Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion and analysis together with the consolidated financial statements and related notes included elsewhere herein.
This report includes forward-looking statements which, although based on assumptions that we consider reasonable, are subject to risks and uncertainties which could cause actual events or conditions to differ materially from those currently anticipated and expressed or implied by such forward-looking statements.
Discussions of 2023 items and year-to-year comparisons between 2024 and 2023 that are not included in this Form 10-K can be found within Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2024.
Overview
We are a messenger RNA medicines company focused on the development of liver and respiratory rare disease therapeutics. We have ongoing Phase 2 clinical studies for our RNA therapeutic candidates to potentially treat ornithine transcarbamylase (OTC) deficiency and cystic fibrosis (CF).
We developed the world’s first approved self-amplifying messenger RNA (sa-mRNA) vaccine, KOSTAIVE ® (“KOSTAIVE”), which we have partnered with Seqirus, Inc. (“CSL Seqirus”), a part of CSL Limited. KOSTAIVE has achieved approval in Japan, the European Union and the United Kingdom as a vaccine against COVID-19, and sales of KOSTAIVE began in Japan in October 2024.
We have several key platform technologies that we leverage to develop and advance a pipeline of mRNA-based therapeutics for rare genetic disorders with significant unmet medical needs and vaccines for infectious diseases. Current mRNA medicines have two critical components: the messenger RNA (“mRNA”) constructs and the lipid nanoparticles (“LNP”) which help deliver the mRNA to disease-relevant target tissues. We have extensive expertise in the design and optimization of mRNA constructs, including with respect to a type of mRNA technology known as self-amplifying mRNA (sa-mRNA). Our proprietary self-amplifying mRNA technology platform, or STARR ® (“STARR”), has been demonstrated to induce a robust, longer-lasting and broader humoral immune response at lower dose levels than conventional mRNA-based vaccines. Our proprietary LNP delivery system, LUNAR ® (“LUNAR”), is intended to address the major hurdle in RNA drug development, namely the effective and safe delivery of RNA to disease-relevant target tissues. LUNAR may enable multiple nucleic acid medicines. We also have significant expertise and valuable know-how in the development and scalability of complex and robust manufacturing processes required to deliver the next generation of nucleic acid medicines.
Our internal pipeline includes RNA therapeutic candidates to potentially treat ornithine transcarbamylase (OTC) deficiency and cystic fibrosis (CF), both rare diseases. In our vaccine program, we have partnered with CSL Seqirus, one of the world’s leading influenza vaccine providers, on the development and commercialization of mRNA vaccines for COVID-19, influenza and three other infectious diseases. In CSL Limited’s half-year results presented on February 11, 2026, CSL Limited reported an accounting write-down of approximately $430 million attributable to our collaboration agreement with CSL Seqirus, citing declining COVID-19 disease burden and more onerous U.S. regulatory requirements.
In our CF program, we enrolled and completed dosing in the three initially planned cohorts of our Phase 2 multiple ascending dose study of ARCT-032, confirming the safety and tolerability of ARCT-032 dosed daily for four weeks. This study was initiated in December 2024 and was designed to identify a safe and effective dose regimen in those with Class I (null) CFTR mutations and people with CF who do not benefit from CFTR modulators. In the study, six CF adults with Class I CFTR mutations inhaled 10 mg doses of ARCT-032 daily over 28 days. Interim results released in October 2025 demonstrated that the treatment was generally safe and well tolerated. Treatment-related adverse events (AEs) that were identified in the single-dose Phase 1 study were also observed in some participants for the first few doses but ceased with continued dosing. Bronchospasm has not been reported in this study thus far, neither with nor without albuterol pretreatment. One serious adverse event (SAE) occurred in a participant after the end of the dosing period. The safety review committee found no convincing evidence that the SAE is related to ARCT-032 and approved the study to proceed. We intend to initiate a 12-week safety and preliminary efficacy study in up to 20 CF participants in the first half of 2026, after the third cohort completes treatment. ARCT-032 has received Orphan Drug Designation by the U.S. Food and Drug Administration (the “FDA”) and Orphan Medicinal Product Designation by the European Medicines Agency (the “EMA”) for the treatment of CF, and Rare Pediatric Disease Designation from the FDA.
KOSTAIVE is the brand name approved in Japan and Europe for ARCT-154, which is the version of the sa-mRNA COVID vaccine encoding the ancestral strain of SARS-CoV-2, and also for updated variant-specific versions of this vaccine. We may use KOSTAIVE or the specific internally generated name, such as ARCT-154, ARCT-2301 and ARCT-2303, to identify a version of the vaccine.
In our OTC program, we have continued to conduct a Phase 2 double-blind multiple-dose study of ARCT-810. Five patients with OTC deficiency have now completed dosing, and a sixth patient has initiated dosing. A type C meeting with the FDA to discuss our plans for a proposed future pediatric study under the RDEP (Rare Disease Evidence Principles) is scheduled for the first half of 2026. ARCT-810 has received Orphan Drug Designation from the FDA and Orphan Medicinal Product Designation from the EMA for treatment of OTC deficiency, as well as Fast Track Designation and Rare Pediatric Disease Designation from the FDA.
Commercial sales of KOSTAIVE began in October 2024 in Japan by Meiji Seika Pharma, Ltd. (“Meiji”), CSL Seqirus’ exclusive partner in Japan, marking the first commercial sales of an Arcturus-developed product. In September 2025, Meiji launched a new presentation of KOSTAIVE in Japan. The product is a 2-dose vial lyophilized presentation incorporating the updated XEC variant strain. Approval for offshore manufacturing of the 2-dose vial lyophilized presentation was granted by Japan in August 2025, followed by approval for onshore manufacturing in January 2026. KOSTAIVE was approved by the European Commission (EC) in February 2025 and by the United Kingdom in January 2026, providing further validation of our platform by additional significant regulatory authorities.
In December 2024, we initiated dosing of an sa-mRNA vaccine candidate against pandemic avian influenza (bird flu) in a Phase 1 trial funded by the Biomedical Advanced Research and Development Authority (“BARDA”). The study results were received in the second half of 2025, indicating a favorable tolerability and safety profile and the ability to induce a robust and durable humoral immune response in young and older adults.
We also improved our platform technologies and advanced our early-stage research activities and manufacturing process development and operations. We conducted exploratory platform development activities, including the evaluation of genome editing, and new targeting approaches, where our LUNAR and STARR platforms could be useful for identification and development of additional products for our portfolio.
Our activities since inception have consisted principally of performing research and development activities, clinical research activities, general and administrative activities and raising capital to fund those efforts. Our activities are subject to significant risks and uncertainties, including failing to secure additional funding before we achieve sustainable revenues and profit from operations. As of December 31, 2025, we had an accumulated deficit of $514.6 million.
Liquidity and Capital Resources
From the Company’s inception through the year ended December 31, 2025, the Company has funded its operations principally with the proceeds from revenues earned through collaboration agreements and government contracts, the sale of capital stock and long-term debt. During fiscal year 2025, we received milestone payments totaling $39.1 million from CSL Seqirus. At December 31, 2025, the Company’s balance of cash and cash equivalents, including restricted cash, was $232.8 million.
CSL Seqirus, Inc. Collaboration and License Agreement
In November 2022, we entered into the CSL Collaboration Agreement with CSL Seqirus for the global exclusive rights to research, develop, manufacture and commercialize self-amplifying mRNA vaccines. The CSL Collaboration Agreement became effective on December 8, 2022, following clearance under the Hart-Scott-Rodino Antitrust Improvements Act.
Under the CSL Collaboration Agreement, CSL Seqirus receives global exclusive rights to our technology for vaccines against SARS-CoV-2 (COVID-19), influenza and three other infectious diseases. Specifically, the collaboration agreement grants CSL Seqirus a license to our STARR mRNA technology and LUNAR lipid-mediated delivery, as well as mRNA drug substance and drug product manufacturing expertise. CSL has also been granted global non-exclusive rights in the field of pandemic preparedness (i.e., pathogens identified as priority diseases by the WHO), with the right to convert to an exclusive license.
The CSL Collaboration Agreement sets forth how the parties will collaborate to research and develop vaccine candidates. In the COVID-19 field, we undertake activities for certain regulatory filings for our leading
self-amplifying mRNA vaccine candidate in COVID-19, ARCT-154, in the United States and Europe and for research and development activities of a next-generation COVID vaccine candidate. CSL Seqirus leads and is responsible for all other research and development in COVID-19, influenza and the other fields.
We received an up-front payment of $200.0 million, with the potential to receive development milestones totaling more than $1.3 billion if all products are registered in the licensed fields. We also are entitled to potentially receive up to $3.0 billion in commercial milestones based on “net sales” of vaccines in the various fields. In addition, we are entitled to receive a 40% share of net profits from COVID-19 vaccine sales and up to low double-digit royalties of annual net sales for vaccines against influenza, pandemic preparedness and three additional infectious diseases. Entitlement to all such payments is subject to the strict conditions, requirements, royalty reduction provisions and other limitations set forth in the CSL Collaboration Agreement.
Either party may terminate the CSL Collaboration Agreement on a field-by-field basis for material breach by the other party, following notice and opportunity to cure. CSL Seqirus may also terminate the collaboration agreement in its entirety or on a field-by-field basis for any reason or no reason whatsoever, with certain limitations. The CSL Collaboration Agreement may also be terminated by CSL Seqirus for safety reasons, clinical data nonviability, commercial nonviability and other specified reasons.
In March 2024, we entered into Amendment Number Two to the CSL Collaboration Agreement to reflect updates to the development program and other adjustments consistent with our prior disclosures regarding the Collaboration and License Agreement (“Amendment Number Two”). Amendment Number Two, among other things, adjusts (i) the development plans for certain product candidates, (ii) various development milestones related to such product candidates, (iii) provisions of the CSL Collaboration Agreement related to specific royalty payments, (iii) provisions of the CSL Collaboration Agreement related to distributors, and (iv) proprietary payment calculations related to the foregoing.
On May 30, 2025, we initiated an arbitration against CSL Seqirus before the International Chamber of Commerce, seeking payment of a milestone under the CSL Collaboration Agreement based on the European Commission’s grant of marketing authorization for a presentation of KOSTAIVE ® in the European Union.
In CSL Limited’s half-year results presented on February 11, 2026, CSL Limited reported an accounting write-down of approximately $430 million attributable to our collaboration agreement with CSL Seqirus, citing declining COVID-19 disease burden and more onerous U.S. regulatory requirements.
Wells Fargo Credit Agreement
On April 21, 2023, the Company’s wholly-owned subsidiary, Arcturus Therapeutics, Inc. entered into a credit agreement with Wells Fargo Bank, National Association (“Wells Fargo”) whereby Wells Fargo agreed to make a $50.0 million revolving credit line available to the Company (as amended, the “Wells Fargo Loan”) with each Wells Fargo Loan evidenced by a revolving line of credit note (each, a “Note”). On June 26, 2024, the parties entered into Amendment No. 1 to the Wells Fargo Loan, whereby the term was extended by one year to April 2026.
Borrowings under the agreement bore interest at a rate of 1.00% above either the Daily Simple SOFR or Term SOFR (as such terms are defined in the Wells Fargo Loan), with “SOFR” being the rate per annum equal to the secured overnight financing rate as administered by the Federal Reserve Bank of New York. If an Event of Default (as defined in the credit agreement) had occurred, then all Wells Fargo Loans would bear interest at a rate equal to 2.00% above the interest rate applicable immediately prior to the occurrence of the Event of Default.
The original term of the agreement was two years, with an option for one-year renewals subject to Wells Fargo approval and the Company furnishing to Wells Fargo a non-refundable commitment fee equal to 0.25% of the Wells Fargo Loan amount for each such renewal. There was no penalty for terminating the agreement and no penalty for terminating the facility prior to the maturity date of the Wells Fargo Loan. As collateral, the Company had agreed to pledge $55.0 million in cash to be held at the Company’s securities accounts with Wells Fargo Securities, LLC, an affiliate of Wells Fargo, pursuant to a security agreement.
In December 2025, the Company terminated the credit agreement and related security agreement, and the $55.0 million of cash previously pledged as collateral was released and is no longer classified as restricted cash.
Grant from the Biomedical Advanced Research and Development Authority
On August 31, 2022, we entered into a cost reimbursement contract (the “BARDA Contract”) with the Biomedical Advanced Research and Development Authority (“BARDA”), a division of the Office of the Assistant Secretary for Preparedness and Response (“ASPR”) within the U.S. Department of Health and Human Services (“HHS”) to support the development of a low-dose pandemic influenza candidate based on our proprietary self-amplifying messenger RNA-based vaccine platform. The BARDA Contract is to support our non-clinical and pre-clinical development, early-stage clinical development through Phase 1, and associated drug product manufacturing, regulatory and quality-assurance activities over a period of three years. It provides for reimbursement by BARDA of our permitted costs up to $63.2 million. As of December 31, 2025, the remaining available funding net of revenue earned was $26.7 million.
General Financial Resources
A portion of our current cash balance is expected to be utilized during fiscal year 2026 to fund (i) advances to our LUNAR-CF program in clinical trials, (ii) the continued Phase 2 trial of ARCT-810, our LUNAR-OTC candidate, (iii) expenses incurred prior to customer payments under the CSL Collaboration Agreement and BARDA agreement and (iv) continued exploratory activities related to our platform and other general administrative activities.
Our future capital requirements are difficult to forecast and will depend on many factors that are out of our control. If we are unable to maintain sufficient financial resources, our business, financial condition and results of operations will be materially and adversely affected. There can be no assurance that we will be able to obtain additional needed financing on acceptable terms or at all. Additionally, equity or debt financings may have a dilutive effect on the holdings of our existing shareholders.
We expect to continue to incur additional losses in the long term, and we will need to raise additional debt or equity financing or enter into additional partnerships to fund development. Our ability to transition to profitability is dependent on regulatory approvals and subsequent sales of KOSTAIVE, and identifying and developing other successful mRNA drug and vaccine candidates. If we are not able to achieve planned milestones or incur costs in excess of our forecasts, we will need to reduce discretionary spending, discontinue the development of some or all of our programs, which will delay part of our development programs, all of which will have a material adverse effect on our ability to achieve our intended business objectives.
Funding Requirements
We anticipate that we will continue to generate losses for the foreseeable future, and we expect the losses to increase as we continue the development of, and seek regulatory approvals for, our product candidates, and begin commercialization of our products. As a result, we will require additional capital to fund our operations in order to support our long-term plans. We believe that our current cash position will be sufficient to meet our anticipated cash requirements through at least the next twelve months, assuming, among other things, no significant unforeseen expenses and continued funding from partners at anticipated levels. We intend to seek additional capital through equity and/or debt financings, collaborative or other funding arrangements with partners or through other sources of financing when and as needed. Should we seek additional financing from outside sources, we may not be able to raise such financing on terms acceptable to us or at all. If we are unable to raise additional capital when required or on acceptable terms, we may be required to scale back or discontinue the advancement of product candidates, reduce headcount, our assets, file for , reorganize, merge with another entity, or operations.
Our future funding requirements are difficult to forecast and will depend on many factors, including but not limited to the following:
the development of our cystic fibrosis and OTC deficiency therapeutic candidates;
the achievement of milestones under our strategic alliance agreements;
maintaining and/or expanding our manufacturing network and capabilities;
the terms and timing of any other strategic alliance, licensing and other arrangements that we may establish, including those with CSL Seqirus and CSL Seqirus’ arrangement with Meiji, and any related payments thereunder;
the initiation, progress, timing and completion of preclinical studies and clinical trials for our product candidates;
the number and characteristics of product candidates that we pursue;
the outcome, timing and cost of regulatory approvals;
delays that may be caused by changing regulatory requirements;
the cost and timing of hiring new employees to support our continued growth;
the costs involved in filing and prosecuting patent applications and enforcing and defending patent claims;
the costs and timing of procuring clinical and commercial supplies of our product candidates;
the costs and timing of establishing sales, marketing and distribution capabilities;
the costs associated with legal proceedings;
the costs associated with potential litigation related to collaboration agreements; and
the extent to which we acquire or invest in businesses, products or technologies.
The following table shows a summary of our cash flows for the years ended December 31, 2025 and 2024:
Year Ended December 31,
(in thousands)
Cash provided by (used in):
Operating activities
Investing activities
Financing activities
Net decrease in cash and restricted cash
Operating Activities
Net cash used in operating activities was $74.3 million for the year ended December 31, 2025, compared to $59.7 million for the year ended December 31, 2024. The $14.5 million increase was primarily due to a $29.7 million increase in accounts receivable and a $21.2 million decrease in accrued liabilities, reflecting the timing of billings, collections, and payments, as well as a $12.6 million decrease in share-based compensation due to reduced headcount and a lower stock price. These changes were partially offset by a $31.3 million smaller decrease in deferred revenue compared to the prior year, a $15.2 million reduction in net loss, a $7.5 million increase in cash provided by prepaid expenses and other assets, and the net impact of other working capital and non-cash items, which together reduced the overall increase in cash used in operating activities.
Investing Activities
Net cash used in investing activities of $0.2 million in 2025 and $0.6 million in 2024 reflected the acquisition of property and equipment.
Financing Activities
Net cash provided by financing activities was $13.4 million for the year ended December 31, 2025, compared to $5.4 million in 2024. The primary driver of the increase was an $11.7 million increase in proceeds from the issuance of common stock under our Sales Agreement for at‑the‑market equity offerings, partially offset by a $3.6 million decrease in proceeds from the exercise of stock options.
Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the consolidated financial statements included in this Annual Report. Our historical results of operations and the year-to-year comparisons of our results of operations that follow are not necessarily indicative of future results.
Revenues
We enter into arrangements with pharmaceutical and biotechnology partners and government agencies that may contain upfront payments, license fees for research and development arrangements, research and development funding, milestone payments, option exercise and exclusivity fees and royalties on future sales. The following table summarizes our total revenues for the periods indicated:
Years Ended December 31,
Change 2025 vs 2024
(in thousands)
Change
Collaboration revenue
Grant revenue
Total
Revenue decreased by $70.3 million during the year ended December 31, 2025 as compared to the year ended December 31, 2024. The decrease during 2025 primarily relates to a $72.2 million decrease in revenue related to the CSL collaboration agreement, primarily due to a $33.1 million decrease in milestone achievements during 2025 as compared to 2024, and a $15.8 million decrease in revenue related to CSL commercial supply agreements, along with decreased revenue recognition from amortization during 2025 as a result of reduced development activities. The decrease was partially offset by an increase in grant revenue of $0.9 million related to the reimbursable research and development expenses for the agreements with BARDA and the Gates Foundation.
Operating Expenses
Our operating expenses consist of research and development and general and administrative expenses.
Years Ended December 31,
Change 2025 vs 2024
(in thousands)
Change
Operating expenses:
Research and development, net
General and administrative
Total
The following table presents our total research and development expenses by category:
Research and Development Expenses, net
Year Ended December 31,
Change 2025 vs 2024
(in thousands)
Change
LUNAR-COVID
LUNAR-OTC
BARDA
LUNAR-CF, net
Early-stage programs
Discovery technologies
Payroll and benefits
Facilities and equipment
Total research and development expenses, net
Our research and development expenses consist primarily of external manufacturing costs, in-vivo research studies and clinical trials performed by contract research organizations, clinical and regulatory consultants, personnel related expenses, facility related expenses and laboratory supplies related to conducting research and development activities.
Research and development expenses were $112.2 million for the year ended December 31, 2025, compared with $195.2 million for the year ended December 31, 2024. The decrease was primarily driven by lower manufacturing and clinical costs related to the LUNAR‑COVID program, reflecting the program’s transition from a development program to the commercial phase. Additional decreases were attributable to lower manufacturing costs for the LUNAR‑CF and LUNAR‑FLU programs, as well as lower clinical costs associated with the LUNAR‑OTC
program. These reductions were partially offset by higher clinical costs for Phase 2 of the LUNAR‑CF program. Payroll and benefits expenses also decreased, primarily due to lower stock‑based compensation expense and a reduction in headcount.
Early-stage programs represent programs that are in the pre-clinical or Phase 1 clinical stage and may be partnered or unpartnered, and primarily includes the LUNAR-FLU program which is partnered with CSL Seqirus. Discovery technologies represent our efforts to expand our product pipeline and are primarily related to pre-partnered studies and new capabilities assessment. A few of our programs are part of our collaborative relationships. The related expenses may be partially offset with funds that have been reimbursed or awarded to the Company and consist of external manufacturing costs, lab supplies, equipment, and consulting and professional fees. Expenses for both early-stage programs and discovery technologies are expected to decrease as we shift our focus to later-stage programs.
Payroll and benefits primarily consists of employee salaries and benefits, share-based compensation and consultant costs. We expect that payroll and benefits costs will not increase over the next twelve months
Facilities and equipment expenses include rent, common area maintenance (“CAM”) costs, depreciation, shipping costs and various other costs related to the operation of our two office and laboratory locations. These costs increased primarily due to a lease‑related impairment recognized in the fourth quarter after the Company vacated an office location with no further operational use.
General and Administrative Expenses
General and administrative expenses consist primarily of salaries and related benefits for our executive, administrative and accounting functions and professional service fees for legal and accounting services as well as other general and administrative expenses.
General and administrative expenses were $46.1 million and $52.8 million for the years ended December 31, 2025 and 2024, respectively. The decrease was primarily due to reduced share-based compensation expense as well as reduced payroll and benefits associated with reductions in headcount.
Finance income (expense), net
Years Ended December 31,
Change 2025 vs 2024
(in thousands)
Change
Interest income
Interest expense
Total
Interest income is generated on cash and cash equivalents. The decrease in interest income from 2024 to 2025 was the result of lower interest rates during the year ended 2025 and a decrease in cash and cash equivalents.
Critical Accounting Policies and Estimates
Our significant accounting policies are summarized in “Note 2 Summary of Significant Accounting Policies,” included in our consolidated financial statements included elsewhere in this annual report on Form 10-K.
The preparation of our consolidated financial statements in conformity with “GAAP” requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of expenses during the reporting period. Significant estimates and assumptions reflected in these consolidated financial statements include, but are not limited to, assumptions related to revenue recognition, accrual of research and development expenses, determination of incremental borrowing rates, and the valuations of stock options. We based our estimates on historical experience, known trends and other market-specific or other relevant factors that we believe to be reasonable under the circumstances. On an ongoing basis, management evaluates these estimates when there are changes in circumstances, facts and experience. Changes in estimates are recorded in the period in which they become known. Actual results could differ from those estimates.
Revenue Recognition
We recognize revenue when control of the products and services is transferred to our customers in an amount that reflects the consideration we expect to receive from our customers in exchange for those products and services. This process involves identifying the contract with a customer, determining the performance obligations in the contract, determining the contract price, allocating the contract price to the distinct performance obligations in the contract, and recognizing revenue when the performance obligations have been satisfied.
Our collaboration agreements typically contain promised goods and services, including technology licenses or options to obtain technology licenses, research and development and regulatory services. Upon entering into a collaboration agreement, we are required to make the following judgments:
Identifying the performance obligations and measuring progress
Our assessment of what constitutes a separate performance obligation requires us to apply judgment. Specifically, we are required to identify which goods and services we are required to provide under the contract are distinct, if any. For performance obligations that are satisfied over time, we typically use the percentage-of-completion method which requires us to estimate the total forecasted costs required to complete the performance obligation. Adjustments to these estimates could materially impact the timing and amount of recognized revenue. If actual costs exceed initial estimates, revenue recognized to date may need to be adjusted downward, negatively impacting current period results. Conversely, favorable cost variances could accelerate revenue recognition.
Determining the transaction price, including any variable consideration
To determine the transaction price, we review the amount of consideration we are eligible to earn under the agreement. We apply a constraint to any payments we may receive in the future to avoid significant reversals since the payments are typically not probable because they are contingent upon certain future events.
We are required to reassess the total transaction price at each reporting period to determine if we should include additional payments that have become probable in the transaction price.
Allocating the transaction price to each of our performance obligations
When we allocate the transaction price to more than one performance obligation, we make estimates of the relative stand-alone selling price of each performance obligation because we do not typically sell our goods or services on a stand-alone basis. The estimate of the relative stand-alone selling price requires us in some cases to make significant judgments. In cases where we deliver a license at the start of an agreement, we use valuation methodologies, such as costs to recreate plus margin, to value the license. Additionally, when we estimate the selling price for research and development and regulatory services, we make estimates, including: the number of internal hours we will spend on the services, the cost of work we and third parties will perform and the cost of clinical trial material we will use.
The revenue we recognize each period is comprised of several types of revenue, including license fees, amortization from upfront payments, milestone payments, research and development and other services. Each of these types of revenue require us to make various judgments and estimates.
Amortization from Upfront Payments
For certain agreements, we recognize revenue from the amortization of upfront payments as we perform research and development, technology transfer and consulting services. We use an input method to estimate the amount of revenue to recognize each period. This method requires us to make estimates of the total costs we expect to incur in order to complete our promised research and development services or the total length of time it will take us to complete our promised research and development services. If we change our estimates, we may have to adjust our revenue.
Milestone Payments
When recognizing revenue related to milestone payments, we typically judge and estimate whether the milestone payment is probable (discussed in detail above under “Determining the transaction price, including any variable consideration”).
License Fees
In some cases, we deliver a license upon execution of an agreement. If we determine that our partner has full use of the license and we do not have any additional material performance obligations related to the license after delivery, then we consider the license to be a separate performance obligation. We generally recognize as license revenue the total amount of the transaction price we determine to be allocated to the performance obligation based upon the relative stand-alone selling price of a license when we deliver the license to our partner. We discuss the estimates we make related to the relative stand-alone selling price of a license in detail above under “Allocating the transaction price to our performance obligations.”
Research and Development Expenses, Including Clinical Trial Accruals/Expenses
Research and development costs consist of salaries and benefits, including share-based compensation, laboratory supplies and facility costs, as well as fees paid to other entities that conduct certain research and development activities on our behalf, such as clinical research organizations, or CROs, and contract manufacturing organizations, or CMOs. Research and development costs are expensed as incurred.
Clinical trial expenses are a significant component of research and development expenses, and we outsource a significant portion of these clinical trial activities to third parties. Third-party clinical trial expenses include investigator fees, site and patient costs, CRO costs, and costs for central laboratory testing and data management. The accrual for site and patient costs includes inputs such as estimates of patient enrollment, patient cycles incurred, clinical site activations, and other pass-through costs. These inputs are required to be estimated due to a lag in receiving the actual clinical information from third parties. Payments for these activities are based on the terms of the individual arrangements, which may differ from the pattern of costs incurred, and are reflected on the balance sheets as prepaid assets or accrued expenses. These third-party agreements are generally cancelable, and related costs are recorded as research and development expenses as incurred. Non-refundable advance clinical payments for goods or services that will be used or rendered for future research and development activities are recorded as a prepaid asset and recognized as expense as the related goods are delivered or the related services are performed. When evaluating the adequacy of the accrued expenses, we analyze progress of the studies, including the phase or completion of events, invoices received and contracted costs. We make estimates of our accrued balances as of each balance sheet date based on facts and circumstances known to our internal personnel at that time. We periodically confirm the accuracy of our estimates with the service providers and make adjustments if necessary. Judgments and estimates may be made in determining the accrued balances at the end of any reporting period. Actual results could differ from the estimates made. Our historical clinical trial accrual estimates have not been materially different from our actual costs.
Leases
We cannot readily determine the interest rate implicit in the lease, therefore, we use our incremental borrowing rate to measure lease liabilities. The incremental borrowing rate is the rate of interest that we would have to pay to borrow over a similar term, and with a similar security, the funds necessary to obtain an asset of a similar value to the right-of-use, or ROU, asset in a similar economic environment. The incremental borrowing rate therefore reflects what we ‘would have to pay’, which requires estimation when no observable rates are available or when they need to be adjusted to reflect the terms and conditions of the lease. We estimate the incremental borrowing rate using observable inputs (such as market interest rates) when available and are required to make certain entity and asset-specific estimates. The incremental borrowing rate used in the calculation of the present
value of lease payments in calculating lease liabilities and the corresponding ROU requires the use of significant judgment by management.
Share-Based Compensation
We recognize compensation expense related to stock options granted to employees and nonemployees based on the estimated grant date fair value and recognize forfeitures as they occur. We estimate the grant date fair value, and the resulting share-based compensation expense, using the Black-Scholes option-pricing model for service-based and performance-based awards. The grant date fair value of the share-based awards is recognized on a straight-line basis over the requisite service period, which is typically the vesting period of the respective awards. The Black-Scholes option-pricing model requires the use of highly subjective assumptions to determine the fair value of share-based awards. Such assumptions involve inherent uncertainties and the application of significant judgment. As a result, if factors or expected outcomes change and we use significantly different assumptions or estimates, our share-based compensation could be materially different.
Item 7A. Quantitative and Qualitat ive Disclosures About Market Risk
Our primary exposure to market risk is interest income and expense sensitivity, which is affected by changes in the general level of United States interest rates. Due to the nature of our investments, we believe that we are not subject to any material market risk exposure. We do not hold a material balance in foreign currencies or engage in derivative financial instruments that could materially impact our financial position.
Item 8. Financial Statement s and Supplementary Data
The consolidated financial statements and related financial statement schedules required to be filed are listed in the Index to Consolidated Financial Statements and are incorporated herein and in Item 15 of Part IV of this Annual Report on Form 10-K.
