UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2016

or

Commission File Number 001-36818

 

TRACON Pharmaceuticals, Inc.

(Exact name of registrant as specified in its charter)

 

(858) 550-0780

(Registrant’s telephone number, including area code)

 

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 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, or a smaller reporting company.

 

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

The number of outstanding shares of the registrant’s common stock as of November 4, 2016 was 13,065,971.

 

 

 

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TRACON Pharmaceuticals, Inc.

FORM 10-Q

TABLE OF CONTENTS

 

 

 

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PART I  FINANCIAL INFORMATION

Item 1.  Financial Statements

TRACON Pharmaceuticals, Inc.

Condensed Consolidated Balance Sheets

(in thousands, except share and per share data)

 

 

See accompanying notes.

 

 

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TRACON Pharmaceuticals, Inc.

Unaudited Condensed Consolidated Statements of Operations

(in thousands, except share and per share data)

 

 

See accompanying notes.

 

 

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TRACON Pharmaceuticals, Inc.

Unaudited Condensed Consolidated Statements of Cash Flows

(in thousands)

 

 

See accompanying notes.

 

 

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TRACON Pharmaceuticals, Inc.

Notes to Condensed Consolidated Financial Statements

 

Organization and Business

TRACON Pharmaceuticals, Inc. (formerly Lexington Pharmaceuticals, Inc.) (TRACON or the Company) was incorporated in the state of Delaware on October 28, 2004. TRACON is a clinical stage biopharmaceutical company focused on the development and commercialization of novel targeted therapeutics for cancer, wet age-related macular degeneration and fibrotic diseases. The Company’s research focuses on antibodies that bind to the endoglin receptor, which is essential to angiogenesis (the process of new blood vessel formation) and a key contributor to fibrosis (tissue scarring).

The unaudited condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, TRACON Pharma Limited, which was formed in September 2015. All significant intercompany accounts and transactions have been eliminated.

Basis of Presentation

As of September 30, 2016, the Company has devoted substantially all of its efforts to product development, raising capital, and building infrastructure and has not realized revenues from its planned principal operations. The Company has incurred operating losses since inception. As of September 30, 2016, the Company had an accumulated deficit of $79.3 million. The Company anticipates that it will continue to incur net losses into the foreseeable future as it: (i) continues the development and commercialization of its product candidates; (ii) works to develop additional product candidates through research and development programs; and (iii) continues to expand its corporate infrastructure. At September 30, 2016, the Company had cash, cash equivalents and short-term investments of $35.1 million. Based on the Company’s current business plan, management believes that existing cash, cash equivalents and short-term investments will be sufficient to fund the Company’s obligations to the middle of 2017. The Company plans to continue to fund its losses from operations and capital funding needs through cash and investments on hand, as well as future debt and equity financing and potential collaboration arrangements. If the Company is not able to secure adequate additional funding, it may be forced to make reductions in spending, extend payment terms with suppliers, liquidate assets where possible, and/or delay or reduce the scope of its planned development programs. Any of these actions could materially harm the Company’s business, results of operations and future prospects.

Unaudited Interim Financial Information

The unaudited condensed consolidated financial statements at September 30, 2016, and for the three and nine months ended September 30, 2016 and 2015, have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (SEC), and with accounting principles generally accepted in the United States (GAAP) applicable to interim financial statements. These unaudited condensed consolidated financial statements have been prepared on the same basis as the audited financial statements and include all adjustments, consisting of only normal recurring accruals, which in the opinion of management are necessary to present fairly the Company’s financial position as of the interim date and results of operations for the interim periods presented. Interim results are not necessarily indicative of results for a full year or future periods. The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of expenses during the reporting period. Actual results could differ materially from those estimates. These unaudited condensed consolidated financial statements should be read in conjunction with the Company’s audited financial statements for the year ended December 31, 2015, included in its Annual Report on Form 10-K filed with the SEC on February 19, 2016.

Use of Estimates

The Company’s condensed consolidated financial statements are prepared in accordance with GAAP. The preparation of the Company’s condensed consolidated financial statements requires management to make estimates and assumptions that impact the reported amounts of assets, liabilities, revenue and expenses and the disclosure of contingent assets and liabilities in the Company’s financial statements and accompanying notes. The most significant estimates in the Company’s financial statements relate to revenue recognition and the valuation of equity awards. Although these estimates are based on the Company’s knowledge of current events and actions it may undertake in the future, actual results may ultimately materially differ from these estimates and assumptions.

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Cash and Cash Equivalents

Cash and cash equivalents consist of cash and highly liquid investments with original maturities of three months or less at the date of purchase. Cash and cash equivalents include cash in readily available checking and money market funds, as well as certificates of deposit.

Concentration of Credit Risk

Financial instruments that potentially subject the Company to significant concentration of credit risk consist primarily of cash and cash equivalents. The Company maintains deposits in federally insured financial institutions in excess of federally insured limits. The Company has not experienced any losses in such accounts and management believes that the Company is not exposed to significant credit risk due to the financial position of the depository institutions in which those deposits are held.

Preferred Stock Warrant Liabilities

Prior to the completion of the Company’s initial public offering in February 2015, the Company had outstanding freestanding warrants to purchase shares of its Series A redeemable convertible preferred stock. Since the underlying Series A redeemable convertible preferred stock was classified outside of permanent equity, these preferred stock warrants were classified as liabilities in the December 31, 2014 balance sheet. The Company adjusted the carrying value of such preferred stock warrants to their estimated fair value at each reporting date, with any related increases or decreases in the fair value recorded as an increase or decrease to other income (expense) in the statements of operations. Upon the completion of the Company’s initial public offering, the warrants no longer required liability accounting and the then fair value of the warrant liability was reclassified into stockholders’ equity.

The Company performed the final remeasurement of the warrant liability as of the initial public offering date and recorded the $65,000 change in fair value into other income (expense) for the nine months ended September 30, 2015.

Revenue Recognition

The Company’s revenue is derived from its license agreement with Santen Pharmaceutical Co., Ltd. (Santen) as described in Note 7. The Company recognizes revenue when all four of the following criteria are met: (1) there is persuasive evidence that an arrangement exists; (2) delivery of the products and/or services has occurred; (3) the selling price is fixed or determinable; and (4) collectability is reasonably assured. Amounts received prior to satisfying the revenue recognition criteria are recorded as deferred revenue.

The Company evaluates multiple-element arrangements to determine: (1) the deliverables included in the arrangement and (2) whether the individual deliverables represent separate units of accounting or whether they must be accounted for as a combined unit of accounting. Deliverables are considered separate units of accounting provided that: (a) the delivered items have value to the customer on a standalone basis and (b) if the arrangement includes a general right of return relative to the delivered items, delivery or performance of the undelivered items is considered probable and substantially in the Company’s control. In assessing whether an item has standalone value, the Company considers factors such as the research, manufacturing and commercialization capabilities of the partner and the availability of the associated expertise in the general marketplace. In addition, the Company considers whether the partner can use the other deliverables for their intended purpose without the receipt of the remaining elements, whether the value of the deliverable is dependent on the undelivered items and whether there are other vendors that can provide the undelivered elements.

Arrangement consideration that is fixed or determinable is allocated among the separate units of accounting using the relative selling price method. The Company uses the following hierarchy of values to estimate the selling price of each deliverable: (1) vendor-specific objective evidence of fair value; (2) third party evidence of selling price; and (3) best estimate of selling price (BESP). The BESP reflects the Company’s best estimate of what the selling price would be if the Company regularly sold the deliverable on a standalone basis. In developing the BESP for a unit of accounting, the Company considers applicable market conditions and relevant entity-specific factors, including factors that are contemplated in negotiating an arrangement and estimated costs. The Company validates the BESP for units of accounting by evaluating whether changes in the key assumptions used to determine the BESP will have a significant effect on the allocation of arrangement consideration between multiple units of accounting.

The Company then applies the applicable revenue recognition criteria to each of the separate units of accounting in determining the appropriate period and pattern of recognition. If there is no discernible pattern of performance and/or objectively measurable performance measures do not exist, then the Company recognizes revenue under the arrangement on a straight-line basis over the period the Company expects to complete its performance obligations.

With respect to revenue derived from reimbursement of direct, out-of-pocket expenses for research and development costs associated with collaborations, where the Company acts as a principal with discretion to choose suppliers, bear credit risk, and

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perform part of the services required in the transaction, the Company records revenue for the gross amount of the reimbursement. The costs associated with these reimbursements are reflected as a component of research and development expense in the statements of operations.

Milestones

The Company uses the milestone method of accounting and revenue is recognized when earned, as evidenced by written acknowledgement from the collaborator or other persuasive evidence that the milestone has been achieved and the payment is non-refundable, provided that the milestone event is substantive. A milestone event is defined as an event: (1) that can only be achieved based in whole or in part on either the Company’s performance or on the occurrence of a specific outcome resulting from the Company’s performance; (2) for which there is substantive uncertainty at the inception of the arrangement that the event will be achieved; and (3) that would result in additional payments being due to the Company. Events for which the occurrence is either contingent solely upon the passage of time or the result of a counterparty’s performance are not considered to be milestone events. A milestone event is substantive if all of the following conditions are met: (a) the consideration is commensurate with either the Company’s performance to achieve the milestone, or the enhancement of the value to the delivered item(s) as a result of a specific outcome resulting from the Company’s performance to achieve the milestone; (b) the consideration relates solely to past performance; and (c) the consideration is reasonable relative to all the deliverables and payment terms (including other potential milestone consideration) within the arrangement.

The Company assesses whether a milestone is substantive at the inception of each arrangement. If a milestone is deemed non-substantive, the Company will account for that milestone payment in accordance with the multiple element arrangements guidance and recognize it consistent with the related units of accounting for the arrangement over the related performance period.

Clinical Trial Expense Accruals

As part of the process of preparing the Company’s financial statements, the Company is required to estimate expenses resulting from its obligations under contracts with vendors, contract research organizations (CROs), and consultants and under clinical site agreements in connection with conducting clinical trials. The financial terms of these contracts vary and may result in payment flows that do not match the periods over which materials or services are provided under such contracts.

The Company’s objective is to reflect the appropriate trial expenses in its financial statements by recording those expenses in the period in which services are performed and efforts are expended. The Company accounts for these expenses according to the progress of the trial as measured by patient progression and the timing of various aspects of the trial. The Company determines accrual estimates through discussion with applicable personnel and outside service providers as to the progress or state of completion of trials. During the course of a clinical trial, the Company adjusts the clinical expense recognition if actual results differ from its estimates. The Company makes estimates of accrued expenses as of each balance sheet date based on the facts and circumstances known at that time. The Company’s clinical trial accruals are dependent upon accurate reporting by CROs and other third-party vendors. Although the Company does not expect its estimates to differ materially from amounts actually incurred, its understanding of the status and timing of services performed relative to the actual status and timing of services performed may vary and may result in reporting amounts that are too high or too low for any particular period. For the three and nine months ended September 30, 2016 and 2015, there were no material adjustments to the Company’s prior period estimates of accrued expenses for clinical trials.

Stock-Based Compensation

Stock-based compensation expense represents the grant date fair value of employee stock option grants, employee restricted stock unit grants and employee stock purchase plan (ESPP) rights recognized as expense over the requisite service period of the awards (usually the vesting period) on a straight-line basis, net of estimated forfeitures. The Company estimates the fair value of stock option grants and ESPP rights using the Black-Scholes option pricing model.

The Company accounts for stock options granted to non-employees using the fair value approach. These option grants, if any, are subject to periodic revaluation over their vesting terms.

Comprehensive Loss

Comprehensive loss is defined as a change in equity during a period from transactions and other events and circumstances from non-owner sources. Net loss and comprehensive loss were the same for all periods presented.

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Net Loss Per Share

Basic net loss per share is calculated by dividing the net loss by the weighted-average shares of common stock outstanding for the period, without consideration for common stock equivalents and adjusted for the weighted-average number of common shares outstanding that are subject to repurchase. The Company has excluded 7,013 and 5,663 weighted-average shares subject to repurchase from the weighted-average number of common shares outstanding for the three and nine months ended September 30, 2016, respectively, and 6,301 and 6,818 weighted-average shares subject to repurchase for the three and nine months ended September 30, 2015, respectively. Diluted net loss per share is calculated by dividing the net loss by the weighted-average number of common stock equivalents outstanding for the period determined using the treasury-stock method. For all periods presented, there is no difference in the number of shares used to calculate basic and diluted shares outstanding due to the Company’s net loss position.

Potentially outstanding dilutive securities not included in the calculation of diluted net loss per share because to do so would be anti-dilutive are as follows (in common stock equivalent shares):

 

 

Recent Accounting Pronouncements Not Yet Adopted

In May 2014, the FASB issued Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers, which converges the FASB and the International Accounting Standards Board standard on revenue recognition. Areas of revenue recognition that will be affected include, but are not limited to, transfer of control, variable consideration, allocation of transfer pricing, licenses, time value of money, contract costs and disclosures. This guidance is effective for the fiscal years and interim reporting periods beginning after December 15, 2017. The Company has not yet selected a transition method and is currently evaluating the impact that the adoption of ASU 2014-09 will have on its financial statements and related disclosures.

In August 2014, the FASB issued ASU 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. ASU 2014-15 requires management to evaluate relevant conditions, events and certain management plans that are known or reasonably knowable that when, considered in the aggregate, raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued, for both annual and interim periods. ASU 2014-15 also requires certain disclosures around management’s plans and evaluation, as well as the plans, if any, that are intended to mitigate those conditions or events that will alleviate the substantial doubt. ASU 2014-15 is effective for fiscal years ending after December 15, 2016. The Company is currently evaluating the impact that the adoption of ASU 2014-15 will have on its financial statements and related disclosures.

In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting, which amends ASC Topic 718, Compensation – Stock Compensation. ASU 2016-09 includes an update which simplifies the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. ASU 2016-09 is effective for public entities for annual reporting periods beginning after December 15, 2016, and interim periods within that reporting period. The Company is currently evaluating the impact that the adoption of ASU 2016-09 will have on its financial statements and related disclosures.

Recently Adopted Accounting Standards

In April 2015, the FASB issued ASU 2015-03, Interest – Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs. ASU 2015-03 requires debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying value of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by ASU 2015-03. ASU 2015-03 was effective for interim and annual periods beginning on January 1, 2016. The Company applied the amended presentation requirements in the first quarter of 2016, which resulted in no change on its financial statements.

 

 

 

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At September 30, 2016, short-term investments consisted of certificates of deposit. The Company classifies all investments as available-for-sale, as the sale of such investments may be required prior to maturity to implement management strategies. These investments are carried at amortized cost which approximates fair value, with the unrealized gains and losses reported as a component of other comprehensive income in equity until realized. A decline in the market value of any short-term investment below cost that is determined to be other-than-temporary will result in a revaluation of its carrying amount to fair value. The impairment is charged to earnings and a new cost basis for the security is established. No such impairment charges were recorded for any period presented.

Realized gains and losses from the sale of short-term investments, if any, are determined on a specific identification basis. Realized gains and losses and declines in value judged to be other-than-temporary, if any, on available-for-sale securities are included in other income or expense on the consolidated statements of operations. Realized and unrealized gains and losses during the periods presented were immaterial. Premiums and discounts are amortized or accreted over the life of the related security as an adjustment to yield using the straight-line method and are included in interest income on the consolidated statements of operations. Interest and dividends on securities classified as available-for-sale are included in interest income on the consolidated statements of operations. At September 30, 2016, the remaining contractual maturities of all available-for-sale investments were less than one year.

The accounting guidance defines fair value, establishes a consistent framework for measuring fair value and expands disclosure for each major asset and liability category measured at fair value on either a recurring or nonrecurring basis. Fair value is defined as an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, the accounting guidance establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows:

 

 

Assets and liabilities are classified based on the lowest level of input that is significant to the fair value measurements. No transfers between levels have occurred during the periods presented.

The fair values of the Company’s assets and liabilities, which are measured at fair value on a recurring basis, were determined using the following inputs (in thousands):

 

 

The carrying amounts of cash and cash equivalents, prepaid and other assets, accounts payable and accrued liabilities are considered to be representative of their respective fair values because of the short-term nature of those instruments. Based on the borrowing rates currently available to the Company for loans with similar terms, which is considered a Level 2 input, the Company believes that the fair value of long-term debt approximates its carrying value.

 

 

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Property and equipment consist of the following (in thousands):

 

 

Depreciation expense related to property and equipment totaled approximately $23,000 and $15,000 for the three months ended September 30, 2016 and 2015, respectively, and $70,000 and $33,000 for the nine months ended September 30, 2016 and 2015, respectively.

 

 

Long-term debt and unamortized debt discount balances are as follows (in thousands):

 

 

In May 2015, the Company entered into an Amended and Restated Loan and Security Agreement with Silicon Valley Bank (the 2015 Amended SVB Loan) under which the Company could borrow up to $10.0 million. At December 31, 2015, the Company had borrowed the full $10.0 million available under the 2015 Amended SVB Loan, of which, borrowings of approximately $8.0 million were used to refinance amounts outstanding under the prior loan and security agreements (the SVB loan), which was first entered into in November 2013 (SVB Loan Agreement) and amended and restated in June 2014 (Amended SVB Loan Agreement).  In connection with the 2015 Amended SVB Loan, the Company issued warrants to purchase up to 18,415 shares of common stock at an exercise price of $10.86 per share.  The warrants are fully exercisable and expire on May 13, 2022.  The transaction was accounted for as a debt modification.

The 2015 Amended SVB Loan provides for interest to be paid at a rate of 6.5% per annum.  Interest-only payments were due monthly through June 2016.  Thereafter, in addition to interest accrued during such period, the monthly payments include an amount equal to the outstanding principal at July 1, 2016 divided by 30 months. At maturity (or earlier prepayment), the Company is also required to make a final payment equal to 8.5% of the original principal amount of the amounts borrowed.  The 2015 Amended SVB Loan provides for prepayment fees of 2.0% of the amount prepaid if the prepayment occurs prior to May 13, 2017 and 1.0% of the amount prepaid if the prepayment occurs thereafter.

The fair value of the warrants and the final payment related to the 2015 Amended SVB Loan were recorded as debt discounts and are being amortized to interest expense using the effective interest method over the term of the debt, in addition to the remaining unamortized discounts related to the SVB Loan and the Amended SVB Loan Agreements.

Consistent with the terms of the SVB Loan and the Amended SVB Loan Agreements, the 2015 Amended SVB Loan is collateralized by substantially all of the Company’s assets, other than the Company’s intellectual property, and contains customary conditions of borrowing, events of default and covenants, including covenants that restrict the Company’s ability to dispose of assets, merge with or acquire other entities, incur indebtedness and make distributions to holders of the Company’s capital stock. Should an event of default occur, including the occurrence of a material adverse change, the Company could be liable for immediate repayment of all obligations under the 2015 Amended SVB Loan.

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In connection with the SVB Loan and the Amended SVB Loan, the Company issued warrants to purchase 37,500 shares and 112,500 shares of Series A redeemable convertible preferred stock, respectively, at an exercise price of $2.00 per share.  The warrants are fully exercisable and expire on November 14, 2023 and June 4, 2024, respectively. The initial fair value of the warrants as of the November 2013 and June 2014 issuance dates was estimated to be $0.1 million and $0.2 million, respectively, based on the application of the Black-Scholes option pricing model, and these discounts are being amortized to interest expense using the effective interest method over the term of the debt.  Upon completion of the Company’s initial public offering in February 2015, the warrants became exercisable for an aggregate of 38,758 shares of common stock at an exercise price of $7.74 per share.

Future minimum principal and interest payments under the 2015 Amended SVB Loan, including the final payment, as of September 30, 2016 are as follows (in thousands):

 

 

 

License Agreements

The Company has entered into various license agreements pursuant to which the Company acquired licenses to certain intellectual property. The agreements generally required an upfront license fee and, in some cases, reimbursement of patent costs. Additionally, under each agreement, the Company may be required to pay annual maintenance fees, royalties, milestone payments and sublicensing fees. Each of the license agreements is generally cancelable by the Company, given appropriate prior written notice. At September 30, 2016, potential future milestone payments under these agreements totaled an aggregate of approximately $127.0 million.

 

 

Initial Public Offering and Related Transactions

In February 2015, the Company completed its initial public offering in which it sold 3,600,000 shares of common stock at an initial public offering price of $10.00 per share. In addition, a concurrent private placement to an existing stockholder was completed in which the Company sold 500,000 shares of common stock, also at $10.00 per share.  Proceeds from the initial public offering and concurrent private placement, net of underwriting discounts, commissions and offering costs paid by us of approximately $6.0 million, were approximately $35.0 million.

In addition, in connection with the completion of the Company’s initial public offering on February 4, 2015, all of the outstanding shares of redeemable convertible preferred stock were converted into 6,369,567 shares of the Company’s common stock; outstanding warrants to purchase 150,000 shares of Series A redeemable convertible preferred stock were converted into warrants to purchase 38,758 shares of the Company’s common stock, and the Company’s certificate of incorporation was amended and restated to authorize 200,000,000 shares of common stock and 10,000,000 shares of undesignated preferred stock.

Redeemable Convertible Preferred Stock

Prior to its automatic conversion in the initial public offering, the Company classified its redeemable convertible preferred stock outside of permanent equity since such stock was contractually redeemable outside of the Company’s control. As a result, the carrying value was increased to its redemption value by periodic accretion charges over the estimated redemption period. In the absence of retained earnings, these accretion charges were recorded against additional paid-in capital.

Sales of Common Stock

In September 2016, concurrent with its License and Option Agreement with Janssen Pharmaceutica N.V. (Janssen) and its affiliate, Johnson & Johnson Innovation-JJDC, Inc. (JJDC) (see Note 7), the Company issued and sold 840,022 shares of its common stock at a purchase price of $5.95 per share (determined by the average of the daily volume weighted average closing prices of the common stock as reported on NASDAQ for the five days prior to the date of the purchase) to JJDC for gross proceeds of $5.0 million. The Company also entered into an Investor Rights Agreement, pursuant to which the Company granted JJDC certain rights to require the Company to register the shares for resale under the Securities Act.  

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The Company issued zero and 9,300 shares of common stock upon the exercise of outstanding stock options during the three and nine months ended September 30, 2016, respectively, and issued 57,512 shares of common stock upon the exercise of outstanding stock options during the year ended December 31, 2015.

Stock-Based Compensation Expense

The weighted-average assumptions used in the Black-Scholes option pricing model to determine the fair value of the employee stock option grants were as follows:

 

 

Stock compensation expense for the Employee Stock Purchase Plan was immaterial for the three and nine months ended September 30, 2016.

The allocation of stock-based compensation is as follows (in thousands):

 

 

 

 

Santen

In March 2014, the Company entered into a license agreement with Santen, under which the Company granted Santen an exclusive, worldwide license to certain patents, information and know-how related to TRC105. Under the agreement, Santen is permitted to use, develop, manufacture and commercialize TRC105 products for ophthalmology indications, excluding systemic treatment of ocular tumors. Santen also has the right to grant sublicenses to affiliates and third party collaborators. In the event Santen sublicenses any of its rights under the agreement, Santen will be obligated to pay the Company a portion of any upfront and certain milestone payments received under such sublicense.

Santen has sole responsibility for funding, developing, seeking regulatory approval for and commercializing TRC105 products in the field of ophthalmology. In the event that Santen fails to meet certain commercial diligence obligations, the Company will have the option to co-promote TRC105 products in the field of ophthalmology in the United States with Santen. If the Company exercises this option, the Company will pay Santen a percentage of certain development expenses, and the Company will receive a percentage of profits from sales of the licensed products in the ophthalmology field in the United States, but will not receive royalties on such sales.

In consideration of the rights granted to Santen under the agreement, the Company received a one-time upfront fee of $10.0 million. The license agreement provides for various types of payments, including the upfront payment, payment for various technical and regulatory support, payments for delivery of drug substance, reimbursement of certain development costs, milestone payments, and royalties on net product sales. The Company has identified multiple deliverables, which include at inception: (1) a license to patents, information and know-how related to TRC105, (2) technology transfer, (3) collaboration, including technical and regulatory support provided by the Company, (4) manufacturing and supply obligations, and (5) shared chemistry, manufacturing and controls (CMC) development activities. Deliverables 1 and 2 above were substantially delivered at the inception of the agreement, and deliverables 3 through 5 are expected to be delivered during the estimated 40-month period over which the Company will provide technical and regulatory support to Santen. At inception and through September 30, 2016, the Company has identified one single unit of accounting for all the deliverables under the agreement since the delivered elements do not have standalone value. The Company’s technical and regulatory expertise, including manufacturing and CMC activities, in the development of biologic therapeutics, specifically TRC105, is a significant component of Santen’s ability to utilize the license and know-how related to TRC105. Given the early stage of development of TRC105 for ophthalmology, the Company is the only party capable of performing the level and type of

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technical and regulatory collaboration services required by Santen under the agreement. As a result, the Company has determined that the license, including the ability to sublicense, and know-how related to TRC105 do not have standalone value to a licensee. As such, the Company is recognizing revenue for the fixed or determinable collaboration consideration on a straight-line basis over the estimated 40-month period over which it will deliver its technical and regulatory support.

During the nine months ended September 30, 2016, the expected term over which the Company will provide technical and regulatory support to Santen was extended from 31 to 40 months. The changes in the estimated term increased net loss by $0.8 million, or $0.06 per share, and $1.9 million, or $0.15 per share, for the three and nine months ended September 30, 2016, respectively.

In addition, the Company is eligible to receive up to a total of $155.0 million in milestone payments upon the achievement of certain milestones, of which $20.0 million relates to the initiation of certain development activities, $52.5 million relates to the submission of certain regulatory filings and receipt of certain regulatory approvals and $82.5 million relates to commercialization activities and the achievement of specified levels of product sales. The Company has determined that $10.0 million related to the initiation of certain clinical development activities will be based upon its efforts and meet the criteria of substantive milestones and therefore will be recognized as revenue upon achievement of the milestone in accordance with the milestone method of accounting. As of September 30, 2016, the Company had received a $3.0 million milestone payment related to development activities, revenue for which was recognized in the year ended December 31, 2015. The remaining $145.0 million of potential milestone payments are not substantive milestones as they do not require the efforts of the Company.

If TRC105 products are successfully commercialized in the field of ophthalmology, Santen will be required to pay the Company tiered royalties on net sales ranging from high single digits to low teens, depending on the volume of sales, subject to adjustments in certain circumstances. In addition, Santen will reimburse the Company for all royalties due by the Company under certain third party agreements with respect to the use, manufacture or commercialization of TRC105 products in the field of ophthalmology by Santen and its affiliates and sublicensees. Royalties will continue on a country-by-country basis through the later of the expiration of the Company’s patent rights applicable to the TRC105 products in a given country or 12 years after the first commercial sale of the first TRC105 product commercially launched in such country.

Santen may unilaterally terminate this agreement in its entirety, or on a country-by-country basis, upon written notice to the Company. Either party may terminate the agreement in the event of the other party’s bankruptcy or dissolution or for the other party’s material breach of the agreement that remains uncured 90 days (or 30 days with respect to a payment breach) after receiving notice from the non-breaching party. Unless earlier terminated, the agreement continues in effect until the termination of Santen’s payment obligations.

In connection with the collaboration with Santen, the Company recognized revenue of $0.8 million and $1.2 million for the three months ended September 30, 2016 and 2015, respectively, and $2.8 million and $6.5 million for the nine months ended September 30, 2016 and 2015, respectively.  At September 30, 2016, deferred revenue totaled $1.7 million.

 

Janssen

 

In September 2016,  the Company entered into a license and option agreement with Janssen (the License and Option Agreement) under which Janssen granted the Company a license to technology and intellectual property to develop, manufacture and commercialize two compounds: a small molecule inhibitor of androgen receptor and androgen receptor mutations (the AR Mutant Program or TRC253) which is intended for the treatment of men with prostate cancer, and an inhibitor of NF-kB inducing kinase (the NIK Program or TRC694, and, together with the AR Mutant Program, the Programs).

 

With respect to the AR Mutant Program, Janssen maintains an option, which is exercisable until 90 days after the Company demonstrates clinical proof of concept, to regain the rights to the licensed intellectual property and to obtain an exclusive license to commercialize the compounds and certain other specified intellectual property developed under the AR Mutant Program. If Janssen exercises the option, Janssen will be obligated to pay the Company (i) a one-time option exercise fee of $45.0 million; (ii) regulatory and commercial based milestone payments totaling up to $137.5 million upon achievement of specified events; and (iii) royalties in the low single digits on annual net sales of AR Mutant Program products. If Janssen does not exercise the option, the Company would then have the right to retain worldwide development and commercialization rights to the AR Mutant Program, in which case, the Company would be obligated to pay to Janssen (x) development and regulatory based milestone payments totaling up to $45.0 million upon achievement of specified events, and (y) royalties in the low single digits based on annual net sales of AR Mutant Program products, subject to certain specified reductions.

 

With respect to the NIK Program, Janssen maintains a right, which is exercisable within 90 days following the date on which the Company demonstrates clinical proof of concept with respect to the NIK Program, to negotiate for a period of six months for a reversion of the related rights in the licensed intellectual property and to obtain an exclusive license to commercialize the compounds

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and certain other specified intellectual property developed under the NIK Program. If Janssen does not exercise its right of first negotiation, or, if after exercise of such right, the Company and Janssen are unable to reach an agreement on the terms of a reversion and exclusive license, and, in either case, the Company continues the development of the NIK Program, then the Company would be obligated to pay Janssen (i) development and regulatory based milestone payments totaling up to $60.0 million upon achievement of specified events, and (ii) royalties in the low single digits based on annual net sales of NIK Program products, subject to certain specified reductions.

 

No consideration was exchanged for these assets on the acquisition date.  Given the early preclinical stage of development of these assets and the low likelihood of success of development through regulatory approval, no value has been assigned to these assets in the accompanying balance sheet.

 

The Company is obligated to use diligent efforts to develop the Programs according to agreed upon development plans, timelines and budgets. For each Program that the Company retains, the Company is further obligated to use commercially reasonable efforts to develop, obtain marketing approval for, and commercialize licensed products.  Until the expiration or earlier termination of the development term of the AR Mutant Program or the NIK Program, as applicable, under the License and Option Agreement, subject to specified exceptions, the Company has agreed not to research, develop or commercialize any compounds or products related to the AR Mutant Program or the NIK Program, as applicable, other than pursuant to the collaboration with Janssen.

 

The License and Option Agreement may be terminated for uncured breach, bankruptcy, or the failure or inability to demonstrate clinical proof of concept with respect to a particular Program during specified timeframes.  In addition, the License and Option Agreement will automatically terminate (a) with respect to the AR Mutant Program, upon Janssen exercising its option in respect of the AR Mutant Program and making payment of the option exercise fee to the Company or, if Janssen does not exercise the option, upon the expiration of all payment obligations of the Company to Janssen with respect of the AR Mutant Program, and (b) with respect to the NIK Program, upon the Company and Janssen entering into an exclusive license agreement following Janssen’s exercise of its right of first negotiation or, if Janssen’s right of first negotiation with respect to the NIK Program expires and the Company and Janssen have not entered into an exclusive license agreement, upon the expiration of all payment obligations of the Company to Janssen with respect of the NIK Program.  The Company may also terminate a Program or the Agreement in its entirety without cause, subject to specified conditions.

 

 

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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 together with our condensed consolidated financial statements and the related notes and other financial information included elsewhere in this Quarterly Report. Some of the information contained in this discussion and analysis or set forth elsewhere in this Quarterly Report, including information with respect to our plans and strategy for our business, timing of future events and future financial performance, includes forward-looking statements that are based upon current beliefs, plans and expectations and involve risks, uncertainties and assumptions. You should review the “Risk Factors” section of this Quarterly Report for a discussion of important factors that could cause our actual results and the timing of selected events to differ materially from those described in or implied by the forward-looking statements contained in this Quarterly Report. We undertake no obligation to update these forward-looking statements to reflect events or circumstances after the date of this Report or to reflect actual outcomes.

Overview

We are a clinical stage biopharmaceutical company focused on the development and commercialization of novel targeted therapeutics for cancer, wet age-related macular degeneration, or wet AMD, and fibrotic diseases. We are a leader in the field of endoglin biology and are using our expertise to develop antibodies that bind to the endoglin receptor. Endoglin is essential to angiogenesis, the process of new blood vessel formation, and a key contributor to the development of fibrosis, or tissue scarring. Our lead product candidate, TRC105, is an endoglin antibody that is being developed for the treatment of multiple solid tumor types in combination with inhibitors of the vascular endothelial growth factor, or VEGF, pathway. The VEGF pathway regulates vascular development in the embryo, or vasculogenesis, and angiogenesis. TRC105 has been studied in seven completed Phase 2 clinical trials and three completed Phase 1 clinical trials, and is currently being dosed in five Phase 2 clinical trials. Our TRC105 oncology clinical development plan is broad and involves a tiered approach. We are initially focused on two orphan indications, angiosarcoma and gestational trophoblastic neoplasia, or GTN, both of which are tumors that highly express endoglin, the target of TRC105, and therefore may be more responsive to treatment with TRC105. We have seen complete ongoing responses in these tumor types and have initiated dosing in an international multicenter Phase 2 trial in GTN and plan to initiate initial Phase 3 development in angiosarcoma in December 2016 or early 2017. The proposed Phase 3 trial in angiosarcoma was recently reviewed by the U.S. Food and Drug Administration, or FDA, and the European Medicines Agency, or EMA, at an End-of-Phase 2 meeting and protocol assistance meeting, respectively. The feedback from both Agencies was incorporated into the Phase 3 protocol. The protocol has been submitted for Special Protocol Assessment to the FDA and any further comments will also be incorporated. The next tier of development includes ongoing Phase 2 trials in renal cell carcinoma, which is a randomized trial, and hepatocellular carcinoma, that are expected to produce top-line data in 2017, and that, if positive, would also enable Phase 3 development. Additionally, we expect top-line data from a Phase 2 randomized trial in glioblastoma in late 2016 or early 2017. We consider these indications attractive because the endpoints for regulatory approval may be attained more quickly than the endpoints for other indications. We also expect that these initial indications would be for the same lines of treatment for which the companion VEGF inhibitor is approved. Finally, the third tier of development includes large indications including an ongoing Phase 1 trial in lung cancer and a Phase 1/2 trial in breast cancer. Positive data in these larger indications would enable further development.  

 

During September 2016, we entered into a strategic licensing collaboration with Janssen Pharmaceutica N.V. (Janssen) for two novel oncology assets from Janssen’s early oncology development portfolio. The agreement grants us the rights to develop TRC253 (formerly JNJ-63576253), a novel small molecule high affinity competitive inhibitor of wild type androgen receptor (AR) and multiple AR mutant receptors which display drug resistance to currently approved treatments, which is intended for the treatment of men with prostate cancer, and TRC694 (formerly JNJ-6420694), a novel, potent, orally bioavailable inhibitor of NF-kB inducing kinase (NIK), which is intended for the treatment of patients with hematologic malignancies, including myeloma.

 

TRC253 has completed IND-enabling studies and we expect to initiate a Phase 1/2 proof of concept, or POC, clinical study in the first half of 2017. Until 90 days after we complete the initial POC study, Janssen has an exclusive option to reacquire full rights to TRC253 for an upfront payment of $45.0 million to us, and obligations to make regulatory and commercialization milestone payments totaling up to $137.5 million upon achievement of specified events and a low single-digit royalty. If Janssen does not exercise its exclusive option to reacquire the program, we would then retain worldwide development and commercialization rights to the program, in which case we would be obligated to pay Janssen a total of up to $45.0 million in development and regulatory milestones upon achievement of specified events, in addition to a low single digit royalty.

 

TRC694 is currently in preclinical development and we expect to file an IND application in 2018, following completion of additional preclinical studies. Until 90 days after we complete the initial POC study, Janssen has a right of first negotiation to reacquire the program on terms to be negotiated between the parties. If Janssen does not exercise the negotiation right or the parties cannot agree to terms following negotiations, and if we elect to continue development of TRC694, we would be obligated to make development and regulatory milestone payments to Janssen totaling up to $60.0 million upon the achievement of specified events and a low single-digit royalty.

 

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In addition, Johnson and Johnson Innovation – JJDC, Inc. made a $5.0 million equity investment in TRACON through the purchase of common stock at $5.95 per share (determined by the average of the daily volume weighted average closing prices of the common stock as reported on NASDAQ for the five days prior to the date of the purchase). We expect this funding to offset development expenses for TRC253 and TRC694 for at least the next 12 months.

 

During October 2016, at the European Society for Medical Oncology (ESMO) 2016 Congress, we reported updated results from a Phase 1b clinical trial combining TRC105 with Inlyta® (axitinib) in patients with advanced or metastatic renal cell carcinoma (RCC). Median progression free survival (PFS) of 11.3 months was observed in all RCC patients in the study, including those patients with clear cell RCC, the most prevalent form of RCC. An objective response rate (ORR) of 29% was also seen in the trial. For comparative purposes, median PFS observed in the large subgroup of VEGFR TKI-refractory patients treated with Inlyta (n=194) in the Inlyta AXIS Phase 3 study in second line clear cell RCC patients (a separate trial) was 4.8 months and ORR was 11.3%.

 

During October 2016, we announced the successful completion of the End-of-Phase 2 meeting process with both the FDA and the EMA. The FDA and the EMA separately determined the acceptability of the following key aspects of the proposed Phase 3 randomized trial comparing Votrient alone to a combination of Votrient (pazopanib) and TRC105 in angiosarcoma:

 

 

 

 

The trial is designed to provide at least 80% power to determine an improvement in median PFS from 4.0 to 7.3 months using a two-tailed alpha of 0.05.

 

In June 2016, we presented updated data from the ascending dose portion of a Phase 2 clinical trial of TRC105 with Votrient in patients with advanced soft tissue sarcoma. The combination of TRC105 and Votrient demonstrated encouraging signs of activity in the five angiosarcoma patients enrolled in the first cohort of the Phase 1b/2 trial. All of these patients had radiographic tumor reductions, including two durable complete responses (CRs) by RECIST 1.1, and median PFS for the five angiosarcoma patients was greater than 12.9 months. For comparison, PFS was 3.0 months with no CRs in a previously completed study with single agent Votrient in 30 angiosarcoma patients and there were no complete responses in sarcoma patients treated with Votrient (n=246) in the Votrient PALETTE Phase 3 trial. Signs of clinical or radiologic activity were also observed in three of four patients enrolled in the trial’s angiosarcoma expansion cohort and treated initially with TRC105 and Votrient. Endoglin expression on archival tumor tissue across all sarcoma subtypes treated in the study was not associated with improved PFS. Tumor heterogeneity, the long period of time between sampling and treatment, and the effects of tumor evolution resulting from prior treatment(s) may have limited the reliability of the archival tumor tissue used to accurately reflect tumor endoglin status at the time of initiation of TRC105 treatment. We plan to initiate a Phase 3 study in angiosarcoma in December 2016 or early 2017.

During May 2016, we received notice that the EMA granted TRC105 orphan drug designation for the treatment of patients with soft tissue sarcoma, including angiosarcoma. This designation complemented the orphan drug designation for TRC105 in soft tissue sarcoma received from the FDA in January 2016, and provides regulatory and financial incentives to develop and market therapies that treat rare diseases.

Our other product candidates include TRC205, an endoglin antibody that is in preclinical development for the treatment of fibrotic diseases, and TRC102, which is a small molecule that is in clinical development for the treatment of lung cancer and glioblastoma. In March 2014, Santen licensed from us exclusive worldwide rights to develop and commercialize our endoglin antibodies for ophthalmology indications.

We completed certain preclinical studies of our endoglin antibodies in the first quarter of 2016, including TRC205, in three fibrosis models in mice: a model of chemically-induced liver fibrosis, a model of chemically induced pulmonary fibrosis, and a model of non-alcoholic steatohepatitis, or NASH. In each study, one or more endoglin antibodies achieved the primary endpoint of the study compared to control. In the NASH study, the clinical candidate TRC205 significantly reduced the Non-Alcoholic Fatty Liver Disease (NAFLD) Activity Score versus control, and reduced fibrotic gene expression without significantly reducing the fibrotic area by visual inspection. We will present data from two of these models in November 2016 at the annual meeting of the American Association for the Study of Liver Disease, or AASLD.

TRC102 is a small molecule in clinical development to reverse resistance to specific chemotherapeutics by inhibiting base‑excision repair, or BER. In initial clinical trials of more than 100 patients, TRC102 has shown good tolerability and promising anti-tumor activity, in combination with alkylating and antimetabolite chemotherapy in the treatment of lung cancer and glioblastoma.  

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TRC102 began Phase 2 testing in mesothelioma in combination with the approved chemotherapeutic Alimta in 2015 and began Phase 2 testing in glioblastoma in combination with the approved chemotherapeutic Temodar in 2016. TRC102 is also being studied in three Phase 1 trials: in combination with Alimta and cisplatin in mesothelioma patients, in combination with chemoradiation in lung cancer patients, and in combination with Temodar in ovarian, lung and colorectal cancer patients. All current TR102 trials are sponsored by the National Cancer Institute, or NCI, and are funded by the NCI. We retain global rights to develop and commercialize TRC102 in all indications.

We have collaborated with NCI, which has selected TRC105 and TRC102 for federal funding of clinical development, as well as Case Western. Under these collaborations, NCI has sponsored or is sponsoring nine completed or ongoing clinical trials of TRC105 and TRC102, and Case Western sponsored two clinical trials of TRC102. We anticipate that NCI will complete ongoing Phase 2 clinical trials of TRC105 and may initiate other Phase 2 clinical trials in addition to the Phase 2 clinical trials of TRC105 that we are sponsoring. In addition, we expect that Phase 2 clinical trials of TRC102 will be completed with NCI funding. If merited by Phase 2 data, we expect to fund additional Phase 3 clinical trials of TRC105 in certain indications beyond angiosarcoma and initial Phase 3 clinical trials of TRC102 and, based on NCI’s past course of conduct with similarly situated pharmaceutical companies in which it has sponsored pivotal clinical trials following receipt of positive Phase 2 data, we anticipate that NCI will sponsor Phase 3 clinical trials in additional indications.

 

The following chart summarizes our pipeline of product candidates:

 

 

 

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The following table summarizes key information regarding ongoing and planned development of our product candidates:

 

 

Since our inception in 2004, we have devoted substantially all of our resources to research and development efforts relating to our product candidates, including conducting clinical trials and developing manufacturing capabilities, in-licensing related intellectual property, providing general and administrative support for these operations and protecting our intellectual property. We have not generated any revenue from product sales and, through December 31, 2014, had funded our operations primarily with the aggregate net proceeds of $79.1 million from the private placement of redeemable convertible preferred stock and common stock, a $10.0 million one-time upfront fee received in connection with our collaboration with Santen, and $10.0 million of commercial bank debt under our credit facility with SVB. In February 2015, we completed our initial public offering and a concurrent private placement and raised proceeds, net of underwriting discounts, commissions and offering costs of approximately $6.0 million, totaling approximately $35.0 million. At September 30, 2016, we had cash, cash equivalents and short-term investments totaling $35.1 million.

We have incurred losses from operations in each year since our inception. Our net losses were $24.4 million and $6.8 million for the years ended December 31, 2015 and 2014, respectively. At September 30, 2016, we had an accumulated deficit of $79.3 million.

We expect to continue to incur significant expenses and increasing operating losses for at least the next several years. Our net losses may fluctuate significantly from quarter to quarter and year to year. We expect our expenses will increase substantially in connection with our ongoing activities as we:

We do not expect to generate any revenues from product sales until we successfully complete development and obtain regulatory approval for one or more of our product candidates, which we expect will take a number of years. If we obtain regulatory

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approval for any of our product candidates, we expect to incur significant commercialization expenses related to product sales, marketing, manufacturing and distribution. Accordingly, we will need to raise substantial additional capital. The amount and timing of our future funding requirements will depend on many factors, including the pace and results of our preclinical and clinical development efforts and the timing and nature of the regulatory approval process for our product candidates. We anticipate that we will seek to fund our operations through public or private equity or debt financings or other sources. However, we may be unable to raise additional funds or enter into such other arrangements when needed on favorable terms or at all. Our failure to raise capital or enter into such other arrangements when needed would have a negative impact on our financial condition and ability to develop our product candidates.

Collaboration and License Agreements

Santen Pharmaceutical Co., Ltd.

In March 2014, we entered into a license agreement with Santen, under which we granted Santen an exclusive, worldwide license to certain patents, information and know-how related to TRC105, or the TRC105 Technology. Under the agreement, Santen is permitted to use, develop, manufacture and commercialize TRC105 products for ophthalmology indications, excluding systemic treatment of ocular tumors. Santen also has the right to grant sublicenses to affiliates and third party collaborators, provided such sublicenses are consistent with the terms of our agreement. Santen has sole responsibility for funding, developing, seeking regulatory approval for and commercializing TRC105 products in the field of ophthalmology.

In consideration of the rights granted to Santen under the agreement, we received a one-time upfront fee of $10.0 million. In addition, we are eligible to receive up to a total of $155.0 million in milestone payments upon the achievement of certain milestones, of which $20.0 million relates to the initiation of certain development activities, $52.5 million relates to the submission of certain regulatory filings and receipt of certain regulatory approvals and $82.5 million relates to commercialization activities and the achievement of specified levels of product sales. As of September 30, 2016, we had received $3.0 million in milestones related to development activities. If TRC105 products are successfully commercialized in the field of ophthalmology, Santen will be required to pay us tiered royalties on net sales ranging from high single digits to low teens, depending on the volume of sales, subject to adjustments in certain circumstances. In addition, Santen will reimburse us for all royalties due by us under certain third party agreements with respect to the use, manufacture or commercialization of TRC105 products in the field of ophthalmology by Santen and its affiliates and sublicensees. Royalties will continue on a country-by-country basis through the later of the expiration of our patent rights applicable to the TRC105 products in a given country or 12 years after the first commercial sale of the first TRC105 product commercially launched in such country.

Janssen Pharmaceutica N.V.

 

During September 2016, we entered into a strategic licensing collaboration with Janssen for two novel oncology assets from Janssen’s early oncology development portfolio. The agreement grants us the rights to develop TRC253 (formerly JNJ-63576253), a novel small molecule high affinity competitive inhibitor of wild type androgen receptor (AR Mutant Program) and multiple AR mutant receptors which display drug resistance to approved treatments, which is intended for the treatment of men with prostate cancer, and TRC694 (formerly JNJ-6420694), a novel, potent, orally bioavailable inhibitor of NF-kB inducing kinase (the NIK Program and, together with the AR Mutant Program, the Programs), which is intended for the treatment of patients with hematologic malignancies, including myeloma.

  

Janssen maintains an option, which is exercisable until 90 days after we demonstrate clinical proof of concept with respect to the AR Mutant Program, to regain the rights to the licensed intellectual property and to obtain an exclusive license to commercialize the compounds and certain other specified intellectual property developed under the AR Mutant Program. If Janssen exercises the option, Janssen will be obligated to pay us (i) a one-time option exercise fee of $45.0 million; (ii) regulatory and commercial based milestone payments totaling up to $137.5 million upon achievement of specified events; and (iii) royalties in the low single digits on annual net sales of AR Mutant Program products. If Janssen does not exercise the option, we would then have the right to retain worldwide development and commercialization rights to the AR Mutant Program, in which case, we would be obligated to pay to Janssen (x) development and regulatory based milestone payments totaling up to $45.0 million upon achievement of specified events, and (y) royalties in the low single digits based on annual net sales of AR Mutant Program products, subject to certain specified reductions.

 

With respect to the NIK Program, Janssen maintains a right, which is exercisable within 90 days following the date on which we demonstrate clinical proof of concept with respect to the NIK Program, to negotiate for a period of six months for a reversion of the related rights in the licensed intellectual property and to obtain an exclusive license to commercialize the compounds and certain other specified intellectual property developed under the NIK Program. If Janssen does not exercise its right of first negotiation, or, if after exercise of such right, Janssen and we are unable to reach an agreement on the terms of a reversion and exclusive license, and, in either case, we continue the development of the NIK Program, then we would be obligated to pay Janssen (i) development and

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regulatory based milestone payments totaling up to $60.0 million upon achievement of specified events, and (ii) royalties in the low single digits based on annual net sales of NIK Program products, subject to certain specified reductions.

 

Financial Operations Overview

Revenue

Our revenue to date has been derived solely from our March 2014 collaboration with Santen. The terms of this arrangement contain multiple deliverables, which include at inception: (1) a license to patents, information and know-how related to TRC105; (2) technology transfer; (3) collaboration, including technical and regulatory support provided by us; (4) manufacturing and supply obligations; and (5) shared CMC development activities. The license agreement provides that we may receive various types of payments, including an upfront payment, payment for various technical and regulatory support, payments for delivery of drug substance, reimbursement of certain development costs, milestone payments, and royalties on net product sales. In accordance with our revenue recognition policy described in detail below, we have identified one single unit of accounting for all the deliverables under the agreement and are recognizing revenue for the fixed or determinable collaboration consideration on a straight-line basis over the estimated development period.

We expect that any revenue we generate will fluctuate from quarter to quarter as a result of the timing of any future achievement of milestones, whether and when Janssen reacquires rights to the AR Mutant Program and/or NIK Program and the extent to which any of our products are approved and successfully commercialized by us or Santen. If we or Santen fail to develop product candidates in a timely manner or obtain regulatory approval for them, our ability to generate future revenues, our results of operations and our financial position could be adversely affected.

Research and Development Expenses

Research and development expenses consist of costs associated with the preclinical and clinical development of our product candidates. These costs consist primarily of:

Research and development costs, including third party costs reimbursed by Santen as part of our collaboration, are expensed 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.

The following table summarizes our research and development expenses by product candidate for the periods indicated:

 

 

Unallocated expenses consist of our internal personnel costs, facility costs and scientific advisory board related expenses.

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We expect our current level of research and development expenses to continue to increase for the foreseeable future as we continue development of TRC105 in orphan indications, including initiating a Phase 3 clinical trial in angiosarcoma and a Phase 2 clinical trial in GTN, initiate manufacturing activities required for regulatory approval, and begin our development of our licensed compounds TRC253 and TRC694.

We cannot determine with certainty the timing of initiation, the duration or the completion costs of current or future preclinical studies and clinical trials of our product candidates due to the inherently unpredictable nature of preclinical and clinical development. Clinical and preclinical development timelines, the probability of success and development costs can differ materially from expectations. We anticipate that we will make determinations as to which product candidates to pursue and how much funding to direct to each product candidate on an ongoing basis in response to the results of ongoing and future preclinical studies and clinical trials, regulatory developments and our ongoing assessments as to each product candidate’s commercial potential. We will need to raise substantial additional capital in the future. In addition, we cannot forecast which product candidates may be subject to future collaborations, when such arrangements will be secured, if at all, and to what degree such arrangements would affect our development plans and capital requirements.

The costs of clinical trials to us may vary significantly based on factors such as:

General and Administrative Expenses

General and administrative expenses consist primarily of salaries and related costs for employees in executive, finance and administration, corporate development and administrative support functions, including stock-based compensation expenses and benefits. Other significant general and administrative expenses include insurance, accounting and legal services, expenses associated with obtaining and maintaining patents, the cost of various consultants and occupancy costs.

We anticipate that our general and administrative expenses will remain relatively constant in the near term.

Other Income (Expense)

Other income (expense) primarily consists of interest related to our loan agreements with SVB offset by interest income from our short-term investments and cash equivalents.

Critical Accounting Policies and Significant Judgments and Estimates

Our management’s discussion and analysis of financial condition and results of operations is based on our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States, or GAAP. The preparation of these condensed consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported revenues and expenses during the reporting periods. These items are monitored and analyzed by us for changes in facts and circumstances, and material changes in these estimates could occur in the future. We base our estimates on our historical experience and on various other factors that we believe to be 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

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from other sources. Changes in estimates are reflected in reported results for the period in which they become known. Actual results may differ materially from these estimates under different assumptions or conditions. There have been no material changes to our critical accounting policies and estimates from the information provided in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies Involving Management Estimates and Assumptions,” included in our Annual Report on Form 10-K for the year ended December 31, 2015.

Recent Accounting Pronouncements Not Yet Adopted

In May 2014, the FASB issued Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers, which converges the FASB and the International Accounting Standards Board standard on revenue recognition. Areas of revenue recognition that will be affected include, but are not limited to, transfer of control, variable consideration, allocation of transfer pricing, licenses, time value of money, contract costs and disclosures. This guidance is effective for the fiscal years and interim reporting periods beginning after December 15, 2017. We have not yet selected a transition method and are currently evaluating the impact that the adoption of ASU 2014-09 will have on our financial statements and related disclosures.

In August 2014, the FASB issued ASU 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. ASU 2014-15 requires management to evaluate relevant conditions, events and certain management plans that are known or reasonably knowable that when, considered in the aggregate, raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued, for both annual and interim periods. ASU 2014-15 also requires certain disclosures around management’s plans and evaluation, as well as the plans, if any, that are intended to mitigate those conditions or events that will alleviate the substantial doubt. ASU 2014-15 is effective for fiscal years ending after December 15, 2016. We are currently evaluating the impact that the adoption of ASU 2014-15 will have on our financial statements and related disclosures.

In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting, which amends ASC Topic 718, Compensation – Stock Compensation. ASU 2016-09 includes an update which simplifies the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. ASU 2016-09 is effective for public entities for annual reporting periods beginning after December 15, 2016, and interim periods within that reporting period. We are currently evaluating the impact that the adoption of ASU 2016-09 will have on our financial statements and related disclosures.

Recently Adopted Accounting Standards

In April 2015, the FASB issued ASU 2015-03, Interest – Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs. ASU 2015-03 requires debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying value of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by ASU 2015-03. ASU 2015-03 was effective for interim and annual periods beginning on January 1, 2016. We applied the amended presentation requirements in the first quarter of 2016, which resulted in no change to our financial statements.

Results of Operations

Comparison of the Three Months Ended September 30, 2016 and 2015

The following table summarizes our results of operations for the three months ended September 30, 2016 and 2015:

 

 

Collaboration revenue.  Collaboration revenue, all of which resulted from our collaboration with Santen, was $0.8 million and $1.2 million for the three months ended September 30, 2016 and 2015, respectively. The decrease of $0.4 million was due to a change in the expected term over which we will provide technical and regulatory support to Santen.

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Research and development expenses.  Research and development expenses were $4.5 million and $5.9 million for the three months ended September 30, 2016 and 2015, respectively. The decrease of $1.4 million was due primarily to decreased TRC105 drug manufacturing expenses, offset by increased clinical study related expenses and expenses associated with acquiring TRC253 and TRC694.

General and administrative expenses.  General and administrative expenses were $1.9 million and $1.5 million for the three months ended September 30, 2016 and 2015, respectively. The increase of $0.4 million was due primarily to increased compensation related expenses, including stock-based compensation expenses, due to increased headcount in 2016.

Other income (expense).  Other income (expense) was ($0.3) million and ($0.2) million for the three months ended September 30, 2016 and 2015, respectively.

Comparison of the Nine Months Ended September 30, 2016 and 2015

 

The following table summarizes our results of operations for the nine months ended September 30, 2016 and 2015:

 

 

Collaboration revenue.  Collaboration revenue, all of which resulted from our collaboration with Santen, was $2.8 million and $6.5 million for the nine months ended September 30, 2016 and 2015, respectively. The decrease of $3.7 million was primarily due to the achievement of a development milestone by Santen in June 2015 in connection with our collaboration, which triggered a $3.0 million milestone payment.

Research and development expenses.  Research and development expenses were $16.8 million and $15.1 million for the nine months ended September 30, 2016 and 2015, respectively. The increase of $1.7 million was due to increased clinical study related expenses, compensation related expenses, including stock-based compensation expenses, due to increased headcount, as well as increased preclinical expenses for TRC105 and expenses associated with acquiring TRC253 and TRC694, offset by decreased TRC105 drug manufacturing expenses.

General and administrative expenses.  General and administrative expenses were $5.9 million and $4.0 million for the nine months ended September 30, 2016 and 2015, respectively. The increase of $1.9 million was due primarily to increased compensation related expenses, including stock-based compensation expenses, due to increased headcount in 2016.

Other income (expense).  Other income (expense) was ($0.8) million and ($0.7) million for the nine months ended September 30, 2016 and 2015.

Liquidity and Capital Resources

We have incurred losses and negative cash flows from operations since our inception. As of September 30, 2016, we had an accumulated deficit of $79.3 million, and we expect to continue to incur net losses for the foreseeable future. We expect that our research and development and general and administrative expenses will continue to increase and, as a result, we will need additional capital to fund our operations, which we may seek to obtain through one or more equity offerings, debt financings, government or other third party funding, and licensing or collaboration arrangements.

Credit Facility with SVB

In May 2015, we entered into an Amended and Restated Loan and Security Agreement with SVB (the 2015 Amended SVB Loan) under which we could borrow up to $10.0 million. At December 31, 2015, we had borrowed the full $10.0 million available, of which, borrowings of approximately $8.0 million were used to refinance amounts outstanding under the prior loan and security agreements. In connection with the 2015 Amended SVB Loan, we issued warrants to purchase up to 18,415 shares of common stock at an exercise price of $10.86 per share. The warrants are fully exercisable and expire on May 13, 2022.

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The 2015 Amended SVB Loan provides for interest to be paid at a rate of 6.5% per annum. Interest-only payments were due monthly through June 2016. Thereafter, in addition to interest accrued during such period, the monthly payments include an amount equal to the outstanding principal at July 1, 2016 divided by 30 months. At maturity (or earlier prepayment), we are also required to make a final payment equal to 8.5% of the original principal amount of the amounts borrowed. The 2015 Amended SVB Loan provides for prepayment fees of 2.0% of the amount prepaid if the prepayment occurs prior to May 13, 2017 and 1.0% of the amount prepaid if the prepayment occurs thereafter.

The 2015 Amended SVB Loan is collateralized by substantially all of our assets, other than our intellectual property, and contains customary conditions of borrowing, events of default and covenants, including covenants that restrict our ability to dispose of assets, merge with or acquire other entities, incur indebtedness and make distributions to holders of our capital stock. Should an event of default occur, including the occurrence of a material adverse change, we could be required to immediately repay all obligations under the 2015 Amended SVB Loan.

ATM Facility

In February 2016, we entered into an At-the-Market Equity Offering Sales Agreement, or the Sales Agreement, with Stifel, Nicolaus & Company, Incorporated, or Stifel, pursuant to which we may sell from time to time, at our option, up to an aggregate of $25.0 million of our shares of our common stock through Stifel, as sales agent. Sales of our common stock made pursuant to the Sales Agreement, if any, will be made on the Nasdaq Global Market under our effective registration statement on Form S-3, by means of ordinary brokers’ transactions at market prices. Additionally, under the terms of the Sales Agreement, we may also sell shares of our common stock through Stifel, on the Nasdaq Global Market or otherwise, at negotiated prices or at prices related to the prevailing market price. Stifel will use its commercially reasonable efforts to sell our common stock from time to time, based upon our instructions (including any price, time or size limits or other customary parameters or conditions we may impose). We are obligated to pay Stifel an aggregate sales agent commission equal to up to 2.5% of the gross proceeds of the sales price for common stock sold under the Sales Agreement. As of September 30, 2016, no shares of our common stock have been sold under the Sales Agreement and the full $25.0 million of common stock remains available to be sold.

Cash Flows

The following table summarizes our net cash flow activity for each of the periods set forth below:

 

 

Operating activities.  Net cash used in operating activities was $21.2 million for the nine months ended September 30, 2016 and was primarily due to our net loss and changes in our working capital, offset by non-cash charges including stock-based compensation. Net cash used in operating activities was $11.6 million for the nine months ended September 30, 2015 and was primarily due to our net loss and changes in our working capital, offset by non-cash charges including stock-based compensation. 

 

Investing activities.  Net cash provided by investing activities was $5.3 million for the nine months ended September 30, 2016 and was primarily due to maturities of short-term investments, offset by purchases of these investments.  Net cash used in investing activities was $10.6 million for the nine months ended September 30, 2015 and was primarily due to the purchase of short-term investments.

Financing activities.  Net cash provided by financing activities was $4.1 million during the nine months ended September 30, 2016 and primarily resulted from $5.0 million in proceeds received from the sale of our common stock to JJDC, offset in part by $1.0 million in repayments under our SVB loan agreement. Net cash provided by financing activities was $34.4 million during the nine months ended September 30, 2015 and resulted from net proceeds received totaling approximately $36.3 million from our initial public offering and concurrent private placement received in the period, offset in part by $1.9 million in net repayments on borrowings under our SVB loan agreement.

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Funding Requirements

At September 30, 2016, we had cash, cash equivalents and short-term investments totaling $35.1 million. We believe that our existing cash, cash equivalents and short-term investments will be sufficient to meet our anticipated cash requirements for our planned operations to the middle of 2017, which we expect will allow us to deliver top-line data in TRC105 randomized trials in glioblastoma and renal cell carcinoma. We will need additional funding to complete the development and commercialization of our product candidates, specifically our lead product candidate, TRC105, including to complete our planned Phase 2 trial in GTN and planned Phase 3 trial in angiosarcoma. In addition, we may evaluate in-licensing and acquisition opportunities to gain access to new product candidates that fit with our strategy. Any such transaction, including our strategic licensing transaction with Janssen, will likely increase our future funding requirements.

Our forecast of the period of time through which our financial resources will be adequate to support our operations is a forward-looking statement that involves risks and uncertainties, and actual results could vary materially.