10-Q 1 prnb-10q_20180930.htm 10-Q prnb-10q_20180930.htm

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

 

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2018

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ________ to ________ 

Commission File Number: 001-38653

 

Principia Biopharma Inc.

(Exact Name of Registrant as Specified in its Charter)

 

Delaware

26-3487603

( State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer
Identification No.)

400 East Jamie Court, Suite 302

South San Francisco, CA 94080

94080

(Address of principal executive offices)

(Zip Code)

Registrant’s telephone number, including area code: (650) 416-7700

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes      No  

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes      No  

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer

 

  

Accelerated filer

 

 

 

 

 

Non-accelerated filer

 

 

  

Smaller reporting company

 

 

 

 

 

 

 

 

Emerging growth company

 

 

 

 

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes      No  

As of November 1, 2018, the registrant had 23,860,837 shares of common stock, $0.0001 par value per share, outstanding.

 

 

 


Table of Contents

 

 

 

 

Page

PART I.

FINANCIAL INFORMATION

 

 

Item 1.

Financial Statements (Unaudited)

 

1

 

Condensed Consolidated Balance Sheets

 

1

 

Condensed Consolidated Statements of Operations

 

2

 

Condensed Consolidated Statements of Comprehensive Income (Loss)

 

3

 

Condensed Consolidated Statements of Cash Flows

 

4

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

5

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

21

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

31

Item 4.

Controls and Procedures

 

31

PART II.

OTHER INFORMATION

 

33

Item 1.

Legal Proceedings

 

33

Item 1A.

Risk Factors

 

33

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

69

Item 3.

Defaults Upon Senior Securities

 

70

Item 4.

Mine Safety Disclosures

 

70

Item 5.

Other Information

 

70

Item 6.

Exhibits

 

71

Signatures

 

72

 

 

 

i


PART I—FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited)

PRINCIPIA BIOPHARMA INC.

Condensed Consolidated Balance Sheets

(Unaudited)

(In thousands, except share and per share amounts)

 

 

 

September 30, 2018

 

 

December 31, 2017

 

Assets

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

149,053

 

 

$

41,054

 

Short-term investments

 

 

39,239

 

 

 

 

Restricted cash

 

 

82

 

 

 

100

 

Prepaid expenses and other current assets

 

 

2,506

 

 

 

1,778

 

Total current assets

 

 

190,880

 

 

 

42,932

 

Property and equipment, net

 

 

552

 

 

 

209

 

Long-term restricted cash

 

 

567

 

 

 

82

 

Other long-term assets

 

 

8,574

 

 

 

280

 

Total assets

 

$

200,573

 

 

$

43,503

 

Liabilities, convertible preferred stock and stockholders' equity

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

Accounts payable

 

$

4,749

 

 

$

3,405

 

Deferred revenue

 

 

20,637

 

 

 

44,134

 

Accrued liabilities

 

 

4,205

 

 

 

1,430

 

Accrued compensation

 

 

1,953

 

 

 

2,262

 

Total current liabilities

 

 

31,544

 

 

 

51,231

 

Deferred revenue, less current portion

 

 

1,116

 

 

 

5,619

 

Long-term deferred rent

 

 

8,827

 

 

 

8

 

Convertible preferred stock warrant liability

 

 

 

 

 

1,576

 

Total liabilities

 

 

41,487

 

 

 

58,434

 

Commitments and contingencies (Note 7)

 

 

 

 

 

 

 

 

Convertible preferred stock, $0.0001 par value, 20,000,000 and 113,680,282

   shares authorized at September 30, 2018 and December 31, 2017,

   respectively

 

 

 

 

 

128,531

 

Stockholders' equity

 

 

 

 

 

 

 

 

Common stock, $0.0001 par value, 500,000,000 and 141,432,765 shares

   authorized at September 30, 2018 and December 31, 2017, respectively;

   23,860,837 and 626,613 shares issued and outstanding September 30,

   2018 and December 31, 2017, respectively

 

 

2

 

 

 

1

 

Additional paid-in-capital

 

 

300,968

 

 

 

7,201

 

Accumulated other comprehensive loss

 

 

(100

)

 

 

(90

)

Accumulated deficit

 

 

(141,784

)

 

 

(150,574

)

Total stockholders’ equity (deficit)

 

 

159,086

 

 

 

(143,462

)

Total liabilities, convertible preferred stock, and stockholders’ equity

 

$

200,573

 

 

$

43,503

 

 

See accompanying notes.

1


PRINCIPIA BIOPHARMA INC.

Condensed Consolidated Statements of Operations

(Unaudited)

(In thousands, except share and per share amounts)

 

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

 

September 30,

 

 

September 30,

 

 

 

2018

 

 

2017

 

 

2018

 

 

2017

 

Revenue

 

$

18,564

 

 

$

1,512

 

 

$

43,000

 

 

$

1,873

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Research and development

 

 

9,200

 

 

 

6,061

 

 

 

26,855

 

 

 

17,847

 

General and administrative

 

 

2,887

 

 

 

1,329

 

 

 

7,265

 

 

 

4,429

 

Total operating expenses

 

 

12,087

 

 

 

7,390

 

 

 

34,120

 

 

 

22,276

 

Income (loss) from operations

 

 

6,477

 

 

 

(5,878

)

 

 

8,880

 

 

 

(20,403

)

Other income (expense), net

 

 

206

 

 

 

274

 

 

 

(90

)

 

 

102

 

Interest expense

 

 

 

 

 

(1,521

)

 

 

 

 

 

(5,566

)

Net income (loss)

 

$

6,683

 

 

$

(7,125

)

 

$

8,790

 

 

$

(25,867

)

Net income (loss) per common share

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

 

 

$

(12.26

)

 

$

 

 

$

(46.85

)

Diluted

 

$

 

 

$

(12.26

)

 

$

 

 

$

(46.85

)

Weighted-average shares used to calculate net income

   (loss) per common share

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

5,087,792

 

 

 

581,355

 

 

 

2,149,583

 

 

 

552,119

 

Diluted

 

 

6,144,492

 

 

 

581,355

 

 

 

3,096,952

 

 

 

552,119

 

 

See accompanying notes.

2


PRINCIPIA BIOPHARMA INC.

Condensed Consolidated Statements of Comprehensive Income (Loss)

(Unaudited)

(In thousands)

 

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

 

September 30,

 

 

September 30,

 

 

 

2018

 

 

2017

 

 

2018

 

 

2017

 

Net income (loss)

 

$

6,683

 

 

$

(7,125

)

 

$

8,790

 

 

$

(25,867

)

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net unrealized loss on available-for-sale securities

 

 

(10

)

 

 

 

 

 

(10

)

 

 

 

Foreign currency translation adjustment

 

 

 

 

 

 

 

 

 

 

 

52

 

Comprehensive income (loss)

 

$

6,673

 

 

$

(7,125

)

 

$

8,780

 

 

$

(25,815

)

 

See accompanying notes.

3


PRINCIPIA BIOPHARMA INC.

Condensed Consolidated Statements of Cash Flows

(Unaudited)

(In thousands)

 

 

 

Nine Months Ended September 30,

 

 

 

2018

 

 

2017

 

Operating activities:

 

 

 

 

 

 

 

 

Net income (loss)

 

$

8,790

 

 

$

(25,867

)

Adjustments to reconcile net income (loss) to net cash used in operating activities:

 

 

 

 

 

 

 

 

Change in fair value of convertible preferred stock warrant liability

 

 

577

 

 

 

240

 

Change in fair value of redemption features liability

 

 

 

 

 

(237

)

Amortization of (discount) premium on short-term investments

 

 

(65

)

 

 

 

Depreciation

 

 

176

 

 

 

138

 

Stock-based compensation

 

 

1,424

 

 

 

743

 

Deferred rent

 

 

468

 

 

 

 

Amortization of debt discount

 

 

 

 

 

4,298

 

Interest expense on convertible notes

 

 

 

 

 

1,223

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

 

Prepaid expenses and other assets

 

 

(1,165

)

 

 

(261

)

Deferred revenue

 

 

(28,000

)

 

 

13,127

 

Accounts payable

 

 

1,344

 

 

 

(1,300

)

Accrued liabilities

 

 

587

 

 

 

1,521

 

Net cash used by operating activities

 

 

(15,864

)

 

 

(6,375

)

Investing activities:

 

 

 

 

 

 

 

 

Purchases of property and equipment

 

 

(455

)

 

 

(41

)

Maturities of short-term investments

 

 

8,500

 

 

 

 

Purchases of short-term investments

 

 

(47,684

)

 

 

 

Net cash used in investing activities

 

 

(39,639

)

 

 

(41

)

Financing activities:

 

 

 

 

 

 

 

 

Net proceeds from initial public offering

 

 

112,401

 

 

 

 

Net proceeds from Series-C preferred stock issuance

 

 

49,792

 

 

 

 

Proceeds from issuance of common stock

 

 

1,253

 

 

 

196

 

Proceeds from exercise of common stock warrants

 

 

56

 

 

 

 

Proceeds from debt obligations

 

 

 

 

 

8,060

 

Net cash provided by financing activities

 

 

163,502

 

 

 

8,256

 

Effect of foreign exchange rate changes on cash and cash equivalents

 

 

 

 

 

61

 

Net increase in cash and cash equivalents

 

 

107,999

 

 

 

1,901

 

Cash and cash equivalents at beginning of period

 

 

41,054

 

 

 

5,867

 

Cash and cash equivalents, at end of period

 

$

149,053

 

 

$

7,768

 

Supplemental disclosures of cash flow information

 

 

 

 

 

 

 

 

Tenant improvement allowance receivables

 

$

8,324

 

 

$

 

Stock issuance costs accrued but not yet paid

 

 

1,907

 

 

 

 

Purchases of property and equipment accrued but not yet paid

 

 

64

 

 

 

 

 

See accompanying notes.

 

4


 

PRINCIPIA BIOPHARMA INC.

Notes to Unaudited Condensed Consolidated Financial Statements

1. Organization

Description of Business

We, Principia Biopharma Inc. (“Principia”), are a clinical-stage biopharmaceutical company focused on developing novel therapies for immunology and oncology. We were incorporated on October 6, 2008, began operations in February 2011, and are headquartered in South San Francisco, California.  

Initial Public Offering

On September 13, 2018, our Registration Statement on Form S-1 was declared effective by the U.S. Securities and Exchange Commission (“SEC”) for our initial public offering (“IPO”). In connection with the IPO, we issued and sold an aggregate of 7,187,500 shares of common stock, including 937,500 shares issued and sold pursuant to the underwriters’ full exercise of their over-allotment option to purchase additional shares, at an offering price to the public of $17.00 per share. Proceeds from the IPO, net of underwriting discounts and commissions, were $113.6 million. In connection with the completion of the IPO in September 2018, all the outstanding shares of convertible preferred stock were converted into 15,760,102 shares of common stock. In addition, all of our convertible preferred stock warrants were converted into warrants to purchase shares of common stock.

In connection with our IPO, on September 18, 2018, our certificate of incorporation was amended and restated to provide for 500,000,000 authorized shares of common stock with a par value of $0.0001 per share and 20,000,000 authorized shares of preferred stock with a par value of $0.0001 per share.

2. Significant Accounting Policies

Basis of Presentation

The accompanying interim condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) and include the accounts of Principia and our wholly-owned Australian subsidiary. All intercompany accounts, transactions and balances have been eliminated.

The interim condensed consolidated balance sheet as of September 30, 2018, and the condensed consolidated statements of operations, comprehensive income (loss) and cash flows for the three and nine months ended September 30, 2018 and 2017 are unaudited. The unaudited interim condensed consolidated financial statements have been prepared on the same basis as the annual consolidated financial statements and reflect, in the opinion of management, all adjustments of a normal and recurring nature that are necessary for the fair presentation of our financial position as of September 30, 2018 and its results of operations and cash flows for the three and nine months ended September 30, 2018 and 2017. The financial data and the other financial information disclosed in the notes to the condensed consolidated financial statements related to the nine-month period are also unaudited. The condensed consolidated results of operations for any interim period are not necessarily indicative of the results to be expected for the full year or for any other future annual or interim period. The condensed consolidated balance sheet as of December 31, 2017 included herein was derived from the audited consolidated financial statements as of that date. These interim condensed consolidated financial statements should be read in conjunction with our audited consolidated financial statements set forth in our prospectus dated September 13, 2018 (“Prospectus”) that forms a part of our Registration Statements on Form S-1 (File No. 333-226922), as filed with the SEC pursuant to Rule 424 promulgated under the Securities Act of 1933, as amended.

Reverse Stock Split

In August 2018, our board of directors approved an amendment to our amended and restated certificate of incorporation to effect a 1-for-9.0839 reverse split (the “Reverse Split”) of shares of our common and convertible preferred stock, which was effected on August 31, 2018. All share and per share information included in the accompanying condensed consolidated financial statements has been adjusted to reflect the Reverse Split. Accordingly, all issued and outstanding common stock and preferred stock and related per share amounts contained in the financial statements have been retroactively adjusted to reflect the Reverse Split for all periods presented.

5


 

Need for Additional Capital

Since commencing operations in 2011, we have devoted substantially all of our resources to identifying and developing our drug candidates, including conducting preclinical studies and clinical trials, and providing general and administrative support for these operations.

To date, we have financed our operations primarily through our IPO, private placements of our convertible preferred stock and convertible notes, and payments from license and research collaborations. From inception to date, we have received $299.5 million in aggregate proceeds through our financings. In 2017, we entered into a license agreement (the “Sanofi Agreement”) with Genzyme Corporation, a wholly owned subsidiary of Sanofi (“Sanofi”) and a development and license agreement (the “AbbVie Agreement”) with AbbVie Biotechnology Limited (“AbbVie”), pursuant to which we received non-refundable upfront payments of $40.0 million and $15.0 million, respectively. In May 2018, we amended the Sanofi Agreement and received additional payments of $10.0 million for the completion of a major part of the Phase 1 trial and $5.0 million for the successful completion of preclinical toxicology studies in July 2018 and August 2018, respectively.

As of September 30, 2018 and December 31, 2017, we held cash, cash equivalents and short-term investments totaling $188.3 million and $41.1 million, respectively. We do not have any products for sale and have not generated any product revenue since our inception. To date, all of our revenue has been generated from the non-refundable payments received from our agreements with Sanofi and AbbVie. For the nine months ended September 30, 2018, our net income was $8.8 million. We have incurred significant operating losses since the commencement of our operations. As of September 30, 2018, we have an accumulated deficit of $141.8 million. We expect to continue to incur significant expenses and operating losses as we advance our clinical programs and expand our pipeline, seek regulatory approval and, if successful, proceed to commercial launch activities. Furthermore, we expect to incur additional costs associated with operating as a public company. We believe our cash, cash equivalents and short-term investments at September 30, 2018 are sufficient to fund our operations for at least the next 12 months from the date the unaudited financial statements are filed with the SEC.

Use of Estimates

The preparation of our financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, as well as related disclosure of contingent assets and liabilities. Significant estimates include amounts to determine the fair value of common stock-based awards, warrants, and other issuances, embedded derivatives, accruals for research and development costs and uncertain tax positions, and the estimated periods of performance used in the determination of collaboration revenues. We base our estimates on historical experience and on various other market specific and relevant assumptions that our management believes to be reasonable under the circumstances. Actual results could differ materially from our estimates.

Concentration of Credit Risk and Other Risks and Uncertainties

Financial instruments that potentially subject us to a significant concentration of credit risk consist primarily of cash, cash equivalents and short-term investments. The majority of our cash and cash equivalents is maintained with one financial institution in the United States. Deposits with this financial institution have exceeded and will continue to exceed federally insured limits. We have not experienced any losses on our cash deposits. Additionally, we have established guidelines regarding diversification of its investments in short-term investments and their maturities, which are designed to minimize risk and maintain liquidity. Cash, cash equivalents and short-term investments totaled $188.3 million and $41.1 million at September 30, 2018 and December 31, 2017, respectively.

We are subject to a number of risks similar to other early-stage biopharmaceutical companies, including, but not limited to, the need to obtain adequate additional funding, possible failure of current or future preclinical studies or clinical trials, our reliance on third parties or partners to conduct our clinical trials, the need to obtain regulatory and marketing approvals for our drug candidates or to rely on partners to do so, competitors developing new technological innovations, the need to successfully commercialize and gain market acceptance of our drug candidates, our right to develop and commercialize our drug candidates pursuant to the terms and conditions of the licenses granted to us, protection of proprietary technology, the ability to make milestone, royalty or other payments due under any license or collaboration agreements, and the need to secure and maintain adequate manufacturing arrangements with third parties. If we do not successfully commercialize or partner any of our drug candidates, we will be unable to generate product revenue or achieve profitability.

6


 

Cash and Cash Equivalents

We consider all highly liquid financial instruments with original maturities of 90 days or less at the date of purchase to be cash equivalents. Cash equivalents are stated at fair value.

Short-term investments

We invest in short-term investments, primarily money market funds, U.S. Treasury Securities and government agency securities. Investments with original maturities greater than 90 days that mature less than one year from the condensed consolidated balance sheet date are classified as short-term investments. Investments with a maturity date greater than one year at each balance sheet date are considered to be long-term investments. All of our short-term investments are considered available-for-sale and carried at estimated fair values on the condensed consolidated balance sheets. Unrealized gains or losses are excluded from net income and reported in accumulated other comprehensive loss as a separate component of stockholders’ equity on the condensed consolidated balance sheets. Realized gains and losses and declines in fair value judged to be other than temporary, if any, on investments in short-term investments are included in other income (expense), net. The cost of securities sold is based on the specific-identification method. Interest earned on investments in short-term investments is included in interest income. The amortized cost of debt securities is adjusted for amortization of premiums and accretion of discounts and such amortization and accretion are included as a component of interest income.

Restricted Cash

As of September 30, 2018 and December 31, 2017, we had $0.6 million and $0.2 million, respectively, in combined restricted cash and long-term restricted cash that is used to secure financing through a company credit card and for a lease security deposit. This amount is separated from cash and cash equivalents on the condensed consolidated balance sheets.

Leases

We enter into lease agreements for our laboratory and office facilities. These leases are classified as operating leases. Rent expense is recognized on a straight-line basis over the term of the lease. Deferred rent consists of the difference between cash payments and the recognition of rent expense for the buildings we occupy.

Lease incentives and allowance provided by our landlord for the construction of leasehold improvements are recorded as lease incentive obligations as the related construction costs are incurred, up to the maximum aggregate allowances. Lease incentive obligations are classified as a component of deferred rent and are amortized on a straight-line basis over the lease term as a reduction of rent expense.

Rent expense from operating leases is recognized on a straight-line basis over the lease term. The difference between rent expense recognized and rental payments is recorded as deferred rent in the condensed consolidated balance sheets.

Revenue Recognition

We generate revenues from our collaboration agreements with Sanofi and with AbbVie. Revenue is recognized when the four revenue recognition criteria are met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services have been rendered; (3) the fee is fixed or determinable; and (4) collectability is reasonably assured.

We account for multiple element arrangements, in which we may provide several deliverables, in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Subtopic 605-25, Multiple Element Arrangements.

Revenue from non-refundable upfront fees that are not dependent on any future performance by us is recognized when such amounts are earned. If we have continuing obligations to perform under the arrangement, such fees are recognized over the estimated period of the continuing performance obligation. Where a portion of non-refundable upfront fees or other payments received is allocated to continuing performance obligations under the terms of the agreement, it is recorded as deferred revenue and recognized as revenue ratably over the term of our estimated performance period under the agreement. We determine the estimated performance periods and review them periodically based on the progress of the related program. The effect of any change made to an estimated performance period and, therefore revenue recognized, would occur on a prospective basis in the period that the change was made. We have received reimbursements for a portion of our research and development costs. Such reimbursements are recorded as a reduction to research and development expenses on our condensed consolidated statements of operations.

7


 

Our collaboration agreements may contain milestone payments that become due upon the achievement of certain milestones. We apply ASC Subtopic 605-28, Milestone Method. Under the milestone method, payments that are contingent upon achievement of a substantive milestone are recognized in the period in which the milestone is achieved. A milestone is defined as an event that can only be achieved based on our performance and there is substantive uncertainty about whether the event will be achieved at the inception of the arrangement. Events that are contingent only on the passage of time or only on counterparty performance are not considered milestones subject to this guidance. Further, for the milestone to be considered substantive, the consideration earned from the milestone must relate solely to prior performance, be reasonable relative to all of the deliverables, and the consideration must be commensurate with our performance to achieve the milestone or the enhancement of the value of the item delivered as a result of a specific outcome resulting from our performance to achieve the milestone. Non-substantive milestone or contingent payments are recognized as revenue over the estimated period of any remaining performance obligations or when earned as a result of counterparty performance in accordance with contractual terms and when such payments can be reasonably estimated and collectability of such payments is reasonably assured.

Convertible Preferred Stock Warrants

Upon the completion of our IPO in September 2018, all of our convertible preferred stock warrants were converted into warrants to purchase shares of common stock. We re-valued the convertible preferred stock warrants upon completion of our IPO and reclassified the estimate fair value of the warrants to additional paid in capital.

Prior to the IPO, freestanding warrants to purchase our convertible preferred stock were recorded as a liability on the condensed consolidated balance sheets. The warrants were subject to revaluation at each balance sheet date, with changes in fair value recognized as a component of other income, net, on the condensed consolidated statements of operations.

Comprehensive Income (Loss)

Comprehensive income (loss) is defined as the change in stockholders’ equity (deficit) of a business enterprise during a period, resulting from transactions from non-owner sources, and consists primarily of losses on foreign currency translation related to our wholly-owned Australian subsidiary and unrealized gains or losses related to our available-for-sale short-term investments are carried at estimated fair values on the condensed consolidated balance sheets.

Net Income (Loss) per Share

Basic net income (loss) per share attributable to common stockholders is calculated by dividing the net income (loss) attributable to common stockholders by the weighted-average number of shares of common stock outstanding for the period.

Diluted net income (loss) per share includes the effect of potentially dilutive securities, which include outstanding warrants and stock options if the effect of their inclusion would be dilutive. In periods of net loss, diluted net loss per share is the same as basic net loss per share as the inclusion of potentially dilutive securities in the calculation would be anti-dilutive.

We have issued securities other than common stock that participate in dividends (“Participating Securities”), and therefore utilize the two-class method to calculate net income (loss) per share. These Participating Securities include Series A, Series B-1, Series B-2, Series B-3 and Series C redeemable convertible preferred stock. The two-class method requires a portion of net income (loss) to be allocated to the Participating Securities to determine net income (loss) attributable to common stockholders. Net income (loss) attributable to common stockholders is equal to the net income (loss) less dividends paid on preferred stock with any remaining earnings allocated in accordance with the bylaws between the outstanding common and redeemable convertible preferred stock as of the end of each period.

Recent Accounting Pronouncements

From time to time, new accounting pronouncements are issued by the FASB, or other standard setting bodies and adopted by us as of the specified effective date. Unless otherwise discussed, the impact of recently issued standards that are not yet effective will not have a material impact on our condensed consolidated financial statements upon adoption. Under the Jumpstart Our Business Startups Act of 2012, as amended (the “JOBS Act”), we meet the definition of an emerging growth company, and have elected the extended transition period for complying with new or revised accounting standards pursuant to Section 107(b) of the JOBS Act.

8


 

Recently Adopted Accounting Standards Updates

In March 2016, the FASB issued Accounting Standards Update (“ASU”) No. 2016-09, Compensation—Stock Compensation (Topic 718), which simplifies the accounting for employee share-based transactions. The amendments in this update cover such areas as the recognition of excess tax benefits and deficiencies, the classification of those excess tax benefits on the condensed consolidated statement of cash flows, an accounting policy election for forfeitures, the amount an employer can withhold to cover income taxes and still qualify for equity classification, and the classification of those taxes paid on the condensed consolidated statement of cash flows. For public entities, ASU 2016-09 was effective for fiscal years, and interim periods within those years, beginning after December 15, 2016. For entities other than public entities, the standard is effective for fiscal years beginning after December 15, 2017, and interim periods within fiscal years beginning after December 15, 2018. Early adoption is permitted. We early adopted ASU 2016-09 in 2017 and the adoption did not have a material impact on our condensed consolidated financial statements.

Recently Issued Accounting Standards or Updates Not Yet Effective

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”), as subsequently amended, which outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most recent current revenue recognition guidance, including industry-specific guidance. The core principle of the revenue model is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 defines a five-step process to achieve this core principle and, in doing so, it is possible more judgment and estimates may be required within the revenue recognition process than required under existing U.S. generally accepted accounting pronouncements. The guidance also specifies the accounting for certain incremental costs of obtaining a contract, and costs to fulfill a contract with a customer.

Entities have the option of applying either a full retrospective approach to all periods presented, or a modified approach that reflects differences prior to the date of adoption as an adjustment to equity. We have elected the extended transition period provided by the JOBS Act and ASU 2014-09, as amended, becomes effective for us for fiscal years beginning after December 15, 2018, and interim periods beginning after December 15, 2019. Early adoption is permitted. We plan to adopt the accounting standard update in 2019 using the modified retrospective method and are currently in the early stages of analyzing our collaboration and license agreements to determine the differences in the accounting treatment under ASU 2014-09 compared to the current accounting standard. The consideration we are eligible to receive under these agreements includes upfront payments, research and development funding, milestone payments and royalties. The new revenue recognition standard differs from the current accounting standard in many respects, such as in the accounting for variable consideration and the measurement of progress toward completion of performance obligations. While we have not completed our assessment of the impact of adoption, adopting ASU 2014-09 may have a material effect on our condensed consolidated financial statements.

In February 2016, the FASB issued ASU No. 2016-02 (Topic 842), Leases (“ASU 2016-02”). ASU 2016-02 requires an entity to recognize assets and liabilities arising from a lease for both financing and operating leases. The ASU will also require new qualitative and quantitative disclosures to help investors and other financial statement users better understand the amount, timing, and uncertainty of cash flows arising from leases. We have elected the extended transition period provided by the JOBS Act and ASU 2016-02 is effective for us for fiscal years beginning after December 15, 2019, and interim periods beginning after December 15, 2020. Early adoption is permitted. The ASU is expected to impact our financial statements as we have certain operating lease agreements under which we are the lessee. We are currently evaluating the impact of the adoption of this ASU and anticipate the recognition of additional assets and corresponding liabilities on our balance sheet related to leases.

In March 2018, the FASB issued ASU No. 2018-05 – Income Taxes (Topic 740): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118, or SAB 118, which provides guidance on accounting for the Tax Act, and provides that the measurement period should not extend beyond one year from the Tax Act enactment date for companies to complete the accounting. In accordance with this guidance, we considered our accounting for the impacts of the new tax law to be provisional. During the three and nine months ended September 30, 2018, no additional measurement-period adjustments were made by us related to the Tax Act. We continue to assess the impact of the recently enacted tax law and associated guidance on its business and consolidated financial statements and plans to complete its accounting for the income tax effects of the Tax Act within the one-year measurement period in 2018.

9


 

3. Fair Value Measurements

Financial assets and liabilities are recorded at fair value. We determine fair value using the fair value hierarchy, which establishes three levels of inputs that may be used to measure fair value, as follows:

Level 1 inputs include quoted prices in active markets for identical assets or liabilities.

Level 2 inputs include observable inputs other than Level 1 inputs, such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; and other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset or liability.

Level 3 inputs include unobservable inputs that are supported by little or no market activity and are significant to the fair value of the underlying asset or liability. Such inputs reflect our best estimate of what market participants would use in pricing the asset or liability at the reporting date. Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model.

Assets and liabilities measured at fair value are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires our management to make judgments and consider factors specific to the asset or liability.

Assets and liabilities measured at fair value on a recurring basis as of September 30, 2018 and December 31, 2017 were as follows (in thousands):

 

 

 

September 30, 2018

 

 

 

Level 1

 

 

Level 2

 

 

Level 3

 

 

Total

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash equivalents

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Money market funds

 

$

11,529

 

 

$

 

 

$

 

 

$

11,529

 

U.S. government agency securities

 

 

 

 

 

69,248

 

 

 

 

 

 

69,248

 

U.S. treasury securities

 

 

 

 

 

58,949

 

 

 

 

 

 

58,949

 

Short-term investments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. government agency securities

 

 

 

 

 

11,372

 

 

 

 

 

 

11,372

 

U.S. treasury securities

 

 

 

 

 

27,868

 

 

 

 

 

 

27,868

 

Total

 

$

11,529

 

 

$

167,437

 

 

$

 

 

$

178,966

 

 

 

 

December 31, 2017

 

 

 

Level 1

 

 

Level 2

 

 

Level 3

 

 

Total

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Money market funds

 

$

30

 

 

$

 

 

$

 

 

$

30

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Convertible preferred stock warrant liability

 

$

 

 

$

 

 

$

1,576

 

 

$

1,576

 

The carrying amounts of accounts payable and accrued liabilities approximate their fair values due to their short-term maturities. Our Level 2 securities are valued using third-party pricing sources. The pricing services utilize industry standard valuation models, including both income and market-based approaches, for which all significant inputs are observable, either directly or indirectly. There were no transfers of assets or liabilities between the fair value measurement levels during the three and nine months ended September 30, 2018 or 2017.

10


 

4. Cash equivalents and Short-term investments

Short-term investments consisted of the following as of September 30, 2018 (in thousands):

 

 

 

September 30, 2018

 

 

 

Amortized Cost

 

 

Unrealized

Gains

 

 

Unrealized

Losses

 

 

Fair Value

 

Cash equivalents

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Money market funds

 

$

11,529

 

 

$

 

 

$

 

 

$

11,529

 

U.S. government agency securities

 

 

69,250

 

 

 

 

 

 

(2

)

 

 

69,248

 

U.S. treasury securities

 

 

58,945

 

 

 

4

 

 

 

 

 

 

58,949

 

Total cash equivalents

 

$

139,724

 

 

$

4

 

 

$

(2

)

 

$

139,726

 

Short-term investments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. government agency securities

 

$

11,376

 

 

$

 

 

$

(5

)

 

$

11,371

 

U.S. treasury securities

 

 

27,875

 

 

 

 

 

 

(6

)

 

 

27,869

 

Total short-term investments

 

$

39,251

 

 

$

 

 

$

(11

)

 

$

39,240

 

Total

 

$

178,975

 

 

$

4

 

 

$

(13

)

 

$

178,966

 

 

We had no short-term investments as of December 31, 2017.

All of our available-for-sale short-term investments have effective maturities of less than one year. There were no sales of available-for-sale short-term investments in any of the periods presented. The carrying value of short-term investments that were in unrealized loss positions totaled $108.5 million as of September 30, 2018. We have determined that (i) we do not have the intent to sell any of these investments, and (ii) it is not more likely than not that we will be required to sell any of these investments before recovery of the entire amortized cost basis. We anticipate that it will recover the entire amortized cost basis of such securities and has determined that no other-than-temporary impairments associated with credit losses were required to be recognized during the three-month and nine-month periods ended September 30, 2018.

5. Balance Sheet Components

Property and equipment as of September 30, 2018 and December 31, 2017 consisted of the following (in thousands):

 

 

 

September 30, 2018

 

 

December 31, 2017

 

Laboratory equipment

 

$

1,977

 

 

$

1,617

 

Computer equipment

 

 

440

 

 

 

281

 

Furniture and Fixtures

 

 

10

 

 

 

10

 

Leasehold improvements

 

 

203

 

 

 

203

 

 

 

 

2,630

 

 

 

2,111

 

Less accumulated depreciation and amortization

 

 

(2,078

)

 

 

(1,902

)

Total

 

$

552

 

 

$

209

 

 

Prepaid expenses and other current assets as of September 30, 2018 and December 31, 2017 consisted of the following (in thousands):

 

 

 

September 30, 2018

 

 

December 31, 2017

 

Other accounts receivable

 

$

1,596

 

 

$

378

 

Prepaid expenses

 

 

910

 

 

 

1,400

 

Total

 

$

2,506

 

 

$

1,778

 

 

Other long-term assets as of September 30, 2018 and December 31, 2017 consisted of the following (in thousands):

 

 

 

September 30, 2018

 

 

December 31, 2017

 

Tenant improvement allowance receivables

 

$

8,324

 

 

$

 

Long-term deposits

 

 

250

 

 

 

280

 

Total

 

$

8,574

 

 

$

280

 

 

11


 

6. License and Collaboration Agreements

Sanofi

In November 2017, we entered into the Sanofi Agreement for an exclusive license to PRN2246 and backup molecules for development in MS and other CNS diseases. Under the Sanofi Agreement, we will complete Phase 1 activities, and Sanofi will take on all further development activities. We and Sanofi will each be responsible for certain early development costs, and Sanofi will be responsible for all further development and commercialization costs, subject to our Phase 3 option described below.

Sanofi has an exclusive license for PRN2246 and its backups for the CNS field, which includes indications of the central nervous system, retina and ophthalmic nerve. We have agreed not to develop other BTK inhibitors within the CNS field, and Sanofi has agreed not to develop PRN2246 or its backups for any indications outside the CNS Field. In the event that we cease all development and commercialization of our other BTK inhibitors or unilaterally decide to offer Sanofi a field expansion, Sanofi could expand its field upon payment to us of a field expansion payment as well as milestones and royalties within the expanded field.

In December 2017, we received a $40.0 million upfront payment. Under the Sanofi Agreement, our deliverables are (i) grant a license of rights to PRN2246, (ii) transfer of technology (know-how) related to PRN2246, and (iii) performance of research and development services related to our responsibilities under the early development plan. We considered the provisions of the revenue recognition multiple-element arrangement guidance and concluded that the delivered license does not have standalone value at the inception of the arrangement due to our proprietary expertise with respect to the licensed compound and related ongoing developmental participation under the agreement, which is required for Sanofi to fully realize the value from the delivered license. Therefore, the $40.0 million received related to this combined unit of accounting is recognized as revenue ratably over the estimated performance period, which is estimated to continue through the fourth quarter of 2018. In May 2018, we amended the Sanofi Agreement to include additional activities under the early development plan and to modify the definition of one of the milestone payments. Pursuant to the amendment, we received a payment of $10.0 million in July 2018 for the completion of a major part of the Phase 1 trial. In August 2018, we received a $5.0 million payment for the successful completion of preclinical toxicology studies. Under ASC Subtopic 605-28, Milestone Method, these milestones are not deemed substantive, and therefore, the $5.0 million payment we achieved in the third quarter of 2018 is recognized ratably over the remaining estimated performance period of the collaboration, which is estimated to continue through the fourth quarter of 2018. For the three and nine months ended September 30, 2018, we recognized approximately $17.1 million and $38.5 million in revenue, respectively, related to the Sanofi Agreement. Deferred revenue related to the Sanofi Agreement was $14.6 million and $38.1 million at September 30, 2018 and December 31, 2017, respectively. Amounts for certain early development plan costs subject to reimbursement from Sanofi, recorded as a reduction of research and development expense, were approximately $1.2 million and $1.9 million, respectively, for the three and nine months ended September 30, 2018.  

Under the amended Sanofi Agreement, we may receive development, regulatory and commercial milestone payments up to an aggregate of $765.0 million, as well as royalties up to the mid-teens. None of the future milestones are considered substantive milestones and therefore any such amounts received will be recognized as revenue ratably over the remaining estimated performance period, if any. We have an option to fund a portion of Phase 3 development costs in return for, at Principia’s option, either a profit and loss sharing arrangement within the United States, or an additional worldwide royalty that would result in royalties up to the high-teens. Only the additional royalty option would be available if we are developing PRN1008 for major enumerated indications overseen by the FDA’s Division of Pulmonary, Allergy and Rheumatology Products or in certain changes of control involving Principia and certain Sanofi competitors. Royalties are subject to specified reductions and are payable, on a product-by-product and country-by-country basis until the later of the date that all of our patent rights that claim a composition of matter of such product expire in such country, the date of expiration of regulatory exclusivity for such product in such country, or the date that is ten years from the first commercial sale of such product in such country.

AbbVie

In June 2017, we entered into the AbbVie Agreement related to the research and development of oral immunoproteasome inhibitors. Under the AbbVie Agreement, we and AbbVie will collaborate on the research and preclinical development of one or more oral immunoproteasome inhibitors with each company bearing its own costs. Following the expiration of the two-year research term (which can be extended by AbbVie for up to six months), AbbVie will become responsible, at its sole cost, for all further development and commercialization activities for each such compound.

12


 

In June 2017, we received an upfront payment of $15.0 million. Under the AbbVie Agreement, we may receive additional development, regulatory and commercial milestones of up to an aggregate of $667.5 million, as well as tiered royalties in the high single digits. Royalties are subject to specified reductions and are payable, on a product-by-product and country-by-country basis, until the later of (i) the date that all patent rights that claim a composition of matter of such product expire in such country, (ii) the date of expiration of regulatory exclusivity for such product in such country, or (iii) the date that is ten years from the first commercial sale of such product in such country.

Exclusivity obligations, which vary depending on the stage of development, apply to us and AbbVie with respect to research and development of certain other inhibitors of the immunoproteasome.

None of the future milestones are considered substantive milestones and therefore any such amounts received will be recognized as revenue ratably over the remaining estimated performance period, if any. Under the AbbVie Agreement, our deliverables are (i) granting a license of rights to certain licensed compounds to develop and commercialize oral immunoproteasome inhibitors, (ii) transfer of technology (know-how) related to the oral immunoproteasome inhibitors program, and (iii) provide research and development services during the two-year research period, which can be extended for up to six months. We considered the provisions of the revenue recognition multiple-element arrangement guidance and concluded that the delivered license does not have standalone value at the inception of the arrangement due to our proprietary expertise with respect to the licensed compounds and related ongoing developmental participation under the AbbVie Agreement, which is required for AbbVie to fully realize the value from the licensed compound. Therefore, the $15.0 million received related to this combined unit of accounting is recognized as revenue ratably over the estimated performance period, which is estimated to continue through the fourth quarter of 2019. For the three and nine months ended September 30, 2018, we recognized approximately $1.5 million and $4.5 million, respectively, in revenue related to the AbbVie Agreement. Revenue related to the AbbVie Agreement was $1.5 million and $1.9 million during the three and nine months ended September 30, 2017, respectively. Deferred revenue related to the AbbVie Agreement was $7.1 million and $11.6 million at September 30, 2018 and December 31, 2017, respectively.

University of California, San Francisco

In November 2009, we entered into a license agreement, or the First Agreement, with the Regents of the University of California, or the Regents, which was amended in October 2010, February 2011, and amended and restated in May 2012. In September 2011, we entered into a separate license agreement, or the Second Agreement, with Regents which was amended and restated in December 2013. We refer to the First Agreement and the Second Agreement together as the UC Agreements. Under the UC Agreements, the Regents have granted to us exclusive, worldwide licenses, with the right to grant sublicenses, under the Regents’ patent rights in certain patent applications to make, use, sell, offer for sale, and import products and services and practice methods covered by such patent applications in all fields of use.

We have paid the Regents license fees of $30,000 and $10,000 under the First Agreement and the Second Agreement, respectively, and we are required to pay the Regents annual license maintenance fees equal to $30,000 and $10,000 for the First Agreement and Second Agreement, respectively, prior to launching any licensed product. We may be obligated to make one-time regulatory and development milestone payments under the First Agreement or the Second Agreement, for future drug candidates. We are obligated to pay the Regents tiered royalty payments in the low single digits on net sales of the licensed products. The royalty is payable under the First Agreement or the Second Agreement, but not both. For licensed products under the First Agreement, we have to make a minimum annual royalty payment of $50,000 beginning in the calendar year after the first commercial sale of a licensed product occurs. The royalties are subject to standard reductions and are payable until the patents upon which such royalties are based expire or are held invalid. The patents issuing under the First Agreement will expire between 2024 and 2030 and under the Second Agreement will expire in 2033, subject to any potential patent term extensions. Additionally, we are obligated to pay the Regents payments on non-royalty licensing revenue we receive from our sub-licensees for products covered by UC patents. The UC Agreements require us to make IPO milestone payments under each of the First Agreement and Second Agreement upon the closing of an IPO. Pursuant to the UC agreements, we made IPO milestone payments totaling approximately $140,000 to the Regents in early October 2018.

Under the UC Agreements, we are required to diligently proceed with the development, manufacture, regulatory approval, and sale of licensed products which include obligations to meet certain development-stage milestones within specified periods of time and to market the resulting licensed products in sufficient quantity to meet market demand. We have the right and option to extend the date by which we must meet any milestone in one year extensions by paying an extension fee for second and subsequent extension, provided we can demonstrate we made diligent efforts to meet the milestone.

13


 

7. Commitments and Contingencies

Leases

Our corporate headquarters are located in South San Francisco, California, where we lease approximately 30,000 square feet of office, research and development, and laboratory space under an operating lease. This facility houses all our personnel. The lease agreement has been subject to several amendments necessary to secure additional space, sublease certain office and laboratory space and/or extend the lease term. The term for the lease expires on January 31, 2019.

In 2015, we entered into agreements to sublease certain office and laboratory space to two different subtenants. Pursuant to the sublease agreements, we received sublease payments of $41,000 and $120,000 for the three and nine months ended September 30, 2017, respectively, each of which are recognized as an offset to rent expense. Both subleases were terminated during 2017.

In April 2018, we signed a lease (the “Lease Agreement”) for approximately 47,500 square feet of office, research and development and laboratory space with occupancy anticipated to commence on February 1, 2019 for a seven year period with an option to extend for another seven year period subject to certain conditions. Pursuant to the April 2018 Lease Agreement, we provided a letter of credit to the landlord for $567,000 which is recorded as long-term restricted cash at September 30, 2018. The Lease Agreement allows for a landlord provided tenant improvement allowance of up to $7.1 million to be applied to the cost of construction of tenant improvements to the new leased premises. The Lease Agreement also provides an option through July 1, 2019 for us to use an additional tenant improvement allowance of up to $1.2 million to apply toward the costs of tenant improvements. Any additional tenant improvement allowance used in connection with this option will be amortized and added to monthly rent payments commencing on the date the tenant improvements are completed. Any portion of the tenant improvement allowance not claimed or drawn by us prior to July 1, 2019 shall expire and shall no longer be available to us thereafter. Reimbursable construction costs incurred will be recorded as a leasehold improvement with a corresponding lease incentive obligation, which is classified as a component of deferred rent. Amounts that will be reimbursed under the tenant improvement allowance will be recorded as deferred rent and amortized as a reduction to rent expense over the lease term. We expect to utilize the aggregate amount of allowances available to us and have recorded $8.3 million of tenant improvement costs as of September 30, 2018. Amounts that exceed the aggregate amount of allowances are not considered lease incentives and will not be recorded to deferred rent.

We recognize rent expense on a straight-line basis over the non-cancellable lease term and record the difference between cash rent payments and the recognition of rent expense as a deferred rent liability. Where leases contain escalation clauses, rent abatements, and/or concessions such as rent holidays and landlord or tenant incentives or allowances, we apply them in the determination of straight-line rent expense over the lease term. We recorded tenant improvement allowances as deferred rent and the associated expenditures as leasehold improvements. Leasehold improvements are being amortized over the shorter of their estimated useful life or the term of the lease. We do not assume renewals in our determination of the lease term unless renewals are deemed by management to be reasonably assured at lease inception. We have determined that our lease related to the Lease Agreement commenced on August 1, 2018, when we had right to use or control physical access to the new leased premises.

Future minimum lease payments for operating leases at September 30, 2018 are as follows (in thousands):

Year ended December 31,

 

 

 

 

2018

 

$

316

 

2019

 

 

2,354

 

2020

 

 

3,087

 

2021

 

 

3,187

 

2022

 

 

3,290

 

2023 and beyond

 

 

10,831

 

Total

 

$

23,065

 

 

We recorded rent expense of $1.0 million and $1.9 million for the three and nine months ended September 30, 2018, respectively, and $0.4 million and $1.2 million, net of sublease payments, for the three and nine months ended September 30, 2017, respectively.

 

14


 

Indemnifications

We are required to recognize a liability for the fair value of any obligations we assume upon the issuance of a guarantee. We have certain agreements with licensors, licensees, collaborators and service providers that contain indemnification provisions. In such provisions, we typically agree to indemnify the licensor, licensee collaborator or service provider against certain types of third party claims. The maximum amount of the indemnifications is usually not limited. We accrue for known indemnification issues when a loss is probable and can be reasonably estimated. There were no accruals for expenses related to indemnification issues for any periods presented.

We indemnify each of our officers and directors for certain events or occurrences, subject to certain limitations, while the officer or director is or was serving at our request in such capacity, as permitted under Delaware law and in accordance with our certificate of incorporation, our bylaws and certain indemnification agreements between us and each of our directors and officers. The term of the indemnification period lasts as long as an officer or a director may be subject to any proceeding arising out of acts or omissions of such officer or director in such capacity. The maximum amount of potential future indemnification is unlimited; however, we currently hold director and officer liability insurance. This insurance allows the transfer of risk associated with our exposure and may enable us to recover a portion of any future amounts paid. We believe that the fair value of these indemnification obligations is minimal. Accordingly, we have not recognized any liabilities relating to these obligations for any period presented.

8. Debt Obligation

Convertible Note Financing

In August 2016, we entered into a Note and Warrant Purchase Agreement (the “Convertible Note Agreement”), as amended in September 2016 and March 2017, with certain of our existing investors, pursuant to which we issued convertible notes (the “Notes”) in the aggregate amount of $21.5 million. At the time of issuance of the Notes in 2016 and 2017, we determined that a beneficial conversion feature existed based on the amount by which the fair value of the underlying shares of Series B-3 preferred stock exceeded the effective conversion rate of the Notes. An incremental debt discount of zero and $0.5 million was recorded related to this beneficial conversion feature during the three and nine months ended September 30, 2017, respectively.

Notes Redemption Features Liability

The Notes also had redemption features that were determined to be an embedded derivative requiring bifurcation and separate accounting. The fair value of the embedded derivative upon issuance was determined to be $3.4 million and $1.9 million for the Notes issued in 2016 and 2017, respectively, and was recognized as a debt discount and as a derivative liability on the condensed consolidated balance sheets. The embedded derivative associated with the Notes required re-measurement to fair value using Level 3 inputs while the Notes were outstanding at the end of each reporting period.

In December 2017, the holders of the Notes exercised their option to convert the Notes and accrued interest into Series B-3 convertible preferred stock. In connection with the conversion, we issued 1,968,561 shares of Series B-3 convertible preferred stock at $11.9907 per share in a non-cash transaction and derecognized our convertible notes payable and related notes interest payable. Upon conversion, the fair value of the convertible notes redemption features liability was re-measured to zero.

In September 2018, upon our IPO, all shares of convertible preferred stocks were converted into an equal number of shares of common stocks.

Preferred Stock Warrant Liability

In connection with the issuance of the Notes, we issued warrants to purchase our capital stock. Upon conversion of the Notes into Series B-3 preferred stock on December 29, 2017, we determined the total number of shares underlying such warrants to be 168,046 shares of our capital stock at an exercise price of $8.99 per share. The warrants are exercisable upon the issuance date and have a five-year term. In September 2018, upon our IPO, all the preferred stock warrants were converted into warrants to purchase shares of common stock.

In September 2011, in connection with entering into a debt facility agreement, we issued warrants to purchase 4,954 shares of Series A convertible preferred stock at a price of $9.0839 per share. The warrants have a 10-year term can be exercised by paying cash or converted into the number of shares of convertible preferred stock equal in value to the intrinsic value of the warrants (“Net Exercises”). In September 2018, all Series A shares of warrants were net exercised and 3,576 shares of common stock were issued.

15


 

The following table summarizes the changes in the estimated fair value of our convertible preferred stock warrant liability related to Series A and Series B-3 warrants for the nine months ended September 30, 2018 (in thousands):

 

 

 

Estimated

Fair Value

of Convertible

Preferred

Stock Warrant

Liability

 

Balance at December 31, 2017

 

 

1,576

 

Change in estimated fair value of convertible preferred stock warrant

   liability included in other income, net

 

 

634

 

Reclassification of warrant liability to additional paid-in-capital upon

   exercise of warrants

 

 

(57

)

Reclassification of warrant liability to additional paid-in-capital upon

   initial public offering

 

 

(2,153

)

Balance at September 30, 2018

 

$

 

The fair value of the preferred stock warrants was determined using a hybrid approach that takes into account the probability of IPO and non-IPO liquidity events. The non-IPO liquidity event scenario uses an option pricing model to allocate the total enterprise value to the various securities within our capital structure based on future expectations. The IPO scenario also uses an option pricing model to estimate the value of the warrant in the case of an IPO. The two OPM models’ inputs reflect assumptions that market participants would use in pricing the instrument in a current period transaction. Fair value of our convertible preferred stock warrant liability related to Series A and Series B-3 warrants were approximately $1.6 million as of December 31, 2017. As of September 30, 2018, no preferred stock warrants were outstanding.

Interest expense

Interest expense of approximately $1.5 million and $5.6 million was recognized during the three and nine months ended September 30, 2017, respectively. They consist of accretion of debt discounts related to the beneficial conversion features, the convertible notes redemption features liability and the convertible preferred stock warrant liability, and accrued interest expense on the Notes which were converted into preferred stock in December 2017. We had no interest expense for the three and nine months ended September 30, 2018.

9. Convertible Preferred Stock

We have issued two classes of stock, convertible preferred stock and common stock. Convertible preferred stock is carried at issuance price, net of issuance costs.

In August 2018, we sold 3,474,668 shares of Series C convertible preferred stock at a price of $14.3898 per share for net proceeds of $49.8 million. Upon the completion of the IPO in September 2018, all the outstanding shares of the convertible preferred stock were converted into 15,760,102 shares of common stock, including shares of Series C convertible preferred stock that was issued in August 2018.  In addition, all of our convertible preferred stock warrants were converted into warrants to purchase shares of common stock.  

As of September 30, 2018, we had no remaining shares of convertible preferred stock issued or outstanding. As of December 31, 2017, convertible preferred stock consisted of the following (in thousands, except share numbers):

 

 

 

Shares

Authorized

 

 

Shares

Issued and

Outstanding

 

 

Liquidation

Amount

 

 

Carrying

Value

 

Series A

 

 

40,094,998

 

 

 

4,408,893

 

 

$

40,050

 

 

$

39,630

 

Series B-1

 

 

22,957,067

 

 

 

2,527,221

 

 

 

25,253

 

 

 

25,028

 

Series B-2

 

 

19,130,887

 

 

 

2,106,014

 

 

 

25,252

 

 

 

25,027

 

Series B-3

 

 

31,497,330

 

 

 

3,243,306

 

 

 

38,890

 

 

 

38,846

 

Total

 

 

113,680,282

 

 

 

12,285,434

 

 

$

129,445

 

 

$

128,531

 

 

16


 

10. Stock-Based Compensation

Equity Incentive Plans

In August 2018, our Board of Directors adopted the 2018 Equity Incentive Plan (the “2018 Plan”). The 2018 Plan provides for the grant of incentive stock options to employees and for the grant of non-statutory stock options, stock appreciation rights, restricted stock awards, restricted stock unit awards, performance stock awards, performance cash awards and other forms of stock awards to employees, directors and consultants. The 2018 Plan initially reserved 2,270,000 of new shares for issuance with automatic annual increases on January 1 of each year equal to 4% of the total number of shares of our capital stock outstanding on the last day of the preceding year, or a lesser number of shares determined by our Board of Directors. For stock options granted under the 2018 Plan, the option price shall be no less than 100% of the estimated fair value on the date of grant. Options granted under the 2018 Plan typically will vest over a four-year period but may be granted with different vesting terms. Awards that expire or terminate without being exercised are added back to the number of shares available for issuance under the 2018 Plan.

Following our IPO and in connection with the effectiveness of the 2018 Plan, the 2008 Equity Incentive Plan (the “2008 Plan”) terminated and no further awards will be granted under that plan. All outstanding awards under the 2008 Plan will continue to be governed by their existing terms. The shares subject to stock options or other stock awards granted under the 2008 Plan and the shares that remained outstanding for issuance under the 2008 Plan were transferred into the 2018 Plan. As of September 30, 2018, there was an aggregate 5,194,378 shares of common stock authorized for issuance under the 2018 Plan.

Prior to its termination, the 2008 Plan provided for the grant of incentive and non-statutory stock options to eligible employees, officers, directors, advisors and consultants. Options granted under the 2008 Plan generally vest over a four-year period and vested options are exercisable from the vesting date and expire 10 years from the date of grant. The 2008 Plan allowed for early exercise of certain options prior to vesting. Upon termination of employment, the unvested shares are subject to repurchase at the original exercise price.

Stock Option Activity

The following table summarizes our stock option activity under the 2008 Plan (in thousands):

 

 

 

Options

Available for

Grant

 

 

Options

Outstanding

 

 

Weighted

Average

Exercise

Price

 

Balance at December 31, 2017

 

 

502,916

 

 

 

1,921,453

 

 

$

4.54

 

Options granted

 

 

(1,102,163

)

 

 

1,102,163

 

 

$

12.13

 

Options forfeited

 

 

17,697

 

 

 

(17,697

)

 

$

5.70

 

Options exercised

 

 

 

 

 

(317,425

)

 

$

4.72

 

Options repurchased

 

 

 

 

 

 

 

 

 

 

Shares added to plans

 

 

3,087,434

 

 

 

 

 

 

 

 

Balance at September 30, 2018

 

 

2,505,884

 

 

 

2,688,494

 

 

$

7.63

 

Vested and expected to vest

 

 

 

 

 

 

2,688,494

 

 

$

7.63

 

Exercisable as of September 30, 2018

 

 

 

 

 

 

2,473,063

 

 

$

6.82

 

 

The weighted-average fair values of stock options granted during each of the nine months ended September 30, 2018 and 2017 were $12.17 and $3.19 per share, respectively. The total fair value of stock options vested was $0.4 million and $0.3 million during the three months ended September 30, 2018 and 2017, respectively, and $1.0 million and $0.7 million for the nine months ended September 30, 2018 and 2017, respectively.

17


 

At September 30, 2018 and December 31, 2017, 38,496 shares and 4,146 shares, respectively, were subject to repurchase by us at the original exercise price in the event that the optionee’s employment is terminated either voluntarily or involuntarily. We classify cash received from the exercise of unvested options as a short term liability. Liabilities related to the early exercise of stock options were $259,000 and $13,000 as of September 30, 2018 and December 31, 2017, respectively, and were included in accrued liabilities on the condensed consolidated balance sheets. Amounts from liabilities are reclassified into common stock and additional paid-in capital as the shares vest, which is generally over 48 months.

Common shares are presented as outstanding on our condensed consolidated balance sheets and consolidated statements of changes in convertible preferred stock and stockholders’ deficit as the shares vest and the underlying right of repurchase lapses.

Valuation Assumptions

We use the Black-Scholes valuation model to estimate fair value of stock options at the grant date. The Black-Scholes valuation model requires us to make certain estimates and assumptions, including assumptions related to the expected term, expected volatility, risk-free interest rate, and the expected dividend yield for our stock.

The fair values for the stock options granted to employees and non-employee directors were estimated at the date of grant using the Black-Scholes valuation model with the following weighted-average assumptions:

 

 

 

Three Months Ended September 30,

 

 

Nine Months Ended September 30,

 

 

2018

 

2017

 

 

2018

 

2017

Risk-free interest rate

 

2.73% - 2.88%

 

1.83%

 

 

2.73% - 2.88%

 

1.83% - 2.10%

Expected term (years)

 

5.90 - 6.08

 

6.03

 

 

5.65 - 6.08

 

5.77 - 6.06

Expected volatility

 

83.31% - 83.69%

 

81.01%

 

 

83.05% - 84.45%

 

81.01% - 85.32%

Dividend yield

 

—%

 

—%

 

 

—%

 

—%

 

The valuation assumptions were determined as follows:

 

Risk-free interest rate—We base the risk-free interest rate on the interest rate payable on U.S. Treasury securities in effect at the time of grant for a period corresponding with the expected option term.

 

Expected term—The expected term of options represents the period of time options are expected to be outstanding. The expected term of the options granted is derived using the “simplified” method (that is, estimating the expected term as the mid-point between the vesting date and the end of the contractual term for each option). We use the simplified method because we do not have sufficient historical option exercise data to provide a reasonable basis upon which to estimate the expected term.

 

Expected volatility—The expected volatility used is based on historical volatilities of similar entities within our industry for periods corresponding with our expected term assumption.

 

Expected dividend yield—Historically, we have never paid dividends on our common stock and do not expect to pay a dividend in the foreseeable future. Therefore, we used an expected dividend yield of zero.

Stock Options Granted to Employees

Employee stock-based compensation is measured at the grant date based on the fair value of the award and is recognized as an expense, net of forfeitures, over the requisite service period, which is generally the vesting period of the respective award. Employee stock-based compensation expense includes expenses related to options granted to employees and non-employee directors.

The following table summarizes stock-based compensation expense for options granted to employees and non-employee directors (in thousands):

 

 

 

Three Months Ended September 30,

 

 

Nine Months Ended September 30,

 

 

 

2018

 

 

2017

 

 

2018

 

 

2017

 

Research and development

 

$

307

 

 

$

153

 

 

$

647

 

 

$

340

 

General and administrative

 

 

370

 

 

 

148

 

 

 

763

 

 

 

399

 

Total

 

$

677

 

 

$

301

 

 

$

1,410

 

 

$

739

 

 

18


 

As of September 30, 2018, there was approximately $11.6 million of unamortized compensation cost related to stock option awards that is expected to be recognized as expense over a weighted-average period of approximately 3.7 years. The weighted-average remaining contractual term of options outstanding at September 30, 2018, is 9.9 years.

Stock Options Granted to Outside Consultants

During the three and nine months ended September 30, 2018, we recorded approximately $10,000 of stock-based compensation expense related to outside consultants and $1,000 and $4,000, respectively, during the three and nine months ended September 30, 2017.

Employee Stock Purchase Plan

In September 2018, we adopted the 2018 Employee Stock Purchase Plan (the “ESPP”), which initially reserved 250,000 shares of our common stock for employee purchases under terms and provisions established by the Board of Directors, with automatic annual increases on January 1 of each year equal to the lesser of (a) 1% of the total number of shares of our common stock outstanding on the last day of the preceding year, or (b) 500,000 shares of our common stock. Under the ESPP, employees may purchase common stock through payroll deductions at a price equal to 85% of the lower of the fair market value of common stock on the first trading day of each offering period or on the exercise date. The ESPP provides for consecutive 12-month offering periods. The offering periods may start on the first trading day on or after May 16 or November 16 of each year, except for the first offering period which commenced on September 13, 2018, the pricing date and the effective date of our registration statement. Contributions under the ESPP are limited to a maximum of 15% of an employee's eligible compensation. We recorded approximately $32,000 of stock-based compensation expense related to our ESPP for the three and nine months ended September 30, 2018.

No income tax benefit has been recognized related to stock-based compensation expense, and no tax benefits have been realized from exercised stock options.

11. Net Income (Loss) per Share

Net income is allocated between our common stock and other participating securities based on their participation rights. Our preferred stock (see Note 9) represents participating securities. Additionally, during the periods in which we have net income, the diluted net income per share has been computed using the weighted average number of shares of common stock outstanding and other dilutive securities. For the periods presented with a net loss herein, the computation of basic earnings per share using the two-class method is not applicable as the participating securities do not have contractual rights and obligations to share in our losses.

The following table presents a reconciliation of the numerators and denominators of the basic and diluted net income (loss) per share computations and the calculation of basic and diluted net income (loss) per share (in thousands, except share and per share data):

 

 

 

Three Months Ended September 30,

 

 

Nine Months Ended September 30,

 

 

 

2018

 

 

2017

 

 

2018

 

 

2017

 

Numerator

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

6,683

 

 

$

(7,125

)

 

$

8,790

 

 

$

(25,867

)

Allocation of undistributed earnings to

   participating securities

 

 

(6,683

)

 

 

 

 

 

(8,790

)

 

 

 

Net income (loss) attributable to common

   stockholders

 

 

 

 

 

(7,125

)

 

 

 

 

 

(25,867

)

Denominator

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted-average common shares

   outstanding, basic

 

 

5,087,792

 

 

 

581,355

 

 

 

2,149,583

 

 

 

552,119

 

Effect of dilutive shares: