UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

 

For the quarterly period ended June 30, 2018

OR

For the transition period from                      to                     

Commission File Number: 001-36644

 

CALITHERA BIOSCIENCES, INC.

(Exact name of registrant as specified in its charter)

 

 

343 Oyster Point Blvd., Suite 200

South San Francisco, CA 94080

(Address of principal executive offices including zip code)

Registrant’s telephone number, including area code: (650) 870-1000

 

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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files).    Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a 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.

 

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 August 2, 2018, the registrant had 35,987,379 shares of common stock, $0.0001 par value per share, outstanding.

 

 

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Calithera Biosciences, Inc.

Quarterly Report on Form 10-Q

For the Quarter Ended June 30, 2018

INDEX

 

 

 

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PART I. – FINANCIAL INFORMATION

Item 1. Financial Statements

 

Calithera Biosciences, Inc.

Condensed Consolidated Balance Sheets

(Unaudited)

(In thousands, except per share amounts)

 

 

See accompanying notes.

 

 

 

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Calithera Biosciences, Inc.

Condensed Consolidated Statements of Operations

(Unaudited)

(In thousands, except per share amounts)

 

 

See accompanying notes.

 

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Calithera Biosciences, Inc.

Condensed Consolidated Statements of Comprehensive Loss

(Unaudited)

(In thousands)

 

 

See accompanying notes.

 

 

 

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Calithera Biosciences, Inc.

Condensed Consolidated Statements of Cash Flows

(Unaudited)

(In thousands)

 

 

See accompanying notes.

 

 

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Calithera Biosciences, Inc.

Notes to Condensed Consolidated Financial Statements

 

 

1. Organization and Basis of Presentation

Organization

Calithera Biosciences, Inc. (the “Company”) was incorporated in the State of Delaware on March 9, 2010. The Company is a clinical-stage biopharmaceutical company focused on discovering and developing small molecule drugs that target novel and critical metabolic pathways in tumor and cancer-fighting immune cells. The Company’s principal operations are based in South San Francisco, California, and it operates in one segment.

Presentation

The condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, Calithera Biosciences UK Limited. All significant intercompany accounts and transactions have been eliminated from the condensed consolidated financial statements.

2. Summary of Significant Accounting Policies

Unaudited Interim Financial Information

The interim condensed consolidated balance sheet as of June 30, 2018, the statements of operations and comprehensive loss for the three and six months ended June 30, 2018 and 2017, and the statements of cash flows for the six months ended June 30, 2018 and 2017, are unaudited. The unaudited interim condensed consolidated financial statements have been prepared on the same basis as the annual 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 the Company’s condensed consolidated financial statements included in this report. The financial data and the other information disclosed in these notes to the condensed consolidated financial statements related to the six-month periods are also unaudited. The results of operations for the six months ended June 30, 2018 are not necessarily indicative of the results to be expected for the year ending December 31, 2018 or for any other future annual or interim period. The balance sheet as of December 31, 2017 included herein was derived from the audited consolidated financial statements as of that date. These condensed consolidated financial statements should be read in conjunction with the Company’s audited financial statements included in the Company’s Form 10-K as filed with the Securities and Exchange Commission (“SEC”).

Use of Estimates

The accompanying condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). The preparation of condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, management evaluates its estimates, including those related to clinical trial accrued liabilities, revenue recognition, fair value of marketable securities, income taxes, and stock-based compensation. Management bases its estimates on historical experience and on various other market specific and relevant assumptions that management believes to be reasonable under the circumstances. Actual results could differ from those estimates.

Cash and Cash Equivalents

The Company considers all highly liquid investments with original maturities of three months or less at the date of purchase to be cash equivalents. Cash equivalents, which consist primarily of amounts invested in money market accounts, are stated at fair value.

 

Investments

All investments have been classified as “available-for-sale” and are carried at estimated fair value as determined based upon quoted market prices or pricing models for similar securities. Management determines the appropriate classification of its investments at the time of purchase and reevaluates such designation as of each balance sheet date. Unrealized gains and losses are excluded from earnings and are reported as a component of comprehensive loss. Realized gains and losses and declines in fair value judged to be other than temporary, if any, on available-for-sale securities are included in interest income, net. The cost of securities sold is based on the specific-identification method. Interest on marketable securities is included in interest income, net.

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Restricted Cash

Restricted cash consists of money market funds held by the Company’s financial institution as collateral for the Company’s obligations under its facility lease for the Company’s corporate headquarters in South San Francisco, California.

Concentrations of Credit Risk

Financial instruments that potentially subject the Company to a concentration of credit risk consist of cash, cash equivalents, investments and restricted cash. The Company invests in a variety of financial instruments and, by its policy, limits these financial instruments to high credit quality securities issued by the U.S. government, U.S. government-sponsored agencies and highly rated banks and corporations, subject to certain concentration limits. The Company’s cash, cash equivalents, investments and restricted cash are held by financial institutions in the United States that management believes are of high credit quality. Amounts on deposit may at times exceed federally insured limits.

All of the Company’s collaboration revenue and the majority of the Company’s receivables from collaborations are derived from its collaboration and license agreement with Incyte Corporation, or Incyte, as described in Note 9, Collaboration and Licensing Agreements - Incyte Collaboration and License Agreement.

Revenue Recognition

Effective January 1, 2018, the Company adopted Accounting Standards Codification, or ASC No. 2014-09, Revenue from Contracts with Customers (Topic 606), or ASC 606, using the modified retrospective approach. Under this approach, the Company recorded a cumulative adjustment to decrease accumulated deficit and deferred revenue by $8.8 million. Under ASC 606, an entity recognizes revenue when its customer obtains control of promised goods or services, in an amount that reflects the consideration that the entity expects to receive in exchange for those goods or services. To determine revenue recognition for arrangements that an entity determines are within the scope of ASC 606, the entity performs the following five steps: (i) identify the contract(s) with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when (or as) the entity satisfies a performance obligation. The Company only applies the five-step model to contracts when it is probable that the entity will collect the consideration it is entitled to in exchange for the goods or services it transfers to the customer. At contract inception, once the contract is determined to be within the scope of ASC 606, the Company assesses the goods or services promised within each contract and determines those that are performance obligations, and assesses whether each promised good or service is distinct. The Company then recognizes as revenue the amount of the transaction price that is allocated to the respective performance obligation when (or as) the performance obligation is satisfied.  

The Company has a collaboration and license agreement with Incyte, or the Incyte Collaboration Agreement, that is within the scope of ASC 606, under which it licenses certain rights to one of its product candidates to Incyte Corporation. The terms of this arrangement include payment to the Company of a non-refundable, upfront license fee, and potential development, regulatory and sales milestones, and sales royalties. Each of these payments results in collaboration revenues, except for revenues from royalties on net sales of licensed products, which would be classified as royalty revenues.

In determining the appropriate amount of revenue to be recognized as it fulfills its obligations under its agreement, the Company performs the following steps: (i) identification of the promised goods or services in the contract; (ii) determination of whether the promised goods or services are performance obligations including whether they are distinct in the context of the contract; (iii) measurement of the transaction price, including the constraint on variable consideration; (iv) allocation of the transaction price to the performance obligations; and (v) recognition of revenue when (or as) the Company satisfies each performance obligation. As part of the accounting for these arrangements, the Company must develop assumptions that require judgment to determine the stand-alone selling price for each performance obligation identified in the contract. 

Licenses of Intellectual Property:  If the license to the Company’s intellectual property is determined to be distinct from the other performance obligations identified in the arrangement, the Company recognizes revenues from non-refundable, upfront fees allocated to the license when the license is transferred to the licensee and the licensee is able to use and benefit from the license. For licenses that are bundled with other promised goods or services, the Company utilizes judgment to assess the nature of the combined performance obligation to determine whether the combined performance obligation is satisfied over time or at a point in time and, if over time, the appropriate method of measuring progress for purposes of recognizing revenue from non-refundable, upfront fees. The Company evaluates the measure of progress each reporting period and, if necessary, adjusts the measure of performance and related revenue recognition.

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Milestone Payments:  At the inception of each arrangement that includes development, regulatory or commercial milestone payments, the Company evaluates whether the milestones are considered probable of being reached and estimates the amount to be included in the transaction price using the most likely amount method. If it is probable that a significant reversal of cumulative revenue would not occur, the associated milestone value is included in the transaction price. Milestone payments that are not within the control of the Company or the licensee, such as regulatory approvals, are not considered probable of being achieved until those approvals are received or the underlying activity has been completed. The transaction price is then allocated to each performance obligation on a relative stand-alone selling price basis, for which the Company recognizes revenue as or when the performance obligations under the contract are satisfied. At the end of each subsequent reporting period, the Company re-evaluates the probability of achievement of such development milestones and any related constraint, and if necessary, adjusts its estimate of the overall transaction price. Any such adjustments are recorded on a cumulative catch-up basis, which would affect collaboration revenue in the period of adjustment. 

Royalties:  For arrangements that include sales-based royalties, including milestone payments based on the level of sales, and the license is deemed to be the predominant item to which the royalties relate, the Company recognizes revenue at the later of (i) when the related sales occur, or (ii) when the performance obligation to which some or all of the royalty has been allocated has been satisfied (or partially satisfied). To date, the Company has not recognized any royalty revenue resulting from any of its licensing arrangements.

The following table summarizes the impact of adopting ASC 606 on select unaudited condensed statement of operations line items for the three and six months ended June 30, 2018 (in thousands, except per share data):

 

 

 

Contract Balances

Upfront payments and fees are recorded as deferred revenue upon receipt or when due, and may require deferral of revenue recognition to a future period until the Company performs its obligations under these arrangements. Amounts payable to the Company are recorded as accounts receivable when the Company’s right to consideration is unconditional.

The Company does not assess whether a contract has a significant financing component if the expectation at contract inception is such that the period between payment by the licensees and the transfer of the promised goods or services to the licensees will be one year or less.

The following table presents changes in the Company’s contract assets and liabilities for the six months ended June 30, 2018 (in thousands):

 

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Deferred revenue related to the Incyte Collaboration Agreement, which was comprised of the $57 million transaction price including a $45 million upfront license payment and a $12 million development milestone achieved, less the collaboration revenue recognized from the effective date of the contract, was recognized as the combined performance obligation was satisfied.

The Company had no contract assets as of June 30, 2018. During the six months ended June 30, 2018, the Company’s contract liabilities, which consisted of deferred revenue, decreased $31.0 million for the six months ended June 30, 2018, related to revenue recognized in the period related to amounts included in the contract liability at the beginning of the period. In addition, the Company recorded a cumulative adjustment to decrease accumulated deficit and deferred revenue by $8.8 million upon the adoption of ASC 606 on January 1, 2018, using the modified retrospective approach. For the three and six months ended June 30, 2018, the Company did not recognize any revenue from performance obligations satisfied in previous periods.

Accrued Research and Development Costs

The Company records accrued liabilities for estimated costs of research and development activities conducted by third-party service providers, which include the conduct of preclinical and clinical studies, and contract manufacturing activities. The Company records the estimated costs of research and development activities based upon the estimated amount of services provided but not yet invoiced, and includes these costs in accrued liabilities in the consolidated balance sheets and within research and development expense in the consolidated statements of operations. These costs are a significant component of the Company’s research and development expenses. The Company accrues for these costs based on factors such as estimates of the work completed and in accordance with agreements established with its third-party service providers under the service agreements. The Company makes significant judgments and estimates in determining the accrued liabilities balance in each reporting period. As actual costs become known, the Company adjusts its accrued liabilities. The Company has not experienced any material differences between accrued costs and actual costs incurred. However, the status and timing of actual services performed, number of patients enrolled, and the rate of patient enrollments may vary from the Company’s estimates, resulting in adjustments to expense in future periods. Changes in these estimates that result in material changes to the Company’s accruals could materially affect the Company’s results of operations.

Net Loss Per Share

Basic net loss per share is calculated by dividing the net loss by the weighted average number of shares of common stock outstanding during the period without consideration of common stock equivalents. Since the Company was in a loss position for all periods presented, basic net loss per share is the same as diluted net loss per share for all periods as the inclusion of all potential common shares outstanding would have been anti-dilutive.  

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (“FASB”) issued a comprehensive new standard on revenue from contracts with customers, ASC 606. The standard’s core principle is that a reporting entity will recognize revenue when it transfers 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. Entities have the option of using either a full retrospective or a modified retrospective approach to adopt this new guidance. In 2016, the FASB updated the guidance for reporting revenue gross versus net to improve the implementation guidance on principal versus agent considerations, and for identifying performance obligations and the accounting of intellectual property licenses. In addition, the FASB introduced practical expedients and made narrow scope improvements to the new accounting guidance.

The Company adopted the accounting standard update on January 1, 2018 using the modified retrospective approach for its collaboration and license agreement with Incyte. Therefore, comparative information was not adjusted and the impact of the transition is reflected in opening accumulated deficit. The consideration the Company is eligible to receive under this agreement includes upfront payments, research and development funding, milestone payments, and sales-based royalties. The new revenue recognition standard differs from the previous accounting in many respects, such as in the accounting for variable consideration and the measurement of progress toward completion of performance obligations. The most significant impact of the standard relates to the Company’s method of revenue recognition for performance obligations that are delivered over time. Under the new standard, milestone payments are included in the transaction price as variable consideration, subject to a constraint, and are allocated to the performance obligations in the contract. Therefore, the milestone payments are recognized over the performance period rather than when achieved. In addition, legacy guidance permitted straight-line recognition of revenue for performance obligations that are delivered over time. The new standard requires an entity to recognize revenue based on the pattern of transfer of the services. The impact of adoption resulted in the Company recording an adjustment to decrease the accumulated deficit and deferred revenue by $8.8 million at January 1, 2018 to reflect revenue being recognized based on a measurement of progress toward completion of the combined performance obligation, rather than on a straight-line basis.

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In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash Payments, or ASC 230, to clarify how entities should present restricted cash and restricted cash equivalents in their statements of cash flows. Under this update, entities are required to show the changes in the total of cash, cash equivalents, restricted cash and restricted cash equivalents in their statements of cash flows. The Company adopted this standard on January 1, 2018 retrospectively. The adoption of this standard did not impact the Company’s unaudited condensed consolidated balance sheets, statements of operations, or statements of comprehensive loss. The following table summarizes the impact of adopting ASC 230 on select unaudited condensed statement of cash flows line items (in thousands) for the six-month period ended June 30, 2017:

 

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which is aimed at making leasing activities more transparent, and requires substantially all leases be recognized by lessees on their balance sheet as a right-of-use asset and corresponding lease liability, including leases currently accounted for as operating leases. The ASU is effective for all interim and annual reporting periods beginning after December 15, 2018 with early adoption permitted and was previously required to be applied with a modified retrospective approach to each prior reporting period presented. In July 2018, the FASB issued ASU No. 2018-11, Leases (Topic 842): Targeted Improvements, or ASU No. 2018-11. In issuing ASU No. 2018-11, the FASB is permitting another transition method for ASU 2016-02, which allows the transition to the new lease standard by recognizing a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. The Company is currently assessing the impact the adoption of ASU 2016-02 will have on the condensed consolidated financial statements. The Company plans to adopt the new standard effective January 1, 2019.

In June 2018, the FASB issued ASU No. 2018-07, Compensation – Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting. The ASU expands the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from nonemployees. The ASU also clarifies that Topic 718 does not apply to share-based payments used to effectively provide (1) financing to the issuer or (2) awards granted in conjunction with selling goods or services to customers as part of a contract accounted for under Revenue from Contracts with Customers (Topic 606). The guidance is effective for fiscal years beginning after December 15, 2018, including interim periods within that fiscal year. Early adoption is permitted. The Company is currently assessing the effect that the ASU will have on its financial position, results of operations, and disclosures.

3. Fair Value Measurements

Fair value accounting is applied for all financial assets and liabilities that are recognized or disclosed at fair value in the condensed consolidated financial statements on a recurring basis (at least annually). Financial instruments include cash and cash equivalents, investments, receivables from collaborations, accounts payable, accrued liabilities and the current portion of deferred revenue that approximate fair value due to their relatively short maturities.

Assets and liabilities recorded at fair value on a recurring basis in the balance sheets are categorized based upon the level of judgment associated with the inputs used to measure their fair values. Fair value is defined as the exchange price that would be received for an asset or an exit price that would be paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The authoritative guidance on fair value measurements establishes a three tier fair value hierarchy for disclosure of fair value measurements as follows:

Level 1—Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date;

Level 2—Inputs are observable, unadjusted quoted prices in active markets for similar assets or liabilities, unadjusted quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the related assets or liabilities; and

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Level 3—Unobservable inputs that are significant to the measurement of the fair value of the assets or liabilities that are supported by little or no market data.

A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. Where quoted prices are available in an active market, securities are classified as Level 1. The Company classifies money market funds as Level 1. When quoted market prices are not available for the specific security, then the Company estimates fair value by using quoted prices for identical or similar instruments in markets that are not active and model-based valuation techniques for which all significant inputs are observable in the market or can be corroborated by observable market data for substantially the full term of the assets. Where applicable, these models project future cash flows and discount the future amounts to a present value using market-based observable inputs obtained from various third party data providers, including but not limited to, benchmark yields, interest rate curves, reported trades, broker/dealer quotes and market reference data. The Company classifies its corporate notes and U.S. government agency securities as Level 2. Level 2 inputs for the valuations are limited to quoted prices for similar assets or liabilities in active markets and inputs other than quoted prices that are observable for the asset or liability. There were no transfers between Level 1 and Level 2 during the periods presented.

The following table sets forth the fair value of our financial assets and liabilities, allocated into Level 1, Level 2 and Level 3, that was measured on a recurring basis (in thousands):

 

 

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4. Financial Instruments

Cash equivalents and investments, all of which are classified as available-for-sale securities and restricted cash, consisted of the following (in thousands):

 

 

At June 30, 2018, the remaining contractual maturities of available-for-sale securities were less than two years. There have been no significant realized gains or losses on available-for-sale securities for the periods presented. As of June 30, 2018, unrealized losses on cash equivalents and investments were $251,000 and the losses were deemed to be temporary. The gross unrealized loss that had been in a continuous loss position for 12 months or longer was not significant as of June 30, 2018. There were no investments in a continuous loss position for 12 months or longer as of December 31, 2017. The Company does not intend to sell its securities that are in an unrealized loss position, and it is unlikely that the Company will be required to sell its securities before recovery of their amortized cost basis, which may be maturity. Factors considered in determining whether a loss is temporary include the length of time and extent to which the fair value has been less than the amortized cost basis and whether the Company intends to sell the security or whether it is more likely than not that the Company would be required to sell the security before recovery of the amortized cost basis. As of June 30, 2018, the Company had a total of $152.7 million in cash, cash equivalents, restricted cash and investments, which includes $0.4 million in cash and $152.3 million in cash equivalents, restricted cash and investments.

 

5. Accrued Liabilities

Accrued liabilities consist of the following (in thousands):

 

 

6. Stockholders’ Equity

At-the-Market Offering 

In August 2017, the Company entered into a sales agreement with Cowen, as sales agent and underwriter, pursuant to which the Company could issue and sell shares of its common stock with an aggregate maximum offering price of $50.0 million under an at-the-market offering program (“ATM program”). The Company will pay Cowen up to 3% of gross proceeds for any common stock sold through the sales agreement. No shares were sold under the ATM program during the six months ended June 30, 2018. As of June 30, 2018, $48.3 million of common stock remained available for sale under the ATM program.

 

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7. Stock Based Compensation

A summary of stock option activity is as follows (in thousands, except weighted-average exercise price and contractual term amounts):

 

 

Total stock-based compensation expense related to the Company’s 2010 Equity Incentive Plan, 2014 Equity Incentive Plan and the 2014 Employee Stock Purchase Plan was as follows (in thousands):

 

 

8. Net Loss per Share

Since the Company was in a loss position for all periods presented, diluted net loss per share is the same as basic net loss per share for all periods as the inclusion of all potential common shares outstanding would have been anti-dilutive.

Potentially dilutive securities that were not included in the diluted net loss per share calculations because they would be anti-dilutive were as follows (in thousands):

 

 

 

9. Collaboration and Licensing Agreements

Incyte Collaboration and License Agreement

On January 27, 2017, the Company entered into a collaboration and license agreement with Incyte (the “Incyte Collaboration Agreement”). Under the terms of the Incyte Collaboration Agreement, the Company granted Incyte an exclusive, worldwide license to develop and commercialize its small molecule arginase inhibitors for hematology and oncology indications. The parties are collaborating on and co-funding the development of the licensed products, with Incyte bearing 70% and the Company bearing 30% of global development costs. The parties will share profits and losses in the United States, with 60% to Incyte and 40% to the Company. The Company will have the right to co-detail the licensed products in the United States, and Incyte will pay the Company tiered royalties ranging from the low to mid-double digits on net sales of licensed products outside the United States. The Company may opt out of its co-funding obligation, in which case the United States profit sharing will no longer be in effect, and Incyte will pay the Company tiered royalties ranging from the low to mid-double digits on net sales of licensed products both in the United States and outside the United States, and additional royalties to reimburse the Company for previously incurred development costs.

Under the Incyte Collaboration Agreement, the Company received an upfront payment of $45.0 million in February 2017. In March 2017, the Company achieved a development milestone of $12.0 million, for which the Company received payment in May of 2017. The Company is also eligible to receive up to an additional $418.0 million in potential development, regulatory and sales

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milestones. Incyte and the Company will share in any future United States net profits and losses, with the Company bearing 40% and Incyte bearing 60%, respectively, and outside the United States the Company will be eligible to receive from Incyte tiered royalties, with rates in the low to mid-teens of sales.

The Incyte Collaboration Agreement also provides that the Company may choose to opt out of its co-funding obligations at any time. In this scenario, the potential development, regulatory and commercialization milestones from Incyte will be up to an additional $738.0 million. The Company would no longer be eligible to receive future United States profits and losses but would be eligible to receive tiered royalty payments on future global sales, including United States sales. In addition, if the Company opts out, the Company will receive an incremental 3% royalty on annual net sales in the United States of such licensed product until such incremental royalty equals 120% of previous development expenditures incurred by the Company.

The Incyte Collaboration Agreement is considered to be under the scope of FASB Topic 808, Collaborative Arrangements. The Company has concluded that the research and development co-funding activities were not representative of a customer relationship and this unit of account is accounted for as an increase to or reduction of research and development expenses, rather than as revenue. The performance obligations under the Incyte Collaboration Agreement consist of intellectual property licenses and the performance of certain manufacturing and manufacturing technology transfer services. The Company has determined that the license is not distinct from the associated manufacturing and technology transfer services to be performed under the agreement. Specifically, the Company believes the license is not capable of being distinct, as Incyte did not have the know-how to manufacture the collaboration product without Calithera’s assistance until completion of the manufacturing technology transfer process, and no other third parties could perform such assistance due to the early stage nature of the licensed intellectual property as well as Calithera’s propriety knowledge with respect to the licensed intellectual property. Prior to the adoption of ASC 606, the Company concluded that the delivered licenses did not have stand-alone value, and the rights conveyed to Incyte did not permit Incyte to perform all efforts necessary to use the Company’s technology to bring the compound through development and, upon regulatory approval, commercialization of the compound, without the associated manufacturing and technology transfer services. Accordingly, the Company combined these deliverables and allocated the upfront consideration of $45.0 million to the combined unit of accounting. The Company recognized the $45.0 million upfront payment on a straight-line basis over the estimated period of performance under the Incyte Collaboration Agreement, and recognized the $12.0 million developmental milestone payment from Incyte on a straight-line basis over the remaining period of performance for the combined unit of accounting. For the three and six months ended June 30, 2017, the Company recognized revenue from its collaboration with Incyte totaling $7.3 million and $11.4 million, respectively, related to amortization of the $45.0 million upfront fee and the $12.0 million milestone.

Upon the adoption of ASC 606 on January 1, 2018 under the modified retrospective approach, the transaction price was determined to be $57.0 million, representing the $45.0 million upfront payment and the $12.0 million developmental milestone payment from Incyte that was earned in March 2017. The $57.0 million transaction price was being recognized over the performance period, based on the measure of progress toward completion for the combined performance obligation, rather than on a straight-line basis. The measure of progress towards completion was based on the effort of certain employees within the Company dedicating time to complete the manufacturing services and technology transfer to Incyte. As of June 30, 2018, the manufacturing services and technology transfer to Incyte were determined to be substantially complete. For the three and six months ended June 30, 2018, the Company recognized revenue from its collaboration with Incyte totaling $17.1 million and $22.3 million, respectively, related to the completion of the combined performance obligation.

Net costs associated with co-development activities performed under the agreement are included in research and development expenses in the accompanying unaudited condensed consolidated statements of operations, with any reimbursement of costs by Incyte reflected as a reduction of such expenses. For the three and six months ended June 30, 2018, net costs reimbursable by Incyte were $1.5 million and $2.6 million, respectively. For the three and six months ended June 30, 2017, net costs reimbursable by Incyte were $2.1 million and $3.6 million, respectively. As of June 30, 2018, the receivable due from Incyte was $2.4 million.

Symbioscience License Agreement

In December 2014, the Company entered into an exclusive license agreement with Mars, Inc., by and through its Mars Symbioscience division (“Symbioscience”), under which the Company has been granted the exclusive, worldwide license to develop and commercialize Symbioscience’s portfolio of arginase inhibitors for use in human healthcare (“Symbioscience License Agreement”). There were no expenses related to its licensing arrangement with Mars Symbioscience recorded in the three and six months ended June 30, 2018.

The Company may make future payments of up to $23.6 million contingent upon attainment of various development and regulatory milestones and $95.0 million contingent upon attainment of various sales milestones. Additionally, the Company will pay royalties on sales of the licensed product, if such product sales are ever achieved. If the Company develops additional licensed

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products, after achieving regulatory approval of the first licensed product, the Company would owe additional regulatory milestone payments and additional royalty payments based on sales of such additional licensed products.

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Item 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with our unaudited condensed consolidated financial statements and related notes included in Part I, Item 1 of this report.

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Forward-looking statements are identified by words such as “believe,” “will,” “may,” “estimate,” “continue,” “anticipate,” “intend,” “should,” “plan,” “expect,” “predict,” “could,” “potentially” or the negative of these terms or similar expressions. You should read these statements carefully because they discuss future expectations, contain projections of future results of operations or financial condition, or state other “forward-looking” information. These statements relate to our future plans, objectives, expectations, intentions and financial performance and the assumptions that underlie these statements. These forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those anticipated in the forward-looking statements. Factors that might cause such a difference include, but are not limited to, those discussed in this report in Part II, Item 1A — “Risk Factors,” and elsewhere in this report. Forward-looking statements are based on our management’s beliefs and assumptions and on information currently available to our management. These statements, like all statements in this report, speak only as of their date, and we undertake no obligation to update or revise these statements in light of future developments. We caution investors that our business and financial performance are subject to substantial risks and uncertainties. In addition, statements that “we believe” and similar statements reflect our beliefs and opinions on the relevant subject. These statements are based on information available to us as of the date of this Quarterly report on Form 10-Q. While we believe that information provides a reasonable basis for these statements, that information may be limited or incomplete. Our statements should not be read to indicate that we have conducted an exhaustive inquiry into or review of, all relevant information. These statements are inherently uncertain and investors are cautioned not to unduly rely on these statements.

Overview

We are a clinical-stage pharmaceutical company focused on discovering and developing small molecule drugs that target novel and critical metabolic pathways in tumor and cancer-fighting immune cells. Tumor metabolism and immuno-oncology have emerged as promising new fields for cancer drug discovery, and recent clinical successes with therapeutic agents in each field have created fundamentally new therapies for cancer patients. With our unique approach, we have established a broad pipeline of small molecule drug candidates that target enzymes controlling metabolically critical pathways in tumor cells and tumor-associated immune cells. Two of our compounds are currently in clinical development and two additional compounds from our preclinical pipeline are expected to enter the clinic in 2019. Our product candidate CB-839 is an oral inhibitor of glutaminase, a critical enzyme in tumor cells that controls utilization of the nutrient glutamine. CB-839 is being evaluated in two randomized trials in patients with renal cell carcinoma, or RCC, with data expected from these trials in 2019 and 2020 respectively. Our product candidate, INCB001158, also known as CB-1158, is an oral inhibitor of arginase, an enzyme that depletes the amino acid arginine, a key metabolic nutrient for T‑cells. INCB001158 is being co-developed with Incyte Corporation, or Incyte, for oncology and hematology indications, and is currently being evaluated in Phase 1/2 trials as a monotherapy and in combination with other anti-cancer agents. Arginase inhibitors also have potential in the treatment of cystic fibrosis; accordingly, we have selected CB-280, a unique oral arginase inhibitor, to enter clinical trials in cystic fibrosis patients in 2019. Our next most advanced oncometabolism program targets CD73, an enzyme in the ATP metabolic pathway that plays a critical immunosuppressive role in tumors. We anticipate that our oral CD73 inhibitor will also enter the clinic in 2019.

CB-839

CB-839 is a potent and reversible oral inhibitor of glutaminase, the key enzyme in cells that converts glutamine to glutamate.  Many tumor cells depend on this metabolic pathway for growth and survival. CB-839, when given alone or in combination with a variety of other anti-cancer agents, effects multiple pathways in tumor cells, leading to nutritional blocks, inhibition of DNA synthesis, oxidative stress, and cell cycle disruptions. Because CB-839 has multiple mechanisms for impacting cellular metabolism, it has anti-tumor effects on a number of different tumor types using a variety of different agents, including tyrosine kinase inhibitors, mTOR inhibitors, taxanes, cdk4/6 inhibitors and PARP inhibitors. CB-839 binds to a site on glutaminase distinct from the glutamine-binding active site, making it a highly selective and unique allosteric inhibitor. CB-839 is well-tolerated in part because of this selectivity. We believe that CB-839 is the only allosteric glutaminase inhibitor currently in clinical trials.  

We are currently developing CB-839 in combination with standard therapies in a select set of solid tumors. Our primary focus is in RCC where we are evaluating CB‑839 in two randomized Phase 2 trials with registration intent. CB-839 is also being evaluated in a Phase 1b/2 trial in combination with nivolumab for the treatment of solid tumors and a Phase 2 non-randomized trial in combination with paclitaxel for the treatment of triple negative breast cancer. In addition to these company sponsored clinical trials, CB-839 is also being studied in smaller, investigator-sponsored trials.

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CB-839 Evaluation in Renal Cell Carcinoma

In January 2018, we presented an update to the Phase 1b trial of CB-839 in combination with everolimus. Twenty-four RCC patients, with a median of 3 prior therapies, were treated and evaluable for response. 92% of patients experienced disease control, including one patient with a partial response and 21 patients with stable disease. The median progression free survival was 5.8 months, which compares favorably to historical data in this patient population. Patients were administered CB-839 in oral doses that ranged from 400-800 mg twice a day in combination with a fixed oral dose of everolimus at 10 mg once a day. The addition of CB-839 to full-dose everolimus has been well tolerated, with a similar safety profile to the known profile of everolimus alone.

In January 2018, we presented Phase 1b RCC data for CB-839 in combination with cabozantinib. Initial data for twelve evaluable late-line RCC patients treated with CB-839 and cabozantinib, including 10 clear cell patients and two papillary patients, showed that 100% of patients experienced tumor shrinkage and had disease control. The response rate was 40% in the clear cell patient population, which compares favorably to historical data with cabozantinib monotherapy. Patients enrolled in this trial had advanced or metastatic disease and had received a median of three prior treatments, which included tyrosine kinase inhibitors, mTOR inhibitors, and checkpoint inhibitors. Patients were administered CB-839 in oral doses that ranged from 600-800 mg twice a day in combination with a fixed oral dose of cabozantinib at 60 mg once a day.

We are enrolling two Phase 2 randomized clinical trials of CB-839 for the treatment of RCC. The ENTRATA trial is a randomized, double-blind, placebo-controlled trial designed to evaluate the safety and efficacy of CB-839 with everolimus versus everolimus alone in approximately 65 patients with metastatic, clear cell RCC patients who have been treated with at least two prior lines of systemic therapy including a VEGFR-targeting tyrosine kinase inhibitor. Patients are randomized in a 2:1 ratio. The primary endpoint is progression free survival; overall survival will be assessed as a secondary endpoint. The multicenter study opened for enrollment in August 2017 and is being conducted at multiple sites in the United States (NCT03163667). The trial is expected to be fully enrolled in the fourth quarter of 2018 or early 2019, with primary endpoint analysis in 2019 or early 2020.

The CANTATA trial (NCT03428217) is a Phase 2 randomized, placebo-controlled trial comparing CB-839 in combination with cabozantinib versus cabozantinib alone in approximately 300 metastatic clear cell RCC patients who have previously received one or two prior lines of therapy, including a prior anti-angiogenic agent or nivolumab. Patients are randomized in a 1:1 ratio. The primary endpoint is progression free survival assessed by independent review; overall survival is a secondary endpoint. Patients will be stratified by International Metastatic Renal Cell Carcinoma Database Consortium, or IMDC, risk category and prior treatment with anti-PD(L)1 therapy. The study has 80% power to show a 35% improvement in progression free survival. In support of the CANTATA trial, Exelixis has entered into a material supply agreement with us for cabozantinib. The U.S. Food and Drug Administration, or FDA, has granted Fast Track designation to CB-839 in combination with cabozantinib, for the treatment of patients with metastatic RCC who have received one or two prior lines of therapy, including at least one vascular endothelial growth factor tyrosine kinase inhibitor or the combination of nivolumab and ipilimumab. The CANTATA trial opened for enrollment in April 2018 and is expected to take approximately two years to reach the primary endpoint analysis in 2020.

Evaluation of CB-839 in Combination with the Immunotherapy Agent Nivolumab

In August 2016 we initiated CX-839-004, a Phase 1/2 clinical trial of CB-839 in combination with the PD-1 inhibitor nivolumab in patients with RCC, melanoma, and non-small cell lung cancer, or NSCLC, designed to assess safety, pharmacokinetics, pharmacodynamics and efficacy of the combination.

In November 2017, we presented initial data from the ongoing study of five patient cohorts. The study enrolled three cohorts of patients who have received a checkpoint inhibitor (PD-1/PD-L1) in the most recent line of therapy. Among 16 evaluable melanoma patients, all of whom were progressing on a checkpoint inhibitor at study entry, one patient achieved a complete response and two patients achieved partial responses. The overall response rate in this cohort was 19%, and the overall disease control rate was 44%. Among six evaluable NSCLC patients, all of whom were progressing on a checkpoint inhibitor at study entry, 67% experienced stable disease. Among eight evaluable RCC patients, 75% were progressing and 25% had stable disease at study entry. Stable disease was achieved in 75%, all of whom were progressing on a checkpoint inhibitor at study entry. With 3.7% immune-related adverse events Grade ≥ 3 across the entire study, the data suggest there was no apparent increase in the rate or severity of immune related events compared to historical rates.

A collaboration with Bristol-Myers Squibb was expanded in November 2017 such that subsequent melanoma development costs would be shared, and a joint development committee will be established to guide the development and regulatory strategy of the combination therapy. An update on the strategy of the combination development program is expected in 2018.

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Evaluation of CB-839 in Combination with Paclitaxel in Triple Negative Breast Cancer (TNBC)

In July 2017, we initiated CX-839-007, a Phase 2 trial of CB-839 with paclitaxel in TNBC patients. Four single arm, open label, cohorts of African American and non-African American patients are being treated in both the early stage setting, where patients have no prior taxane treatment, as well as the late stage setting after prior taxane. The primary endpoint of this trial is objective response rate and a number of predictive biomarkers are being assessed. Based on our preliminary Phase 2 clinical trial results and recent changes in the competitive landscape of TNBC, we do not plan to pursue further development of CB-839 plus paclitaxel in triple negative breast cancer patients at this time. We will continue to assess the CB-839 competitive landscape to determine if there is rationale to pursue other combinations in TNBC.

Evaluation of CB-839 in PIK3CA-mutated Colorectal Carcinoma (CRC)

CRC is one of the most common cancers with approximately 140,250 new cases and 50,630 deaths in the U.S. in 2018 (American Cancer Society). The oncogene PIK3CA, which encodes the p110α catalytic subunit of phosphatidylinositol-3-kinase α, is one of the most frequently mutated oncogenes in human cancers and is common in CRC. Mutations in PIK3CA are found in approximately 10-20% of CRC, which will result in between 14,000 and 28,000 new cases of mutated PIK3CA CRC in the United States in 2018.

An academic research group at Case Western Reserve University demonstrated that single agent CB-839 inhibits the growth of CRC tumors with PIK3CA mutations in immune-compromised mice, but CRC tumors with a normal PIK3CA gene were not inhibited. Remarkably, the combination of CB-839 with 5-florouracil induced complete and long-lasting tumor regressions in animals bearing PIK3CA mutant CRC tumors, but not tumors with normal PIK3CA, suggesting that this combinational therapy may be a unique and effective approach in the clinic.

An investigator-sponsored clinical trial was initiated by Drs. Jennifer Eads, Alok Khorana, and Neal Meropol, at the Case Western Comprehensive Cancer Center. This research is supported by a Stand Up To Cancer Colorectal Cancer Dream Team Translational Research Grant (Grant Number: SU2C-AACR-DT22-17). The Phase 1 portion of the trial is designed to determine safety and the recommended dose of the combination of CB-839 and capecitabine in patients with advanced treatment refractory solid tumors, while the Phase 2 portion of the trial is designed to evaluate activity of the regimen in patients with late line PIK3CA mutant colorectal cancer. To date, 16 patients have been enrolled, including 12 patients with colorectal cancer. Colorectal patients must have progressed on prior fluoropyrimidine containing therapy. In the dose escalation phase of the trial, there were no dose limiting toxicities and CB-839 plus capecitabine was well tolerated at full dose of CB-839. The recommended Phase 2 dose for the combination is CB-839 at 800 mg BID with capecitabine at 1000 mg/m2 BID. All late-line colorectal cancer patients had progressed on at least one prior fluoropyrimidine-containing regimen. For colorectal patients with PIK3CA mutated cancer (n=7), the median PFS was 26 weeks and for patients with PIK3CA wild-type cancer (n=5) the median PFS was 16 weeks (p=0.058). These results compare favorably to historical data on third line CRC patients receiving standard of care therapies, where the median PFS is approximately 8 weeks. The Phase 2 dose expansion portion of this study in patients with PIK3CA mutant colorectal cancer is ongoing.

Additional Development Opportunities

CB-839 is also the subject of a number of additional investigator-sponsored clinical trials and the National Cancer Institute, or NCI, Cancer Therapy Evaluation Program (CTEP). Investigator sponsored trials are ongoing in RAS wild-type colorectal cancer and myelosdysplastic syndromes and a third trial is planned in IDH mutated astrocytoma. CTEP currently plans to sponsor four additional Phase 1 trials of CB-839 for the treatment of NSCLC, soft tissue sarcoma and glioma. The study designs for the CETP trials are currently being evaluated as project teams are established.

INCB001158

Our product candidate INCB001158, which is a potent and selective orally bioavailable inhibitor of the enzyme arginase, was discovered by us and is being co-developed with Incyte. Arginase depletes arginine, a nutrient that is critical for the activation and proliferation of the body’s cancer-fighting immune cells, such as cytotoxic T-cells and natural killer (NK)-cells. During normal activation of the immune system, arginase, which is expressed by suppressive myeloid immune cells, plays an important role in halting T-cell proliferation. But in many tumors, including lung, gastrointestinal, bladder, renal cancer, squamous cell cancer of the head and neck, and acute myeloid leukemia, arginase-expressing myeloid cells accumulate and maintain an immunosuppressive environment, blocking the ability of T-cells and NK-cells to kill cancer cells. We believe that inhibitors of arginase can promote an anti-tumor immune response by restoring arginine levels, thereby allowing activation of the body’s own immune cells, including cytotoxic T-cells and NK-cells. INCB001158 is currently being evaluated in Phase 1/2 solid tumor clinical trials.

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INCB001158 entered clinical trials in September 2016. The first Phase 1/2 trial (NCT02903914) was designed to evaluate the safety of the drug and to determine the recommended Phase 2 dose of INCB001158 as a monotherapy and in combination with immune checkpoint therapy. We presented monotherapy data in June 2017 at the American Society of Clinical Oncology, or ASCO, annual meeting. As of the data cut-off date of April 24, 2017, a total of 17 patients with advanced solid tumors had received single agent doses ranging from 50 to 150 mg twice a day. INCB001158 was generally well-tolerated with no drug-related serious adverse events. Treatment related adverse events were limited to one case each of Grade 1 anemia, fatigue, increased ALT and myalgia. No Grade 3 treatment-related adverse events were reported. Reversible, asymptomatic elevations of urinary orotic acid, a highly sensitive marker of urea cycle inhibition, were observed in two patients at 150 mg BID. At 50 and100 mg, plasma levels of arginase were inhibited continuously at > 90% in all patients, and in 10 of 11 patients plasma arginine increased 1.5-fold or more.

The recommended Phase 2 dose for monotherapy is 100 mg BID and monotherapy expansion cohorts in non-small cell lung cancer, colorectal cancer, and other solid tumors are currently enrolling patients. Expansion cohorts of INCB001158 dosed in combination with Keytruda® are enrolling checkpoint naïve patients diagnosed with metastatic microsatellite stable, or MSS, colorectal cancer, gastric cancer, squamous cell head and neck cancer and mesothelioma. Expansion cohorts of INCB001158 dosed in combination with Keytruda® are also enrolling patients who had prior checkpoint inhibitor therapy as their most immediate prior therapy. These cohorts include patients diagnosed with non-small cell lung cancer, melanoma, urothelial cell carcinoma, and microsatellite instable, or MSI, colorectal cancer. A second clinical trial (NCT03314935) designed to evaluate INCB001158 in combination with chemotherapy opened for enrollment in November 2017. This Phase 1/2 chemotherapy combination trial in patients with solid tumors (including metastatic microsatellite stable, or MSS, colorectal cancer, biliary tract cancer, gastroesophageal cancer, endometrial cancer or ovarian cancer), is evaluating INCB001158 administered twice daily with either folinic acid, fluorouracil and oxaliplatin, also known as FOLFOX, gemcitabine/cisplatin or paclitaxel. Primary endpoints include safety and objective response rate. A third clinical trial (NCT03361228) designed to evaluate the safety and antitumor activity of INCB001158 plus epacadostat, with or without pembrolizumab, in patients with advanced or metastatic solid tumors will not be enrolling additional patients due to changes in Incyte’s epacadostat development program. We believe that INCB001158 is the only arginase inhibitor in clinical trials.

In January 2017, we entered into a collaboration and license agreement, or the Incyte Collaboration Agreement, with Incyte Corporation. Under the terms of the Incyte Collaboration Agreement, we granted Incyte an exclusive, worldwide license to develop and commercialize its small molecule arginase inhibitors for hematology and oncology indications. The parties are collaborating on and co-funding the development of the licensed products, and, unless we opt out of our co-funding obligation, Incyte will fund 70% of global development costs and we will be responsible for the remaining 30%. The parties will share profits and losses in the U.S., with 60% to Incyte and 40% to us. We will have the right to co-detail the licensed products in the U.S, and Incyte will pay us tiered royalties ranging from the low to mid-double digits on net sales of licensed products outside the U.S. We may opt out of our co-funding obligation, in which case the U.S. profit sharing will no longer be in effect, and Incyte will pay us tiered royalties ranging from the low to mid-double digits on net sales of licensed products both in the U.S. and outside the U.S., and additional royalties to reimburse us for previously incurred development costs.

CB-280

Under our collaboration agreement with Incyte, we retained the rights to develop a second arginase inhibitor in specific non-oncology rare disease indications, including cystic fibrosis, or CF. We have now selected a compound, CB-280, to advance into clinical development in cystic fibrosis. We plan to file an investigational new drug, or IND, application for CB-280 with the U.S. FDA and initiate a Phase 1 clinical trial in the first half of 2019.

Arginase has been proposed to be critical in the pathophysiology of CF. Reduced arginine is thought to exacerbate pulmonary disease in CF by impairing production of nitric oxide, leading to diminished airway function and a diminished anti-bacterial immune response. Sputum from patients with CF, have elevated arginase activity and diminished levels of arginine. Reduced airway nitric oxide has been observed in the bronchial airways of patients with CF, and correlates directly with worsened lung function and increased colonization with pathogens, including Pseudomonas aeruginosa. Calithera, along with our pre-clinical collaborators, have validated arginase inhibitors in mouse models of CF. Based on pre-clinical studies in a mouse model of CFTR mutated CF, we believe that arginase inhibition can lead to improvements in lung function and reduction of Pseudomonas aeruginosa infection. We believe these data support the clinical development of CB-280 in CF and we look forward to the presentation of these data in the near future.

Oral Small Molecule Inhibitor of CD73

We have developed a small molecule inhibitor of CD73. CD73 is an enzyme in the adenosine pathway that plays a critical role in converting extracellular ATP into adenosine, a powerful inhibitor of immune cell activity in tumors. CD73 has a soluble form and a cell surface bound form. There are anti-CD73 monoclonal antibodies currently in clinical trials, yet we believe that direct inhibition of CD73 with a small molecule could have an advantage. The small molecule approach may be preferable, as a small molecule that binds directly to the active site of the enzyme could efficiently inhibit both soluble and cell surface forms of CD73 and may be able to more fully inhibit the CD73 enzyme in tumors. We have identified a CD73 inhibitor, CB-708, as a clinical candidate and plan to file an IND and initiate clinical studies in 2019.

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Critical Accounting Policies and Estimates

Revenue Recognition

Effective January 1, 2018, we adopted Accounting Standards Codification, or ASC, Revenue from Contracts with Customers (Topic 606), or ASC 606, using the modified retrospective approach. Under this approach, we recorded a cumulative adjustment to decrease accumulated deficit and deferred revenue by $8.8 million. Under ASC 606, an entity recognizes revenue when its customer obtains control of promised goods or services, in an amount that reflects the consideration that the entity expects to receive in exchange for those goods or services. To determine revenue recognition for arrangements that an entity determines are within the scope of ASC 606, the entity performs the following five steps: (i) identify the contract(s) with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when (or as) the entity satisfies a performance obligation. We only apply the five-step model to contracts when it is probable that we will collect the consideration we are entitled to in exchange for the goods or services we transfer to the customer. At contract inception, once the contract is determined to be within the scope of ASC 606, we assess the goods or services promised within each contract and determine those that are performance obligations, and assess whether each promised good or service is distinct. We then recognize as revenue the amount of the transaction price that is allocated to the respective performance obligation when (or as) the performance obligation is satisfied.  

We have a collaboration and licensing agreement that is within the scope of ASC 606, under which we license certain rights to one of our product candidates to Incyte Corporation. The terms of this arrangement include payment to us of a non-refundable, upfront license fee, and potential development, regulatory and sales milestones, and sales royalties. Each of these payments results in collaboration revenues, except for revenues from royalties on net sales of licensed products, which would be classified as royalty revenues.

In determining the appropriate amount of revenue to be recognized as we fulfill our obligations under our agreement, we perform the following steps: (i) identification of the promised goods or services in the contract; (ii) determination of whether the promised goods or services are performance obligations including whether they are distinct in the context of the contract; (iii) measurement of the transaction price, including the constraint on variable consideration; (iv) allocation of the transaction price to the performance obligations; and (v) recognition of revenue when (or as) we satisfy each performance obligation.  As part of the accounting for these arrangements, we must develop assumptions that require judgment to determine the stand-alone selling price for each performance obligation identified in the contract. 

Licenses of Intellectual Property:  If the license to our intellectual property is determined to be distinct from the other performance obligations identified in the arrangement, we recognize revenues from non-refundable, upfront fees allocated to the license when the license is transferred to the licensee and the licensee is able to use and benefit from the license. For licenses that are bundled with other promised goods or services, we utilize judgment to assess the nature of the combined performance obligation to determine whether the combined performance obligation is satisfied over time or at a point in time and, if over time, the appropriate method of measuring progress for purposes of recognizing revenue from non-refundable, upfront fees. We evaluate the measure of progress each reporting period and, if necessary, adjust the measure of performance and related revenue recognition.

Milestone Payments:  At the inception of each arrangement that includes development, regulatory or commercial milestone payments, we evaluate whether the milestones are considered probable of being reached and estimate the amount to be included in the transaction price using the most likely amount method. If it is probable that a significant reversal of cumulative revenue would not occur, the associated milestone value is included in the transaction price. Milestone payments that are not within our control or the licensees’ control, such as regulatory approvals, are not considered probable of being achieved until those approvals are received or the underlying activity has been completed. The transaction price is then allocated to each performance obligation on a relative stand-alone selling price basis, for which we recognize revenue as or when the performance obligations under the contract are satisfied. At the end of each subsequent reporting period, we re-evaluate the probability of achievement of such development milestones and any related constraint, and if necessary, adjust our estimate of the overall transaction price. Any such adjustments are recorded on a cumulative catch-up basis, which would affect collaboration revenue in the period of adjustment. 

Royalties:  For arrangements that include sales-based royalties, including milestone payments based on the level of sales, and the license is deemed to be the predominant item to which the royalties relate, we recognize revenue at the later of (i) when the related sales occur, or (ii) when the performance obligation to which some or all of the royalty has been allocated has been satisfied (or partially satisfied). To date, we have not recognized any royalty revenue resulting from any of our licensing arrangements.

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Contract Balances

Upfront payments and fees are recorded as deferred revenue upon receipt or when due, and may require deferral of revenue recognition to a future period until we perform our obligations under these arrangements. Amounts payable to us are recorded as accounts receivable when our right to consideration is unconditional.

We receive payments from Incyte based on billing schedules established in the contract. Upfront payments and fees are recorded as deferred revenue upon receipt or when due, and may require deferral of revenue recognition to a future period until we perform our obligations under these arrangements. Amounts are recorded as accounts receivable when our right to consideration is unconditional. We do not assess whether a contract has a significant financing component if the expectation at contract inception is such that the period between payment by the licensees and the transfer of the promised goods or services to the licensees will be one year or less.

For a discussion of our other significant accounting policies, please see our Annual Report on Form 10-K for the fiscal year ended December 31, 2017. Except for our revenue recognition policy, there have been no material changes in our critical accounting policies during the six months ended June 30, 2018, as compared to those disclosed in the Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies and Estimates” in our Form 10-K dated December 31, 2017, filed with the SEC.

Financial Overview

Collaboration Revenue

Collaboration revenue represents the portion of deferred revenue recognized from a $45.0 million upfront fee and $12.0 million milestone achieved in the first quarter of 2017, both from the Incyte Collaboration Agreement. The combined transaction price of $57.0 million was recognized over the estimated period of performance under the Incyte Collaboration Agreement based on the measure of progress toward completion for the combined performance obligation, which was satisfied as of June 2018. Effective January 1, 2018, we adopted ASC 606 using the modified retrospective approach. Refer to Item 1, Notes to condensed consolidated financial statements, Notes 2 and 9, for further information on the adoption of ASC 606.

Research and Development Expenses

Research and development expenses represent costs incurred to conduct research, such as the discovery and development of our product candidates. We recognize all research and development costs as they are incurred. Costs associated with co-development activities performed under the Incyte Collaboration Agreement and our other collaboration agreement are included in research and development expenses, with any reimbursement of costs by Incyte and our other collaborator reflected as a reduction of such expenses.

Research and development expenses consist primarily of the following:

 

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The largest component of our total operating expenses has historically been our investment in research and development activities including the clinical development of our product candidates. We allocate to research and development expenses the salaries, benefits, stock-based compensation expense, and indirect costs of our clinical and preclinical programs on a program-specific basis, and we include these costs in the program-specific expenses. The following table shows our research and development expenses for the three and six months ended June 30, 2018 and 2017: