Note 3. License and Collaboration Agreement

Agreement Terms

On May 26, 2017, the Company and Janssen Biotech, Inc., (“Janssen”), one of the Janssen Pharmaceutical Companies of Johnson & Johnson, entered into an exclusive license and collaboration agreement (the “Janssen License and Collaboration Agreement”) for the development, manufacture and potential commercialization of PTG-200 worldwide for the treatment of Crohn’s disease (“CD”) and ulcerative colitis (“UC”). Janssen is a related party to the Company as Johnson & Johnson Innovation - JJDC, Inc., a significant stockholder of the Company, and Janssen are both subsidiaries of Johnson & Johnson. PTG-200 is the Company’s orally delivered gut-restricted Interleukin 23 receptor (“IL 23R”) antagonist drug candidate currently in development. The Janssen License and Collaboration Agreement became effective on July 13, 2017. Upon the effectiveness of the agreement, the Company received a non-refundable, upfront cash payment of $50.0 million from Janssen.

Under the Janssen License and Collaboration Agreement, the Company granted to Janssen an exclusive worldwide license to develop, manufacture and commercialize PTG-200 and related IL 23R compounds for all indications, including CD and UC. The Company was responsible, at its own expense, for the conduct of the Phase 1 clinical trial for PTG-200, and Janssen is responsible for the conduct of the Phase 2 clinical trial for PTG-200 in CD, including filing the U.S. Investigational New Drug application (“IND”). Development costs for the Phase 2 clinical trial are shared between the parties on an 80/20 basis, with Janssen assuming the larger share. Janssen submitted an IND for PTG-200 in CD during the second quarter of 2019, which took effect in July 2019. The Company initiated a Phase 2 clinical study for PTG-200 in CD with Janssen in the fourth quarter of 2019.

The Company entered into an amendment (the “First Amendment”) to the Janssen License and Collaboration Agreement effective May 7, 2019. The First Amendment builds upon the Company’s ongoing development collaboration with Janssen for PTG-200 and, upon the effectiveness of the First Amendment, the Company became eligible to receive a $25.0 million payment from Janssen, which was received during the second quarter of 2019. The First Amendment expanded the scope of the Janssen License and Collaboration Agreement by supporting research efforts towards identifying and developing second-generation IL-23R antagonists (“second-generation compounds”).

As part of the services added in the First Amendment, Janssen will pay certain costs and milestones related to advancing pre-clinical candidates from the second-generation research program through Phase 1 studies, including funding of a certain number of full-time equivalent employees (“FTEs”) at the Company for a set period of time. The Company will pay 100% of the costs for the Phase 1 studies for the first second-generation compound, and 50% of the costs of the Phase 1 studies for the second and third second-generation compounds; thereafter Janssen will pay 100% of any further Phase 1 development costs. Development costs for the Phase 2 clinical trials for second-generation compounds are shared between the parties on an 80/20 basis, with Janssen assuming the larger share. The Company’s Phase 1 and Phase 2 development costs are also limited by overall spending caps. In December 2019, the Company became eligible to receive a $5.0 million payment trigged by the successful nomination of a second-generation development compound. The Company will be eligible to receive a $7.5 million milestone payment at the completion of a Phase 1 study for the first second-generation compound.

Prior to the effectiveness of the First Amendment, the Company had been eligible to receive a $25.0 million milestone payment upon Janssen’s filing of the IND. This amount had been considered constrained until a time at which the Company would have become eligible to receive the $25.0 million payment from Janssen. Payments to the Company for research and development services are generally billed and collected as services are performed or assets are delivered, including research activities and Phase 1 and Phase 2 development activities. Janssen bills the Company for its 20% share of the Phase 2 development costs as expenses are incurred by Janssen. Milestone payments are received after the related milestones are achieved.

Pursuant to the First Amendment, the Company will be eligible to receive clinical development, regulatory and sales milestones, if and as achieved, and/or payments relating to Janssen’s elections to maintain or expand its license rights. The next such payment is a $50.0 million payment based on Phase 2a clinical trial results, as follows:

• Janssen can elect to advance PTG-200 into Phase 2b following receipt of the top line results of the CD Phase 2a clinical trial for PTG-200 by paying a $50.0 million maintenance fee (the “Amended First Opt-in Election”); or

• Janssen would make a $50.0 million milestone payment following dosing of the third patient in first Phase 2b clinical trial for CD for a second-generation product (the “Second-Generation Phase 2b Milestone”).

Janssen can also then elect to receive exclusive, world-wide commercial rights for both PTG-200 and second-generation products following the Phase 2b completion date for PTG-200 or a second-generation product by paying a $50.0 million payment (the “Amended Second Opt-in Election”). Formerly, the first and second opt-in payments were $125.0 million and $200.0 million, respectively. If Janssen does not make the Amended Second Opt-in Election, with respect to either PTG-200 or a second-generation compound, the Janssen License and Collaboration Agreement would terminate.

The Company will also be eligible for certain additional milestone payments including a potential payment of either $100.0 million upon a Phase 3 CD clinical trial meeting a primary clinical endpoint with respect to PTG-200 or $115.0 million upon a Phase 3 CD clinical trial meeting a primary clinical endpoint with respect to a second-generation compound.

Pursuant to the First Amendment, the Company will be eligible to receive tiered royalties on net product sales at percentages ranging from mid-single digits to ten percent. Under the terms of the First Amendment, the Company will be eligible to receive up to $1.0 billion in research, development, regulatory and sales milestones.

The Janssen License and Collaboration Agreement remains in effect until the royalty obligations cease following patent and regulatory expiry, unless terminated earlier. Upon a termination of the Janssen License and Collaboration Agreement, all rights revert back to the Company, and in certain circumstances, if such termination occurs during ongoing clinical trials, Janssen would, if requested, provide certain financial and operational support to the Company for the completion of such trials.

Revenue Recognition

The Company has concluded that the amended Janssen License and Collaboration Agreement continues to contain a single performance obligation including the development license; second-generation compound research services; Phase 1 development services for PTG-200 and potential second-generation compounds; the Company’s services associated with Phase 2 development for PTG-200 until Phase 2a; the Company’s services associated with Phase 2 development for a second-generation product until the dosing of the third patient in Phase 2b; and all other such services that the Company may perform at the request of Janssen to support the development of PTG-200, second-generation research services, or the development of a second-generation compound. The Company concluded that the Amended First Opt-in Election and the Amended Second Opt-in Election options are not considered to be material rights.

The Company determined that the license was not distinct from the added research and development services within the context of the agreement because the added research and development services significantly increase the utility of the intellectual property. The Company also determined that the remaining research and development services are not distinct from the partially delivered combined promise comprised under the agreement prior to the First Amendment of the development license and PTG-200 services, including compound supply and other services. Therefore, the First Amendment is treated as if it were part of the original Janssen License and Collaboration Agreement. The First Amendment was accounted for as if it were an extension of services under the initial Janssen License and Collaboration Agreement by applying a cumulative catch-up adjustment to revenue. As of the effective date of the First Amendment, the Company calculated the adjusted cumulative revenue under the amended Janssen License and Collaboration Agreement by updating the transaction price for the incremental consideration to be received, net of the incremental development cost reimbursement to be paid to Janssen, and an updated percentage complete, which resulted in a cumulative adjustment recorded during the year ended December 31, 2019 that reduced revenue by $9.4 million.

The contract duration is defined as the period in which parties to the contract have present enforceable rights and obligations. For revenue recognition purposes, the Company determined that the duration of the Janssen License and Collaboration Agreement, as amended, began on the effective date of July 13, 2017 and ends upon the later of end of Phase 2a for PTG-200 or upon dosing of the third patient in Phase 2b for a second-generation compound.

The Company uses the most likely amount method to estimate variable consideration included in the transaction price. Variable consideration after the First Amendment consists of future milestone payments and cost sharing payments from Janssen for agreed upon services offset by Phase 2 development costs reimbursement payable to Janssen. Cost sharing payments from Janssen relate to the agreed upon services for Phase 2 activities that the Company performs within the duration of the contract are included in the transaction price at an amount equal to 80% of the estimated budgeted costs for these activities, including primarily internal full-time equivalent effort and third party contract costs. Cost sharing payments to Janssen relate to agreed upon services for Phase 2 activities that Janssen performs within the duration of the contract are not a distinct service that Janssen transfers to the Company. Therefore, the consideration payable to Janssen is accounted for as a reduction in the transaction price.

The Company determined that the transaction price of the Janssen License and Collaboration Agreement was $112.9 million as of December 31, 2019, an increase of $52.2 million from the transaction price of $60.7 million at December 31, 2018 and $59.0 million from the transaction price of $53.9 million at December 31, 2017. In order to determine the transaction price, the Company evaluated all payments to be received during the duration of the contract, net of Phase 2 development costs reimbursement expected to be payable to Janssen. The Company determined that the transaction price includes the $50.0 million upfront payment, the $25.0 million payment received upon the effectiveness of the First Amendment, the $5.0 million payment triggered by the successful nomination of a second-generation compound, $18.3 million of reimbursement from Janssen for services performed for PTG-200 Phase 2 and for second-generation compound research costs and other services, and $14.6 million of estimated variable consideration, which includes a $7.5 million milestone payment subject to the completion of a Phase 1 study for a second-generation compound. The Company evaluated whether the variable component of the transaction price should be constrained to ensure that a significant reversal of revenue recognized on a cumulative basis as of December 31, 2019 is not probable. The Company concluded that the variable consideration constraint does not further decrease the estimated transaction price as of December 31, 2019. The additional potential development, regulatory and sales milestone payments after the completion of Phase 2b activities that the Company would be eligible to receive are currently outside the contract term as defined for revenue recognition purposes and as such have been excluded from the transaction price. The increase in transaction price following the effectiveness of the First Amendment was primarily due to the collection of the $25.0 million payment, the $5.0 million payment receivable as of December 31, 2019, the $7.5 million milestone payment for the successful completion of a Phase 1 study for a second- generation compound and increases in reimbursable costs related to new and extended research and development services, offset by Phase 2 development costs reimbursement payable to Janssen.

The Company re-evaluates the transaction price, including variable consideration, at the end of each reporting period and as uncertain events are resolved or other changes in circumstances occur. The Company and Janssen make quarterly cost sharing payments to one another in amounts necessary to ensure that each party bears its contractual share of the overall shared costs incurred.

The Company utilizes a cost-based input method to measure proportional performance and to calculate the corresponding amount of revenue to recognize. In applying the cost-based input methods of revenue recognition, the Company uses actual costs incurred relative to expected costs to fulfill the combined performance obligation. These costs consist primarily of internal FTE effort and third-party contract costs. Revenue will be recognized based on actual costs incurred as a percentage of total estimated costs as the Company completes its performance obligations. A cost-based input method of revenue recognition requires management to make estimates of costs to complete the Company’s performance obligations. The Company believes this is the best measure of progress because other measures do not reflect how the Company transfers its performance obligation to Janssen. In making such estimates, significant judgment is required to evaluate assumptions related to cost estimates. The cumulative effect of revisions to estimated costs to complete the Company’s performance obligations will be recorded in the period in which changes are identified and amounts can be reasonably estimated. A significant change in these assumptions and estimates could have a material impact on the timing and amount of revenue recognized in future periods.

For the year ended December 31, 2019, the Company recognized $0.2 million of license and collaboration revenue. This amount included a $9.4 million cumulative catchup adjustment as a reduction of revenue, offset by $8.0 million of license and collaboration revenue recognized following the contract modification for the First Amendment and $1.6 million of collaboration revenue recognized during the first quarter of 2019 under the original Janssen License and Collaboration Agreement prior to the effectiveness of the First Amendment.

For the year ended December 31, 2018, the Company recognized $30.9 million of license and collaboration revenue. This amount included $30.8 million of the transaction price for the Janssen License and Collaboration Agreement recognized based on proportional performance, and $0.1 million, net, for other services related to Phase 2 activities performed by the Company on behalf of Janssen that were not included in the performance obligations identified under the Janssen License and Collaboration Agreement.

For the year ended December 31, 2017, the Company recognized $20.1 million of license and collaboration revenue. This amount included $19.0 million of the transaction price for the Janssen License and Collaboration Agreement recognized based on proportional performance, and $1.1 million for other services related to Phase 2 activities performed by the Company on behalf of Janssen that were not included in the performance obligations identified under the Janssen License and Collaboration Agreement.

The following table presents changes in the Company’s contract assets and liabilities for the years ended December 31, 2019 and 2018 (in thousands):


	Balance at						Balance at
	Beginning of						End of
Year Ended December 31, 2019	Period		Additions		Deductions		Period
Contract assets:
Receivable from collaboration partner - related party	$	2,042	$	36,837	$	(32,924)	$	5,955
Contract asset - related party	$	2,545	$	800	$	(2,545)	$	800
Contract liabilities:
Deferred revenue - related party	$	8,223	$	42,456	$	(9,149)	$	41,530
Payable to collaboration partner - related party	$	1,061	$	1,468	$	(1,267)	$	1,262


	Balance at						Balance at
	Beginning of						End of
Year ended December 31, 2018	Period		Additions		Deductions		Period
Contract assets:
Receivable from collaboration partner - related party	$	1,816	$	6,665	$	(6,439)	$	2,042
Contract asset - related party	$	—	$	2,545	$	—	$	2,545
Contract liabilities:
Deferred revenue - related party	$	31,752	$	7,296	$	(30,825)	$	8,223
Payable to collaboration partner - related party	$	—	$	1,574	$	(513)	$	1,061

During the year ended December 31, 2019, the Company recognized $1.6 million in revenue from the deferred revenue contract liability balance at the beginning of the year, which represents the revenue recognized during the first quarter of 2019 prior to the effectiveness of the First Amendment. During the year ended December 31, 2018, the Company recognized $23.5 million in revenue from the deferred revenue contract liability balance at the beginning of the year. During the year ended December 31, 2017, the Company did not recognize any revenue from amounts included in the contract asset and the contract liability balances at the beginning of the year or from performance obligations satisfied in previous periods. None of the costs to obtain or fulfill the contract were capitalized.