Equillium, Inc.

EQ
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EQUILLIUM : Management's Discussion and Analysis of Financial Condition and Results of Operations. (form 10-K)

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03/26/2020 | 09:37 pm

You should read the following discussion and analysis of our financial condition
and results of operations together with the section entitled "Selected Financial
Data" and our consolidated financial statements and related notes appearing
elsewhere in this Annual Report on Form 10-K. This discussion and analysis
contain forward-looking statements based upon current expectations that involve
risks and uncertainties. Our actual results may differ materially from those
anticipated in these forward-looking statements as a result of various factors,
including those discussed in the section entitled "Risk Factors" and in other
parts of this Annual Report on Form 10-K. Please also see the section entitled
"Special Note Regarding Forward-Looking Statements."



Overview



We are a clinical-stage biotechnology company leveraging deep understanding of
immunobiology to develop products to treat severe autoimmune and inflammatory,
or immuno-inflammatory, disorders with high unmet medical need. Our initial
product candidate, itolizumab (EQ001), is a clinical-stage, first-in-class
monoclonal antibody that selectively targets the novel immune checkpoint
receptor CD6. CD6 plays a central role in the modulation of effector T cell, or
Teff cell, activity and trafficking. Activated Teff cells drive a number of
immuno-inflammatory diseases across therapeutic areas including transplant
science, systemic autoimmunity, pulmonary, neurologic, gastrointestinal, renal,
vascular, ophthalmic and dermatologic disorders. Therefore, we believe
itolizumab (EQ001) may have broad therapeutic utility in treating a large and
diverse set of severe immuno-inflammatory diseases.



Our pipeline is focused on developing itolizumab (EQ001) as a potential
best-in-class, disease modifying treatment for multiple severe
immuno-inflammatory disorders. Our Investigational New Drug application, or IND,
with the U.S. Food and Drug Administration, or FDA, for acute graft-versus-host
disease, or aGVHD, was accepted in July 2018. The FDA granted itolizumab (EQ001)
Fast Track designation for the treatment of aGVHD in December 2018 and Orphan
Drug designations for both the prevention and treatment of aGVHD in February
2019
. In March 2019, we initiated a Phase 1b/2 clinical trial of itolizumab
(EQ001) for the treatment of aGVHD. In June 2019, we initiated a Phase 1b
proof-of-concept clinical trial in Australia for the treatment of uncontrolled
moderate to severe asthma. Our IND for lupus nephritis was accepted by the FDA
in July 2019, and we initiated a Phase 1b proof-of-concept clinical trial for
the treatment of lupus nephritis in September 2019. The FDA granted itolizumab
(EQ001) Fast Track designation for the treatment of lupus nephritis in December
2019
. In March 2020, as a result of impacts and risks associated with the
current global pandemic caused by COVID-19, we decided to pause enrollment of
our Phase 1b clinical trial of itolizumab (EQ001) in uncontrolled asthma and our
Phase 1b clinical trial of itolizumab (EQ001) in lupus nephritis. This decision
was not based on any observed safety issues associated with itolizumab (EQ001)
but rather out of an abundance of caution related to the current global pandemic
and our concern for the well-being of patients and their caregivers. We are
continuing to enroll patients in the Phase 1b/2 clinical trial of itolizumab
(EQ001) for the treatment of aGVHD given the acute life-threatening severity of
the disease as we believe itolizumab (EQ001) represents a potentially
life-saving treatment for these severely ill patients.



We have ongoing translational biology programs to assess the therapeutic utility
of itolizumab (EQ001) in additional indications where CD6 and its ligand,
activated leukocyte cell adhesion molecule (ALCAM), play an important role in
the pathogenesis of T cell mediated diseases. Our selection of current and
future indications is driven by our analysis of the scientific, translational,
clinical and commercial rationale for advancing itolizumab (EQ001) into further
development.



We acquired rights to itolizumab (EQ001) for the territories of the United
States
and Canada in May 2017 pursuant to a collaboration and license agreement
with Biocon, and the territories of Australia and New Zealand in December 2019,
pursuant to an amendment to that agreement. Following completion of a Phase 3
clinical trial conducted by Biocon outside of North America, itolizumab (EQ001)
was approved in India for the treatment of moderate to severe plaque psoriasis
and is marketed by Biocon in India as ALZUMAb. Today, India is the only
jurisdiction where ALZUMAb is approved or marketed. Our partnership with Biocon
includes an exclusive supply agreement for clinical and commercial drug product
of itolizumab (EQ001). Biocon currently manufactures itolizumab (EQ001) at
commercial scale in a facility in India regulated by the FDA. In August 2019, we
entered into a letter agreement with Biocon that grants us exclusive rights to
negotiate licensing rights with third parties to develop and commercialize
itolizumab (EQ001) in select major markets outside of North America. This letter
agreement allows us to represent itolizumab (EQ001) more broadly commercially
and participate in value that may be created with strategic partners across
geographies.






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Since our inception, substantially all of our efforts have been focused on
organizing and staffing our company, business planning, raising capital,
in-licensing rights to itolizumab (EQ001), conducting preclinical research,
filing two initial INDs and commencing clinical development of itolizumab
(EQ001). We have not generated any revenue from product sales or otherwise.
Since inception, we have primarily financed our operations through our initial
public offering, or IPO, private placements of convertible promissory notes,
term loans and our ATM facility. We have incurred losses since our inception.
Our net losses were $25.6 million and $13.3 million for the years ended December
31, 2019
and 2018, respectively. As of December 31, 2019, we had an accumulated
deficit of $41.1 million. Substantially all of our operating losses resulted
from expenses incurred in connection with our research and development
activities, preclinical and clinical activities and general and administrative
costs associated with our operations.



We expect to continue to incur significant expenses and increasing losses into
the foreseeable future. We anticipate our expenses will increase substantially
as we continue our research and development activities, including the ongoing
and planned clinical development of itolizumab (EQ001), potentially acquire
additional products and/or product candidates, seek regulatory approval for and
potentially commercialize any approved product candidates, hire additional
personnel, protect our intellectual property, and incur general corporate costs.
We expect that our existing cash, cash equivalents and short-term investments as
of December 31, 2019, will enable us to fund our currently planned operations
for at least the next 12 months.



We do not expect to generate any revenues from product sales unless and until we
successfully complete development and obtain regulatory approval for itolizumab
(EQ001) or any future product candidate, which will not be for at least the next
several years, if ever. Accordingly, until such time as we can generate
significant revenue from sales of our product candidates, if ever, we expect to
finance our cash needs through a combination of equity offerings, debt
financings, and collaboration and license agreements. However, we may not be
able to secure additional financing or enter into such other arrangements in a
timely manner or on favorable terms, if at all. In addition, subject to limited
exceptions, our loan and security agreement with Oxford Finance LLC and Silicon
Valley Bank
also prohibits us from incurring indebtedness without the prior
written consent of the lenders. Our failure to raise capital or enter into such
other arrangements when needed would have a negative impact on our financial
condition and could force us to delay, reduce or terminate our research and
development programs or other operations, or grant rights to develop and market
product candidates that we would otherwise prefer to develop and market
ourselves.






ATM Facility


In November 2019, we entered into the ATM facility with Jefferies, under which
we may offer and sell shares of our common stock having an aggregate offering
price of up to $8.45 million from time to time through Jefferies acting as our
sales agent. Sales of our shares of common stock will be made by any method that
is deemed to be an "at the market offering". As of December 31, 2019, we sold
18,250 shares of our common stock under the ATM facility for gross proceeds of
$0.1 million.




Financial Overview

Revenue


We currently have no products approved for sale, and we have not generated any
revenues to date. In the future, we may generate revenue from collaboration or
license agreements we may enter into with respect to our product candidates, as
well as product sales from any approved product, which approval we do not expect
to occur for at least the next several years, if ever. Our ability to generate
product revenues will depend on the successful development and eventual
commercialization of itolizumab (EQ001) and any future product candidates. If we
fail to complete the development of itolizumab (EQ001) or any future product
candidates in a timely manner, or to obtain regulatory approval for our product
candidates, our ability to generate future revenue and our results of operations
and financial position would be materially adversely affected.



Research and Development Expenses



Research and development expenses primarily consist of costs associated with our
research and development activities, preclinical activities, and clinical
development of itolizumab (EQ001). Our research and development expenses
include:




• salaries and other related costs, including stock-based compensation and
benefits, for personnel in research and development functions;


• external research and development expenses incurred under arrangements with
third parties, such as consultants and advisors for research and
development;


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• costs of services performed by third parties, such as contract research
organizations, or CROs, that conduct research and development and
preclinical activities on our behalf;


• costs related to preparing and filing two INDs with the FDA; and


• costs related to general overhead expenses such as travel, insurance and
rent expenses associated with our research and development activities.



We expense research and development costs as incurred. We account for
nonrefundable advance payments for goods and services that will be used in
future research and development activities as expenses when the service has been
performed or when the goods have been received.



Our direct research and development expenses consist principally of external
costs, such as fees paid to CROs and consultants in connection with our
preclinical and clinical development.



We plan to substantially increase our research and development expenses for the
foreseeable future as we continue the development of itolizumab (EQ001) and
potentially expand the number of indications for which we are developing
itolizumab (EQ001). The successful development of itolizumab (EQ001) is highly
uncertain. At this time, due to the inherently unpredictable nature of
preclinical and clinical development, we cannot reasonably estimate the nature,
timing or costs of the efforts that will be necessary to complete the remainder
of the development of itolizumab (EQ001) or the period, if any, in which
material net cash inflows from itolizumab (EQ001) may commence. Clinical
development timelines, the probability of success, and development costs can
differ materially from expectations.



Completion of clinical trials may take several years or more, and the length of
time generally varies according to the type, complexity, novelty, and intended
use of a product candidate. The cost of clinical trials may vary significantly
over the life of a project as a result of differences arising during clinical
development, including, among others:




• per patient clinical trial costs;


• the number of clinical trials required for approval;


• the number of sites included in our clinical trials;


• the length of time required to enroll suitable patients;


• the inefficiencies and additional costs related to any delays and potential
restarts of clinical trials;


• the number of doses that patients receive;


• the number of patients that participate in our clinical trials;


• the drop-out or discontinuation rates of patients in our clinical trials;


• the duration of patient follow-up;


• potential additional safety monitoring or other studies requested by
regulatory agencies;


• the number and complexity of procedures, analyses and tests performed during
our clinical trials;


• the costs of procuring drug product for our clinical trials;


• the phase of development of the product candidate; and


• the efficacy and safety profile of the product candidate.



General and Administrative Expenses



General and administrative expenses consist primarily of salaries and other
related costs, including stock-based compensation and benefits, and consulting
fees for executive, finance, and accounting functions. Other significant costs
include legal fees relating to patent and corporate matters, insurance, travel
and facility costs.




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We anticipate that our general and administrative expenses will increase in
future periods, reflecting an expanding infrastructure, increased legal, audit,
tax and other professional fees associated with being a public company and
maintaining compliance with stock exchange listing and SEC requirements,
director and officer insurance premiums associated with being a public company,
and accounting and investor relations costs. In addition, if we obtain
regulatory approval for any product candidate, we expect to incur expenses
associated with building the infrastructure to commercialize such product.
However, we do not expect to receive any such regulatory approval for at least
the next several years, if ever.



Interest Expense



Interest expense consists of interest on our term loans payable and convertible
promissory notes, which convertible promissory notes were converted into shares
of common stock in connection with our IPO in October 2018.



Interest Income



Interest income consists primarily of interest income earned on cash, cash
equivalents and short-term investments.



Other Income, net



Other income, net consists of net foreign currency transaction gains related to
our Australian subsidiary.



Change in Fair Value of Biocon Anti-Dilution Right



Prior to the IPO, we were required to issue to Biocon additional shares of
common stock to maintain Biocon's ownership interest of our fully-diluted
capitalization until we have received aggregate cumulative gross proceeds from
sales of equity securities of $15.0 million, or the Biocon Anti-Dilution Right.
The Biocon Anti-Dilution Right was classified as a liability in the accompanying
consolidated balance sheet. The Biocon Anti-Dilution Right was recorded at fair
value using the precedent transaction method. The fair value of the Biocon
Anti-Dilution Right was re-measured at each financial reporting period with any
changes in fair value being recognized as a component of other income (expense).
The Biocon Anti-Dilution Right was satisfied in full upon the issuance of
228,060 shares of common stock to Biocon in connection with the completion of
the IPO.



Results of Operations



Comparison of the Year Ended December 31, 2019 and 2018



The following table sets forth our results of operations for the years ended
December 31, 2019 and 2018 (in thousands):






Year Ended Year Ended
December 31, December 31,
2019 2018 Increase
Research and development $ 17,640 $ 4,943 $ 12,697
General and administrative 9,087 3,672 5,415
Interest expense (279 ) (2,558 ) 2,279
Interest income 1,391 340 1,051
Other income, net 15 - 15
Change in fair value of Biocon
Anti-Dilution Right - (2,417 ) 2,417





Research and Development Expenses



Research and development expenses were $17.6 million for the year ended
December 31, 2019, compared to $4.9 million for the year ended December 31,
2018
. The increase in research and development expense primarily includes the
following changes:




$7.4 million increase in clinical development activities


$3.9 million increase in employee compensation and benefits and consulting
expenses


$0.7 million increase in preclinical research activities


$0.7 million increase in overhead expenses primarily related to increased
travel costs associated with our research and development activities


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General and Administrative Expenses



General and administrative expenses were $9.1 million for the year ended
December 31, 2019, compared to $3.7 million for the year ended December 31,
2018
. The increase in general and administrative expense primarily includes the
following changes:




$2.9 million increase in employee compensation and benefits and consulting
expenses


$1.8 million increase in costs associated with being a public company


$0.7 million increase related to legal and audit fees



Interest Expense



Interest expense was $0.3 million for the year ended December 31, 2019, compared
to $2.6 million for the year ended December 31, 2018. The decrease in interest
expense consists primarily of non-cash interest expense incurred in 2018,
including accretion of debt premium and issuance costs in relation to our
convertible promissory notes. The convertible promissory notes were converted
into equity in connection with the IPO in October 2018. In 2019, interest
expense incurred was primarily associated with our term notes payable.



Interest Income



Interest income was $1.4 million for the year ended December 31, 2019, as
compared to $0.3 million for the year ended December 31, 2018. The increase in
interest income was primarily due to higher average cash, cash equivalents and
short-term investment balances during 2019 compared to 2018.



Other Income, net



Other income, net consists of net foreign currency transaction gains related to
our Australian subsidiary.



Change in Fair Value of Biocon Anti-Dilution Right



Change in fair value of the Biocon Anti-Dilution Right was $2.4 million for the
year ended December 31, 2018. In connection with our IPO in October 2018, the
liability associated with the Biocon Anti-Dilution Right was reclassified to
stockholders' equity. Therefore, there was no further activity in the year ended
December 31, 2019.



Liquidity and Capital Resources



Sources of Liquidity



From inception through December 31, 2019, we have raised an aggregate of
approximately $91.1 million in gross proceeds pursuant to our IPO, private
placements of convertible promissory notes, proceeds from our term loans and
proceeds from equity issuances under our ATM facility.



In September 2019, we entered into the Loan Agreement pursuant to which we can
borrow up to $20.0 million in a series of term loans. Upon entering into the
Loan Agreement, we borrowed $10.0 million, or Term A Loan. Under the terms of
the Loan Agreement, we may, at our sole discretion, borrow from the Lenders (i)
up to an additional $5.0 million, or Term B Loan, upon our achievement of
positive topline data in either our (a) itolizumab (EQ001) Phase 1b aGVHD trial
or (b) itolizumab (EQ001) Phase 1b asthma trial, supporting a formal decision to
advance into Phase 2 development, and as confirmed by our Board of Directors, or
the Term B Milestone, and (ii) up to an additional $5.0 million, or Term C Loan
and together with Term A Loan and Term B Loan, the Term Loans, upon our
achievement of positive topline data in both our EQ001 Phase 1b aGVHD trial and
our itolizumab (EQ001) Phase 1b asthma trial, supporting a formal decision to
advance into Phase 2 development, and as confirmed by our Board of Directors, or
the Term C Milestone. We may draw the Term B Loan during the period commencing
on the date of the occurrence of the Term B Milestone and ending on the earliest
of (i) December 31, 2020, (ii) 60 days after achieving the Term B Milestone, and
(iii) the occurrence of an event of default and may draw the Term C Loan during
the period commencing on the date of the occurrence of the Term C Milestone and
ending on the earliest of (i) December 31, 2020, (ii) 60 days after achieving
the Term C Milestone, and (iii) the occurrence of an event of default.



In November 2019, we entered into the ATM facility with Jefferies under which we
may offer and sell shares of our common stock having an aggregate offering price
of up to $8.45 million from time to time through Jefferies acting as our sales
agent. As of December 31, 2019, we have sold an aggregate of 18,250 shares of
our common stock under the ATM facility for gross proceeds of $0.1 million.




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Funding Requirements



We expect our expenses to increase substantially in connection with our ongoing
activities, particularly as we advance and expand our clinical development of
itolizumab (EQ001). We expect that our primary uses of capital will be for
clinical research and development services, preclinical research, manufacturing,
legal and other regulatory compliance expenses, compensation and related
expenses, and general overhead costs.



We expect that our existing cash, cash equivalents and short-term investments as
of December 31, 2019, will enable us to fund our currently planned operations
for at least the next 12 months. We have based this estimate on assumptions that
may prove to be wrong, and we could use our capital resources sooner than we
expect. Furthermore, our operating plans may change, and we may need additional
funds sooner than planned. Additionally, the process of testing product
candidates in clinical trials is costly, and the timing of progress in these
trials is uncertain. Because the outcome of these efforts is uncertain, we
cannot estimate the actual amounts necessary to successfully complete the
development and commercialization of itolizumab (EQ001) or whether, or when, we
may achieve profitability.



Our future capital requirements will depend on many factors, including:




• the initiation, progress, timing, costs and results of our ongoing and
planned clinical trials for itolizumab (EQ001);


• the number and scope of indications we decide to pursue for itolizumab
(EQ001) development;


• the cost, timing and outcome of regulatory review of any Biologics License
Application, or BLA, we may submit for itolizumab (EQ001);


• the costs and timing of manufacturing for itolizumab (EQ001), if approved;


• the costs of preparing, filing and prosecuting patent applications,
maintaining and enforcing our intellectual property rights and defending
intellectual property-related claims;


• our efforts to enhance operational systems and our ability to attract, hire
and retain qualified personnel, including personnel to support the
development of itolizumab (EQ001);


• the costs associated with being a public company;


• the terms and timing of establishing and maintaining collaborations,
licenses and other similar arrangements;


• the extent to which we acquire or in-license other product candidates and
technologies; and


• the cost associated with commercializing itolizumab (EQ001), if approved for
commercial sale.



Until such time as we can generate substantial product revenues, if ever, we
expect to finance our cash needs through a combination of equity offerings, debt
financings, and collaboration and license agreements. The sale of additional
equity or convertible debt could result in additional dilution to our
stockholders and the terms of these securities may include liquidation or other
preferences that adversely affect the rights of our existing common
stockholders. The incurrence of debt financing would result in debt service
obligations and the governing documents would likely include operating and
financing covenants that would restrict our operations. If we raise additional
funds through collaboration or license agreements, we may have to relinquish
valuable rights to our technologies, future revenue streams, research programs
or product candidates or grant licenses on terms that may not be favorable to us
and/or that may reduce the value of our common stock. If we are unable to raise
capital when needed or on attractive terms, we would be forced to delay, reduce
or eliminate our research and development programs or other operations. Any of
these actions could have a material effect on our business, financial condition
and results of operations. We have experienced net losses and negative cash
flows from operating activities since our inception and expect to continue to
incur net losses into the foreseeable future. We had an accumulated deficit of
$41.1 million as of December 31, 2019. We expect operating losses and negative
cash flows to continue for at least the next several years as we continue to
incur costs related to the development of itolizumab (EQ001).




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Cash Flows



The following table sets forth the primary sources and uses of cash for each of
the periods set forth below (in thousands):






Year Ended Year Ended
December 31, December 31,
2019 2018
Net cash (used in) provided by:
Operating activities $ (22,949 ) $ (7,526 )
Investing activities (2,166 ) (37,434 )
Financing activities 9,836 66,365
Effect of exchange rate changes on cash (10 ) -


Net (decrease) increase in cash and cash equivalents $ (15,289 ) $ 21,405







Operating Activities



Net cash used in operating activities during the year ended December 31, 2019
primarily consisted of net loss of $25.6 million plus net non-cash adjustments
of $2.0 million and net changes in operating assets and liabilities of $0.7
million
. The primary non-cash adjustments to net loss include stock-based
compensation of $2.3 million and non-cash interest expense of $0.1 million
offset by accretion of discount on investments of $0.4 million. Cash flow
impacts from changes in operating assets and liabilities were primarily driven
by increases in accounts payable and accrued expenses of $1.8 million associated
with higher clinical costs to support our clinical trials as well as higher
bonus compensation accruals offset by $1.1 million of increased prepayments
related to clinical costs and director and officer insurance premiums.



Net cash used in operating activities during the year ended December 31, 2018
primarily consisted of net loss of $13.3 million plus net non-cash adjustments
of $5.4 million and net changes in operating assets and liabilities of $0.3
million
. The primary non-cash adjustments to net loss include non-cash interest
expense of $2.6 million, $2.4 million for the change in fair value of the Biocon
Anti-Dilution Right and stock-based compensation of $0.4 million. Cash flow
impact from changes in operating assets and liabilities were primarily driven by
increases in accounts payable and accrued expenses of $1.4 million offset by
prepaid expenses of $1.1 million primarily related to payments in the fourth
quarter of 2018 for our director and officer insurance premiums.



Investing Activities



Net cash used in investing activities totaled $2.2 million during the year ended
December 31, 2019. We purchased $54.6 million of short-term investments and
$52.5 million of our short-term investments matured during the period. Purchases
of property and equipment for the year ended December 31, 2019 totaled $0.1
million
.



Net cash used in investing activities was $37.4 million during the year ended
December 31, 2018 primarily due to purchases of short-term investments during
the period.



Financing Activities



Net cash provided by financing activities totaled $9.8 million during the year
ended December 31, 2019. We received net proceeds from the issuance of term
notes payable totaling $9.9 million and proceeds from both the exercise of stock
options and the sale of shares under our employee stock purchase plan totaling
$0.1 million offset by a net use of cash of $0.2 million related to the ATM
facility costs offset by the sale of shares under the ATM facility.



Net cash provided by financing activities totaled $66.4 million during the year
ended December 31, 2018. We received net proceeds totaling $64.5 million from
our IPO, $1.6 million in net proceeds from our convertible promissory notes and
$0.3 million in proceeds from exercise of stock options.



Off-Balance Sheet Arrangements



We did not have during the periods presented, and we do not currently have, any
off-balance sheet arrangements, as defined under SEC rules, and similarly did
not and do not have any holdings in variable interest entities.




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Critical Accounting Policies and Estimates



Our management's discussion and analysis of our financial condition and results
of operations is based on our consolidated financial statements, which have been
prepared in accordance with generally accepted accounting principles in the
United States
. The preparation of our consolidated financial statements requires
us to make estimates and assumptions that affect the reported amounts of assets,
liabilities and expenses and the disclosure of contingent assets and liabilities
in our consolidated financial statements and accompanying notes. We evaluate
these estimates on an ongoing basis. We base our estimates on historical
experience and on various other factors that we believe are reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying value of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different
assumptions or conditions.



While our significant accounting policies are more fully described in Note 2 to
our consolidated financial statements appearing elsewhere in this Annual Report
on Form 10-K, we believe that the following accounting policies are the most
critical for fully understanding and evaluating our financial condition and
results of operations.



Accrued Research and Development Expense



We are required to estimate our expenses resulting from our obligations under
contracts with vendors, consultants and contract research organizations, in
connection with conducting research and development activities. The financial
terms of these contracts are subject to negotiations, which vary from contract
to contract and may result in payment flows that do not match the periods over
which materials or services are provided under such contracts. We reflect
research and development expenses in our consolidated financial statements by
matching those expenses with the period in which services and efforts are
expended. We account for these expenses according to the progress of the
preclinical or clinical study as measured by the timing of various aspects of
the study or related activities. We determine accrual estimates through review
of the underlying contracts along with preparation of financial models taking
into account discussions with research and other key personnel as to the
progress of studies, or other services being conducted. During the course of a
study, we adjust our rate of expense recognition if actual results differ from
our estimates.



Although we do not expect our estimates to be materially different from amounts
actually incurred, if our estimates of the status and timing of services
performed differ from the actual status and timing of services performed, it
could result in us reporting amounts that are too high or too low in any
particular period. To date, there have been no material differences between our
estimates of such expenses and the amounts actually incurred.



Stock-Based Compensation Expense



We measure employee and non-employee stock-based awards, including stock options
and stock purchase rights, at grant-date fair value and record compensation
expense on a straight-line basis over the vesting period of the award. We use
the Black-Scholes option pricing model to value our stock option awards.
Estimating the fair value of stock option awards requires management to apply
judgment and make estimates of certain assumptions, including the volatility of
our common stock, the expected term of our stock options and the expected
dividend yield on the measurement date. As a result, if factors change and
management uses different assumptions, stock-based compensation expense could be
materially different for future awards.



Income Taxes



We account for income taxes under the asset and liability method, which requires
the recognition of deferred tax assets and liabilities for the expected future
tax consequences that have been included in the consolidated financial
statements. Under this method, deferred tax assets and liabilities are
determined on the basis of the differences between the consolidated financial
statements and tax basis of assets and liabilities using enacted tax rates in
effect for the year in which the differences are expected to reverse. We record
a full valuation allowance against net deferred tax assets unless, based upon
the available evidence, it is more likely than not that the deferred tax assets
will be realized.



We record uncertain tax positions on the basis of a two-step process whereby (i)
management determines whether it is more likely than not that the tax positions
will be sustained on the basis of the technical merits of the position and (ii)
for those tax positions that meet the more likely-than-not recognition
threshold, management recognizes the largest amount of tax benefit that is more
than 50 percent likely to be realized upon ultimate settlement with the related
tax authority. We will recognize interest and penalties in income tax expense if
and when incurred.



Recent Accounting Pronouncements



See Note 1 to our consolidated financial statements included elsewhere in this
Annual Report on Form 10-K for information concerning recent accounting
pronouncements.




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