the transaction price for the license performance obligations under the amended license agreement with Huadong due to the satisfaction of a development milestone.
Research and Development Expenses
Research and development expenses were $13.6 million and $12.4 million for the years ended December 31, 2023 and 2022, respectively. The increase in research and development expenses during this period of approximately $1.2 million, or 10.0%, was primarily driven by (i) higher spending on cadisegliatin of $0.6 million due to increases in drug product related costs as well as higher spending on trial preparation costs, and (ii) an increase of $0.6 million in indirect costs and other projects.
General and Administrative Expenses
General and administrative expenses were $11.9 million and $12.2 million for the years ended December 31, 2023 and 2022, respectively. The decrease in general and administrative expenses during this period of approximately $0.3 million, or 2.4%, was primarily driven by (i) a decrease of $3.1 million in legal expense, and (ii) a decrease of $0.8 million in severance costs, partially offset by (iii) an increase in payroll costs of $1.8 million, (iv) an increase in other general and administrative costs of $1.5 million, and (v) an increase in share-based compensation expense of $0.3 million.
Interest Income
Interest income for the year ended December 31, 2023 of $0.5 million is related to imputed interest on the G42 Promissory Note and dividend income from our money market account . Interest income for the year ended December 31, 2022 of $0.4 million is related to the imputed interest on the G42 Promissory Note.
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Interest Expense
Interest expense for the years ended December 31, 2023 and 2022, was insignificant.
Other Expense, Net
Other expense was $0.9 million for the year ended December 31, 2023 and was driven by the recording of an impairment charge on a cost-method investment of $4.2 million offset by a realized gain recognized related to the Company’s Repurchase Agreement with Reneo as well as the gains related to the change in the fair value of the outstanding warrants to purchase shares of our Class A common stock issued to related parties. Other expense was $2.7 million for the year ended December 31, 2022, and was driven by an unrealized loss recognized related to the Company’s investment in Reneo as well as the losses related to the change in the fair value of the outstanding warrants to purchase shares of our Class A common stock issued to related parties.
Liquidity and Capital Resources
Liquidity and Going Concern
As of December 31, 2023, we had an accumulated deficit of $281.0 million. Since our inception, we have experienced a history of negative cash flows from operating activities. We anticipate that we will continue to incur losses and negative cash flow from operations for the foreseeable future as we continue our clinical trials. Further, we expect that we will need additional capital to continue to fund our operations. As of December 31, 2023, we had cash and cash equivalents of $9.4 million.
On February 27, 2024, the Company closed a private placement financing of up to $51.0 million and additionally granting investors the right to purchase up to an additional $30.0 million of common stock 18 months following the closing of the private placement financing. (See note 20). The financing raised will allow the Company to further advance its lead program for cadisegliatin (TTP399) .
In addition to available cash and cash equivalents and available funds discussed above, we are seeking possible additional partnering opportunities for our GKA, GLP-1r and other drug candidates which we believe may provide additional cash for use in our operations and the continuation of the clinical trials for our drug candidates. We are evaluating several financing strategies to fund our planned and ongoing clinical trials, including direct equity investments and future public offerings of our common stock. The timing and availability of such additional financing are not yet known.
As required by ASC Topic 205-40, Presentation of Financial Statements - Going Concern , management has assessed our ability to continue as a going concern for one year from the consolidated financial statements issuance date for the fiscal year ended December 31, 2023. Based on the cash and cash equivalents currently available to us as discussed above, we have concluded there is not substantial doubt regarding our ability to continue as a going concern for at least twelve months from the issuance of the December 31, 2023 Form 10-K.
ATM
TD Cowen Sales Agreement
On February 28, 2024, we entered into a sales agreement (the "TD Cowen Sales Agreement") with Cowen and Company, LLC (“TD Cowen”) pursuant to which we may offer and sell, from time to time, through or to TD Cowen, as sales agent or principal, shares of our Class A common stock having an aggregate offering price of up to $50.0 million, although we may only offer and sell under the TD Cowen ATM Offering up to one-third of the aggregate market value of our voting and non-voting common equity held by non-affiliates during any 12 calendar month period pursuant to General Instruction I.B.6 of Form S-3 . We are not obligated to sell any shares under the TD Cowen Sales Agreement. Under the terms of the TD Cowen Sales Agreement, we will pay TD Cowen a commission of 3% of the aggregate proceeds from the sale of shares and reimburse certain legal fees or other disbursements.
Cantor Fitzgerald Sales Agreement
We previously entered into the Sales Agreement with Cantor Fitzgerald pursuant to which could offer and sell, from time to time, through or to Cantor Fitzgerald, as sales agent or principal, shares of our Class A common stock having an aggregate offering price of up to $68.5 million. As of December 31, 2023, we had sold $31.2 million worth of Class A common stock pursuant to the Sales Agreement for net proceeds of $30.3 million.
The Sales Agreement with Cantor Fitzgerald was terminated on February 26, 2024.
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Lincoln Park Purchase Agreement
We entered into the Purchase Agreement with Lincoln Park ("LPC Purchase Agreement"), which provides that, upon the terms and subject to the conditions and limitations set forth therein, we may sell to Lincoln Park up to $47.0 million of shares of our Class A common stock from time to time over the 36-month term of the LPC Purchase Agreement. Upon execution of the Purchase Agreement, we issued 10,643 shares of our Class A common stock to Lincoln Park as commitment shares in accordance with the closing conditions contained within the Purchase Agreement. We have issued 133,282 shares of our Class A common stock to Lincoln Park under the LPC Purchase Agreement through the date of the filing of this Annual Report on Form 10-K.
The LPC Purchase Agreement expired on November 24, 2023.
Cash Flows
Year Ended December 31,
2023 2022
(dollars in thousands)
Net cash used in operating activities $ (19,081) $ (16,022)
Net cash provided by (used in) investing activities 4,404 (21)
Net cash provided by financing activities 11,997 14,754
Net decrease in cash and cash equivalents $ (2,680) $ (1,289)
Operating Activities
For the year ended December 31, 2023, our net cash used in operating activities increased by $3.1 million from the prior year. The significant contributor to the change in cash used during the year was working capital changes offset by $6.8 million of cash received related to contract liabilities.
Investing Activities
For the year ended December 31, 2023, net cash provided by investing activities was driven by the sale of our investments in Reneo. For the year ended December 31, 2022, net cash used in investing activities was insignificant.
Financing Activities
For the year ended December 31, 2023, net cash provided by financing activities was driven by the receipt of proceeds of $12.0 million from the G42 Promissory Note early redemption. For the year ended December 31, 2022, net cash provided by financing activities was driven by sales of our Class A common stock to a collaboration partner and from the CinRx Purchase Agreement.
Future Funding Requirements
To date, we have not generated any revenue from drug product sales. We do not know when, or if, we will generate any revenue from drug product sales. We do not expect to generate revenue from drug sales unless and until we obtain regulatory approval of and commercialize any of our drug candidates. At the same time, we expect our expenses to continue or to increase in connection with our ongoing development activities, particularly as we continue the research, development and clinical trials of, and seek regulatory approval for, our drug candidates. In addition, subject to obtaining regulatory approval of any of our drug candidates, we expect to incur significant commercialization expenses for product sales, marketing, manufacturing and distribution. We anticipate that we will need substantial additional funding in connection with our continuing operations.
Based on our current operating plan, we believe that our current cash and cash equivalents will allow us to meet our liquidity requirements for at least the next twelve months. We plan to finance our operations into the first quarter of 2026 through the use of our cash and cash equivalents and based on current operating plans, we are evaluating several financing strategies to fund the ongoing and future clinical trials of cadisegliatin , including direct equity investments and the potential licensing and monetization of other Company programs. The timing of any such transactions is not certain, and we may not be able to complete such transactions on acceptable terms, or at all. Even if we are able to complete such transactions, they may contain restrictions on our operations or cause substantial dilution to our stockholders. We have based our estimates on assumptions that may prove to be wrong, and we may use our available capital resources sooner than we currently expect. Because of the numerous risks and uncertainties associated with the development and commercialization of our drug candidates, we are unable to estimate the amounts of increased capital outlays and operating expenditures necessary to complete the development of our drug candidates. Additionally, we may rely on our ability to sell shares of our Class A
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common stock pursuant to the ATM Offering. However, the ability to use this source of capital is dependent on a number of factors, including the prevailing market price of and the volume of trading in the Company’s Class A common stock.
Our future capital requirements will depend on many factors, including:
• the progress, costs, results and timing of our planned trials to evaluate cadisegliatin as a potential adjunctive therapy for the treatment of type 1 diabetes;
• the willingness of the FDA to rely upon our completed and planned clinical and preclinical studies and other work, as the basis for review and approval of our drug candidates;
• our ability to maintain control over our costs in line with our budget to complete the Phase 3 clinical trial for our lead product candidate, cadisegliatin ;
• the outcome, costs and timing of seeking and obtaining FDA and any other regulatory approvals;
• the number and characteristics of drug candidates that we pursue, including our drug candidates in preclinical development;
• the ability of our drug candidates to progress through clinical development successfully;
• our need to expand our research and development activities;
• the costs associated with securing, establishing and maintaining commercialization capabilities;
• the costs of acquiring, licensing or investing in businesses, products, drug candidates and technologies;
• our ability to maintain, expand and defend the scope of our intellectual property portfolio, including the amount and timing of any payments we may be required to make, or that we may receive, in connection with the licensing, filing, prosecution, defense and enforcement of any patents or other intellectual property rights;
• our need and ability to hire additional management, scientific, and medical personnel;
• the effect of competing technological and market developments;
• our need to implement additional internal systems and infrastructure, including financial and reporting systems;
• the economic and other terms, timing and success of our existing licensing arrangements and any collaboration, licensing or other arrangements into which we may enter in the future;
• the amount of any payments we are required to make to M&F TTP Holdings Two LLC in the future under the Tax Receivable Agreement.
Until such time, if ever, as we can generate substantial revenue from drug sales, we expect to finance our cash needs through a combination of equity offerings, debt financings, marketing and distribution arrangements and other collaborations, strategic alliances and licensing arrangements.
To the extent that we raise additional capital through the sale of equity or convertible debt securities, the ownership interests of our common stockholders will be diluted, and the terms of these securities may include liquidation or other preferences that adversely affect the rights of our common stockholders. Debt financing and preferred equity financing, if available, may involve agreements that include covenants that will further limit or restrict our ability to take specific actions, such as incurring additional debt, making capital expenditures or declaring dividends. If we raise additional funds through collaborations, strategic alliances or marketing, distribution or licensing arrangements with third parties, we may be required to relinquish valuable rights to our technologies, future revenue streams or drug candidates or grant licenses on terms that may not be favorable to us.
Off-Balance Sheet Arrangements
As of December 31, 2023, we do not currently have outstanding any off-balance sheet arrangements as defined under SEC rules.
Discussion of Critical Accounting Policies and Estimates
Our management’s discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which we have prepared in accordance with generally accepted accounting principles in the United States (“GAAP”). The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at
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the date of our consolidated financial statements, as well as the reported revenues and expenses during the reported periods. We evaluate these estimates and judgments on an ongoing basis. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
While our significant accounting policies are more fully described in Note 2, “Summary of Significant Accounting Policies,” to our audited consolidated financial statements, we believe that the following accounting policies related to revenue recognition, research and development, income taxes, and share-based compensation are the most critical for fully understanding and evaluating our financial condition and results of operations.
Revenue Recognition
The majority of our revenue results from its license and collaboration agreements associated with the development of investigational drug products. We account for a contract when it has approval and commitment from both parties, the rights of the parties are identified, payment terms are identified, the contract has commercial substance and collectability of consideration is probable. For each contract meeting these criteria, we identify the performance obligations included within the contract. A performance obligation is a promise in a contract to transfer a distinct good or service to the customer. We then recognize revenue under each contract as the related performance obligations are satisfied.
The transaction price under the contract is determined based on the value of the consideration expected to be received in exchange for the transferred assets or services. Development, regulatory and sales milestones included in our collaboration agreements are considered to be variable consideration. The amount of variable consideration expected to be received is included in the transaction price when it becomes probable that the milestone will be met. For contracts with multiple performance obligations, the contract’s transaction price is allocated to each performance obligation using our best estimate of the standalone selling price of each distinct good or service in the contract. The primary method used to estimate standalone selling price is the expected cost plus margin approach. Revenue is recognized over the related period over which we expect the services to be provided using a proportional performance model or a straight-line method of recognition if there is no discernible pattern over which the services will be provided.
See Note 2 “Summary of Significant Accounting Policies”, to the Consolidated Financial Statements in Item 15 of Part IV of this Annual Report on Form 10-K for further information.
Research and Development
Major components of research and development costs include cash compensation to employees, costs of preclinical studies, clinical trials and related clinical manufacturing, costs of drug development, costs of materials and supplies, facilities cost, overhead costs, regulatory and compliance costs, and fees paid to consultants and other entities that conduct certain research and development activities on our behalf. Costs incurred in research and development are expensed as incurred.
We record accruals based on estimates of the services received, efforts expended and amounts owed pursuant to contracts with numerous contract research organizations. In the normal course of business, we contract with third parties to perform various clinical study activities in the ongoing development of potential products. The financial terms of these agreements are subject to negotiation and variation from contract to contract and may result in uneven payment flows. Payments under the contracts depend on factors such as the achievement of certain events and the completion of portions of the clinical study or similar conditions. The objective of our accrual policy is to match the recording of expenses in our consolidated financial statements to the actual services received and efforts expended. As such, expense accruals related to clinical studies are recognized based on our estimate of the degree of completion of the event or events specified in the specific clinical study.
We record nonrefundable advance payments we make for future research and development activities as prepaid expenses. Prepaid expenses are recognized as expense in the statements of operations as we receive the related goods or services.
Income Taxes
In connection with the Initial Public Offering, vTv Therapeutics Inc. was formed. From August 1, 2015, vTv Therapeutics Inc. has been subject to corporate level income taxes. Prior to July 30, 2015, our predecessor entities were taxed as partnerships and all their income and deductions flowed through and were subject to tax at the partner level.
vTv Therapeutics Inc. holds vTv Units and is required to recognize deferred tax assets and liabilities for the difference between the financial reporting and tax basis of its investment in vTv LLC.
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Our income tax expense, deferred tax assets and liabilities and reserves for unrecognized tax benefits reflect management’s best assessment of estimated future taxes to be paid. We are subject to income taxes in both the United States and various state jurisdictions. Significant judgments and estimates are required in determining the consolidated income tax expense.
We account for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events included in the consolidated financial statements. Under this method, we determine deferred tax assets and liabilities on the basis of differences between the consolidated financial statement and tax bases of assets and liabilities by using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period in which the enactment date occurs.
We recognize deferred tax assets to the extent we believe these assets are more-likely-than-not to be realized. In making such a determination, we consider all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax planning strategies and recent results of operations.
We record uncertain tax positions on the basis of a two-step process in which (1) we determine whether it is more-likely-than-not that the tax positions will be sustained on the basis of the technical merits of the position and (2) for those tax positions meeting the more-likely-than-not recognition threshold, we recognize the largest amount of tax benefit that is more than 50% likely to be realized upon ultimate settlement with the related tax authority.
Interest and penalties related to income taxes are included in the benefit (provision) for income taxes in our Consolidated Statement of Operations. We have not incurred any significant interest or penalties related to income taxes in any of the periods presented.
Share-Based Compensation
Compensation expense for share-based compensation awards issued is based on the fair value of the award at the date of grant, and compensation expense is recognized for those awards earned over the service period. The grant date fair value of stock option awards is estimated using the Black-Scholes option pricing formula. Expected volatility is based on the historical volatility of the Company’s Class A common stock over the most recent period commensurate with the estimated expected term of the Company’s stock options offering period which is derived from historical experience. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant. Due to a lack of historical exercise data, we estimate the expected life of our outstanding stock options using the simplified method specified under Staff Accounting Bulletin Topic 14.D.2. The fair value of restricted stock units (“RSU”) grants is based on the market value of our Class A common stock on the date of grant. We also estimate the amount of share-based awards that are expected to be forfeited based on historical employee turnover rates.
Effect of Recent Accounting Pronouncements
See discussion of recent accounting pronouncements in Note 2, “Summary of Significant Accounting Policies”, to the Consolidated Financial Statements in Item 15 of Part IV of this Annual Report on Form 10-K.