You should read the following discussion and analysis of our financial condition and results of operations together with our consolidated financial statements and related notes and other financial information appearing in this Annual Report. Some of the information contained in this discussion and analysis or set forth elsewhere in this Annual Report, including information with respect to our plans and strategy for our business, operations, and product candidates, includes forward-looking statements that involve risks and uncertainties. You should review the sections of this Annual Report on Form 10-K captioned "Risk Factors" and "Cautionary Note Regarding Forward-Looking Statements" for a discussion of important factors that could cause our actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.
Overview
We are a clinical-stage biopharmaceutical company focused on identifying, developing, and commercializing innovative therapies that change patients' lives for the better. We concentrate on small-molecule therapeutics with novel mechanisms of action for the treatment of severe, life-threatening diseases with few or no approved therapies. Our lead programs are in rare forms of CKD and a rare neurological disease. We recently announced positive topline data from registrational studies for both of our lead product candidates, bardoxolone in patients with CKD caused by Alport syndrome, and omaveloxolone in patients with a neurological disorder called FA. Both bardoxolone and omaveloxolone activate the transcription factor Nrf2 to normalize mitochondrial function, restore redox balance, and resolve inflammation. Because mitochondrial dysfunction, oxidative stress, and inflammation are features of many diseases, we believe bardoxolone and omaveloxolone have many potential clinical applications. We possess exclusive, worldwide rights to develop, manufacture and commercialize bardoxolone, omaveloxolone, and our next-generation Nrf2 activators, excluding certain Asian markets for bardoxolone in certain indications which are licensed to KKC.
Programs in Chronic Kidney Disease
We are developing bardoxolone for the treatment of patients with CKD caused by
Alport syndrome, ADPKD, and other rare forms of CKD that, in the aggregate,
affect more than 700,000 patients in
Alport syndrome is a rare, genetic form of CKD caused by mutations in the genes encoding type IV collagen, which is a major structural component of the GBM in the kidney. Alport syndrome patients experience a progressive worsening of the kidney's capacity to filter waste products out of the blood that can lead to ESKD and the need for chronic dialysis treatment or a kidney transplant. Alport syndrome affects both children and adults and, in patients with the most severe forms of the disease, approximately 50% progress to dialysis by age 25, 90% by age 40, and nearly 100% by age 60. According to theAlport Syndrome Foundation , Alport syndrome affects approximately 30,000 to 60,000 people inthe United States . There are currently no approved therapies to treat CKD caused by Alport syndrome. InNovember 2019 , we announced that the Phase 3 portion of the CARDINAL study of bardoxolone in patients with CKD caused by Alport syndrome met its primary and key secondary Year 1 endpoints. After 48 weeks of treatment, patients treated with bardoxolone had a statistically significant improvement compared to placebo in mean eGFR of 9.50 mL/min/1.73 m2 (p<0.0001). After 48 weeks of treatment and a four-week withdrawal period, patients treated with bardoxolone had a statistically significant improvement compared to placebo in mean retained eGFR of 5.14 mL/min/1.73 m2 (p=0.0012). After 52 weeks, patients in the placebo arm of CARDINAL lost an average of 6.1 mL/min/1.73 m2. Based on these positive results, and subject to discussions with regulatory authorities, we plan to proceed with the submission of regulatory filings this year for marketing approval inthe United States . ADPKD is a rare and serious hereditary form of CKD caused by a genetic defect in PKD1 or PKD2 genes leading to the formation of fluid-filled cysts in the kidneys and other organs. Cyst growth can cause the kidneys to expand up to five to seven times their normal volume, leading to pain and progressive loss of kidney function. ADPKD affects both men and women of all racial and ethnic groups and is the leading inheritable cause of kidney failure with an estimated diagnosed population of 140,000 patients inthe United States . Despite current standard of 93
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care treatment, an estimated 50% of ADPKD patients progress to ESKD and require dialysis or a kidney transplant by 60 years of age.
In a Phase 2 study calledPHOENIX , bardoxolone demonstrated a statistically significant increase from baseline of 9.3 mL/min/1.73 m2 in mean eGFR after 12 weeks of treatment in 31 patients with ADPKD. Available historical data for 29 of these patients showed an average annual decline in eGFR of 4.8 mL/min/1.73 m2 in the three-year period prior to study entry. InMay 2019 , we began enrollment in FALCON, an international, multi-center, randomized, double-blind, placebo-controlled Phase 3 trial studying the safety and efficacy of bardoxolone in approximately 300 patients with ADPKD. The trial will enroll a broad range of patients from 18 to 70 years old with an eGFR between 30 to 90 mL/min/1.73 m². The FDA has provided us with written guidance that, in patients with ADPKD, an analysis of retained eGFR demonstrating an improvement versus placebo after one year of bardoxolone treatment may support accelerated approval, and an improvement versus placebo after two years of treatment may support full approval. Three additional rare forms of CKD were studied inPHOENIX , IgAN, T1D CKD, and FSGS. In each of these Phase 2 cohorts, bardoxolone demonstrated a statistically significant increase from baseline in mean eGFR after 12 weeks of treatment in patients whose available historical data showed annual declines in eGFR in the three-year period prior to study entry. We believe that clinical trials similar to the design of the Phase 3 CARDINAL and FALCON trials with a two-year duration and a retained eGFR benefit endpoint after one and two years of treatment may be acceptable for submission of an NDA for these forms of CKD to the FDA. We plan to pursue each of these rare and serious forms of CKD as commercial indications. The FDA has granted orphan drug designation to bardoxolone for the treatment of Alport syndrome and ADPKD, and theEuropean Commission has granted orphan drug designation to bardoxolone for the treatment of Alport syndrome.
Programs in Neurological Diseases
We are developing omaveloxolone for the treatment of patients with FA, an inherited, debilitating, and degenerative neuromuscular disorder that is typically diagnosed during adolescence and can ultimately lead to premature death. Patients with FA experience progressive loss of coordination, muscle weakness, and fatigue, which commonly progresses to motor incapacitation and wheelchair reliance. Symptoms generally occur in children, with patients requiring a wheelchair by their teens or early 20s. FA affects approximately 5,000 children and adults inthe United States and 22,000 individuals globally. There are currently no approved therapies to treat FA. InOctober 2019 , we announced that the registrational part 2 portion of the MOXIe Phase 2 trial of omaveloxolone in patients with FA met its primary endpoint of change in mFARS relative to placebo after 48 weeks of treatment. Patients treated with omaveloxolone (150 mg/day) demonstrated a statistically significant, placebo-corrected 2.40 point mean improvement (decrease) in mFARS after 48 weeks of treatment (p=0.014). Omaveloxolone treatment was generally reported to be well-tolerated. Based on these positive results, and subject to discussions with regulatory authorities, we plan to proceed with the submission of regulatory filings this year for marketing approval of omaveloxolone for the treatment of FA inthe United States . The FDA and theEuropean Commission have granted orphan drug designation to omaveloxolone for the treatment of FA. In addition, we have observed compelling activity of omaveloxolone and our other Nrf2 activators in preclinical models of Parkinson's disease, dementia, epilepsy, Huntington's disease, and ALS, and we plan to pursue the development of omaveloxolone and our other Nrf2 activators for one or more of these diseases. We are also developing RTA 901 in neurological indications. RTA 901 is the lead product candidate from our Hsp90 modulator program. We have observed favorable activity of RTA 901 in a range of preclinical models of neurological disease, including models of diabetic neuropathy, neuroinflammation, and neuropathic pain. We have completed a Phase 1 trial to evaluate the safety, tolerability, and pharmacokinetic profile of RTA 901 administered orally, once-daily in healthy adult volunteers, and no safety or tolerability concerns were reported plan. We plan to continue RTA 901 development activities in neurological diseases such as diabetic neuropathy. We are the exclusive licensee of RTA 901 and have worldwide commercial rights. 94
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Other Clinical Programs
In addition to our lead programs in rare forms of CKD and a rare neurological disease, we are exploring additional clinical and preclinical programs. Our most advanced program outside of CKD and neurological diseases is the registrational Phase 3 CATALYST study of bardoxolone in PAH caused by CTD-PAH. CTD-PAH is a rare, serious, and progressive disease that leads to heart failure and death. CTD-PAH patients are less responsive to existing vasodilator therapies than patients with the more common, I-PAH and have a worse prognosis. In a Phase 2 clinical trial in patients with PAH called LARIAT, bardoxolone demonstrated a statistically significant, time-averaged increase in mean 6MWD at 16 weeks in CTD-PAH patients compared to baseline. CATALYST is an international, multi-center, randomized, double-blind, placebo-controlled trial studying the safety and efficacy of bardoxolone in CTD-PAH patients randomized one-to-one to active drug or placebo. We completed the enrollment of CATALYST and expect to have top-line data in mid-2020. Based on discussions with the FDA, the primary endpoint of CATALYST is the change from baseline in 6MWD compared to placebo after 24 weeks of treatment. If positive, we believe that the results of CATALYST, together with other data from our development program, may be sufficient to form the basis of an NDA submission to the FDA seeking approval of bardoxolone for the treatment of CTD-PAH. The FDA has granted orphan drug designation to bardoxolone for the treatment of PAH. In addition, we are developing RTA 1701, the lead product candidate from our proprietary series of ROR?t inhibitors, for the potential treatment of a broad range of autoimmune, inflammatory, and fibrotic diseases. We have completed a Phase 1 trial to evaluate the safety, tolerability, and pharmacokinetic profile of RTA 1701 in healthy adult volunteers. No safety or tolerability concerns were reported, and we observed an acceptable pharmacokinetic profile. We plan to continue development for RTA 1701 in autoimmune, inflammatory, or fibrotic diseases. We retain all rights to our ROR?t inhibitors, which are not subject to any existing commercial collaborations.
Collaborations Update
InOctober 2019 , we and AbbVie entered into the Reacquisition Agreement, under which we reacquired the development, manufacturing, and commercialization rights provided in the AbbVie License Agreement and the Collaboration Agreement. Under the Reacquisition Agreement, the AbbVie License Agreement and the Collaboration Agreement were amended, resulting in AbbVie granting its exclusive sublicenses back to us, such that we reacquired the worldwide rights to bardoxolone, excluding certain Asian countries previously licensed to KKC, and the worldwide rights to omaveloxolone and certain next-generation Nrf2 activators. By reacquiring our rights, we were relieved from our obligations under the AbbVie License Agreement and the Collaboration Agreement. In exchange for such rights, we agreed to pay AbbVie$330.0 million , of which$100.0 million was paid as ofDecember 31, 2019 ,$150.0 million will be payable onJune 30, 2020 , and$80.0 million will be payable onNovember 30, 2021 . Additionally, we will pay AbbVie an escalating, low single-digit royalty on worldwide net sales, on a product-by-product basis, of omaveloxolone and certain next-generation Nrf2 activators. After the$330.0 million has been paid to AbbVie, the licenses granted to AbbVie and the sublicenses granted to us with respect to omaveloxolone and certain next-generation Nrf2 activators will terminate, with all rights reverting to us, and, if (or when) 18 months has elapsed since the execution of the Reacquisition Agreement, the licenses granted to AbbVie and the sublicenses granted to us with respect to bardoxolone will also terminate, with all rights reverting to us.
Corporate Overview
To date, we have focused most of our efforts and resources on developing our product candidates and conducting preclinical studies and clinical trials. We have historically financed our operations primarily through revenue generated from our collaborations with AbbVie and KKC, from sales of our securities, and with secured loans. We have not received any payments or revenue from collaborations other than nonrefundable upfront, milestone, and cost sharing payments from our collaborations with AbbVie and KKC and reimbursements of expenses under the terms of our agreement with KKC. We have incurred losses in each year since our inception, other than in 2014. As ofDecember 31, 2019 , we had$664.3 million of cash and cash equivalents and an 95 -------------------------------------------------------------------------------- accumulated deficit of$710.5 million . We continue to incur significant research and development and other expenses related to our ongoing operations. Despite contractual product development commitments and the potential to receive future payments from KKC, we anticipate that we will continue to incur losses for the foreseeable future, and we anticipate that our losses will increase as we continue our development of, seek regulatory approval for, and potential commercialization of our product candidates. If we do not successfully develop and obtain regulatory approval of our existing product candidates or any future product candidates and effectively manufacture, market, and sell any products that are approved, we may never generate revenue from product sales. Furthermore, even if we do generate revenue from product sales, we may never again achieve or sustain profitability on a quarterly or annual basis. Our prior losses, combined with expected future losses, have had and will continue to have an adverse effect on our stockholders' equity and working capital. Our failure to become and remain profitable could depress the market price of our Class A common stock and could impair our ability to raise capital, expand our business, diversify our product offerings, or continue our operations. InNovember 2019 , we closed a follow-on underwritten public offering of 2,760,000 shares of our Class A common stock for gross proceeds of$505.1 million . We received net proceeds from the offering of$491.9 million , after deducting underwriting discounts and commissions and offering expenses. We intend to use the net proceeds for working capital and general corporate purposes, which include, but are not limited to, advancing the development of bardoxolone and omaveloxolone through clinical trials, preparing to file one or more NDAs, and planning for commercialization of our potential products. The probability of success for each of our product candidates and clinical programs and our ability to generate product revenue and become profitable depend upon a variety of factors, including the quality of the product candidate, clinical results, investment in the program, competition, manufacturing capability, commercial viability, and our collaborators' ability to successfully execute our development and commercialization plans. We will also require additional capital through equity, debt, or royalty financings or collaboration arrangements in order to fund our operations and execute on our business plans, and there is no assurance that such financing or arrangements will be available to us on commercially reasonable terms or at all. For a description of the numerous risks and uncertainties associated with product development and raising additional capital, see "Risk Factors" included in this Annual Report. Financial Operations Overview Revenue Our revenue to date has been generated primarily from licensing fees received under our collaborative license agreements and reimbursements for expenses. We currently have no approved products and have not generated any revenue from the sale of products to date. In the future, we may generate revenue from product sales, royalties on product sales, reimbursements for collaboration services under our current collaboration agreements, or license fees, milestones, or other upfront payments if we enter into any new collaborations or license agreements. We expect that our future revenue will fluctuate from quarter to quarter for many reasons, including the uncertain timing and amount of any such payments and sales. Our license and milestone revenue have been generated primarily from the KKC Agreement, the AbbVie License Agreement, and the Collaboration Agreement and consists of upfront payments and milestone payments. License revenue recorded with respect to the KKC Agreement, the AbbVie License Agreement, and the Collaboration Agreement consists solely of the recognition of deferred revenue. Under our revenue recognition policy, collaboration revenue associated with upfront, non-refundable license payments received under our license and collaboration agreements are deferred and recognized ratably over the expected term of the performance obligations under each agreement. Under the Reacquisition Agreement, we no longer have performance obligations under the AbbVie License Agreement and the Collaboration Agreement, and the related remaining deferred revenue balance of$191.1 million under the Collaboration Agreement was expensed as reacquired license rights in the fourth quarter of 2019. As the AbbVie License Agreement was fully recognized in 2017, we only expect to recognize revenue under the KKC Agreement, which extends through 2021. 96
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Research and Development Expenses
The largest component of our total operating expenses has historically been our investment in research and development activities, including the clinical development of our product candidates. From our inception throughDecember 31, 2019 , we have incurred a total of$774.9 million in research and development expense, a majority of which relates to the development of bardoxolone and omaveloxolone. We expect our research and development expense to continue to increase in the future as we advance our product candidates through clinical trials and expand our product candidate portfolio. The process of conducting the necessary clinical research to obtain regulatory approval is costly and time-consuming, and we consider the active management and development of our clinical pipeline to be crucial to our long-term success. The actual probability of success for each product candidate and preclinical program may be affected by a variety of factors, including the safety and efficacy data for product candidates, investment in the program, competition, manufacturing capability, and commercial viability.
Research and development expenses include:
• expenses incurred under agreements with clinical trial sites that
conduct research and development activities on our behalf; • expenses incurred under contract research agreements and other agreements with third parties;
• employee and consultant-related expenses, which include salaries,
benefits, travel, and stock-based compensation;
• laboratory and vendor expenses related to the execution of preclinical
and non-clinical studies and clinical trials;
• the cost of acquiring, developing, manufacturing, and distributing
clinical trial materials;
• the cost of development, scale up, and process validation activities to
support product registration; and
• facilities, depreciation, and other expenses, which include direct and
allocated expenses for rent and maintenance of facilities, insurance,
and other supply costs.
Research and development costs are expensed as incurred. Costs for certain development activities such as clinical trials are highly judgmental and are recognized based on an evaluation of the progress to completion of specific tasks using information and data provided to us by our vendors and our clinical sites. We base our expense accruals related to clinical trials on our estimates of the services received and efforts expended pursuant to contracts with multiple research institutions and CROs that conduct and manage clinical trials on our behalf. The financial terms of these agreements vary from contract to contract and may result in uneven payment flows. Payments under some of these contracts depend on factors such as the successful enrollment of patients and the completion of clinical trial milestones. In accruing costs, we estimate the time period over which services will be performed and the level of effort to be expended in each period. If we do not identify costs that we have begun to incur or if we underestimate or overestimate the level of services performed or the costs of these services, our actual expenses could differ from our estimates. To date, we have not experienced material changes in our estimates of accrued research and development expenses after a reporting period. However, due to the nature of estimates, we cannot assure you that we will not make changes to our estimates in the future as we become aware of additional information about the status or conduct of our clinical trials and other research activities. Currently, KKC has allowed us to conduct clinical studies of bardoxolone in CTD-PAH and certain rare forms of kidney diseases inJapan and has reimbursed us the majority of the costs for our CARDINAL study inJapan and is paying for the costs of a certain number of patients as the in-country caretaker in our FALCON study inJapan . We reduced our expenses by$0.5 million ,$2.0 million and$0.5 million for KKC's share of the study costs for the year endedDecember 31, 2019 , 2018 and 2017, respectively. 97
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The following table summarizes our research and development expenses incurred
during the years ended
2019 2018 2017 (in thousands) Bardoxolone methyl$ 47,994 $ 43,566 $ 35,999 Omaveloxolone 23,992 19,277 10,123 RTA 901 1,859 350 1,927 RTA 1701 1,505 2,263 2,942
Other research and development expenses 52,759 31,832 20,282
Total research and development expenses
The program-specific expenses summarized in the table above include costs that we directly allocate to our product candidates. Our other research and development expenses include research and development salaries, benefits, stock-based compensation and preclinical, research, and discovery costs, which we do not allocate on a program-specific basis.
Acquired License Rights
All acquired license costs that are in-process research and development (the "IPR&D"), which are acquired directly in a transaction other than a business combination and which do not have an alternative future use, are expensed as incurred. InOctober 2019 , we and AbbVie entered into the Reacquisition Agreement, under which we reacquired the development, manufacturing, and commercialization rights provided in the AbbVie License Agreement and the Collaboration Agreement. Under the Reacquisition Agreement, the AbbVie License Agreement and the Collaboration Agreement were amended, resulting in AbbVie granting its exclusive sublicenses back to us, such that we reacquired the worldwide rights to bardoxolone, excluding certain Asian countries previously licensed to KKC, and the worldwide rights to omaveloxolone and certain next-generation Nrf2 activators. By reacquiring our rights, we were relieved from our obligations under the AbbVie License Agreement and the Collaboration Agreement.
General and Administrative Expenses
General and administrative expenses consist primarily of employee-related expenses for executive, operational, finance, legal, compliance, and human resource functions. Other general and administrative expenses include personnel expense, facility-related costs, professional fees, accounting and legal services, depreciation expense, other external services, and expenses associated with obtaining and maintaining our intellectual property rights. We anticipate that our general and administrative expenses will increase in the future as we increase our headcount to support our continued research and development and potential commercialization of our product candidates. We have also incurred, and anticipate incurring in the future, increased expenses associated with being a public company, including exchange listing andSEC requirements, director and officer insurance premium, legal, audit and tax fees, compliance with the Sarbanes-Oxley Act, regulatory compliance programs, and investor relations costs. Additionally, if and when we believe the first regulatory approval of one of our product candidates appears likely, we anticipate an increase in payroll and related expenses as a result of our preparation for commercial operations, especially for the sales and marketing of our product candidates. Other Income (Expense), Net Other income (expense) includes interest and gains earned on our cash and cash equivalents, interest expense on term loan, amortization of debt issuance costs, imputed interest on long term payables, loss on extinguishment of debt, foreign currency exchange gains and losses, and gains and losses on sales of assets. 98
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Provision for Taxes on Income
Provision for taxes on income consists of net loss, taxed at federal tax rates and adjusted for certain permanent differences. We maintain a full valuation allowance against our net deferred tax assets. Changes in this valuation allowance also affect the tax provision.
Results of Operations
Comparison of the Years Ended
The following table sets forth our results of operations for the years endedDecember 31 : 2019 Change 2018 Change 2017 (in thousands, except percentage data) Consolidated Statements of Operations Data Collaboration revenue License and milestone$ 25,276 (52 )%$ 52,351 11 %$ 47,103 Other revenue 1,241 0 % 1,238 30 % 955 Total collaboration revenue 26,517 (51 )% 53,589 12 % 48,058 Expenses Research and development 128,109 32 % 97,288 37 % 71,273 Reacquired license rights 124,398 100 % - - - General and administrative 58,298 78 % 32,748 41 % 23,260 Depreciation 932 116 % 431 (1 )% 437 Total expenses 311,737 139 % 130,467 37 % 94,970 Other income (expense), net (4,942 ) (36 )% (3,642 ) (382 )% (756 ) Loss before taxes on income (290,162 ) (260 )% (80,520 ) (69 )% (47,668 ) Provision for taxes on income 8 (69 )% 26 767 % 3 Net loss$ (290,170 ) (260 )%$ (80,546 ) (69 )%$ (47,671 ) Revenue License and milestone revenue represented approximately 95%, 98%, and 98% of total revenue for the years endedDecember 31, 2019 , 2018, and 2017, respectively, and consisted primarily of the recognition of deferred revenue. License and milestone revenue decreased by 52% during 2019 compared to 2018, primarily due to additional revenue related to variable consideration that was included in the transaction price under the KKC Agreement and recognized in the prior year period. Since we did not have a similar event in the current period, the revenue decreased by comparison. Additionally, revenue decreased due to the Reacquisition Agreement inOctober 2019 , which ended our performance obligations under the Collaboration Agreement and resulted in the writing off of the related remaining deferred revenue balance as reacquired license rights expense, after which no further revenue was recognized. Total revenue expected to be recognized from deferred revenue in 2020 is$4.7 million from the KKC Agreement. License and milestone revenue increased by 11% during 2018 compared to 2017. The increase was primarily due to additional revenue of$22.5 million related to the KKC Agreement, offset by the full recognition of deferred revenue for the AbbVie License Agreement inNovember 2017 . 99
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The following table summarizes the sources of our revenue for the years endedDecember 31 : 2019 2018 2017 (in thousands) License and milestone AbbVie license agreement $ - $ -$ 18,420 AbbVie collaboration agreement 20,588 26,647 26,647 KKC agreement 4,688 24,704 1,536 Other - 1,000 500 Total license and milestone$ 25,276 $ 52,351 $ 47,103 Other revenue 1,241 1,238 955 Total collaboration revenue$ 26,517 $ 53,589 $ 48,058
The following table summarizes our expenses, in thousands and as a percentage of
total expenses, for the years ended
% of % of % of Total Total Total Description 2019 Expenses 2018 Expenses 2017 Expenses Research and development$ 128,109 41 %$ 97,288 75 %$ 71,273 75 % Reacquired license rights 124,398 40 % - - - - General and administrative 58,298 19 % 32,748 25 % 23,260 25 % Depreciation 932 0 % 431 0 % 437 0 % Total expenses$ 311,737 $ 130,467 $ 94,970
Research and Development Expenses
Research and development expenses increased by 32% during 2019 compared to 2018. The increase was primarily due to$16.0 million in increased personnel and equity compensation expenses to support growth of our development activities,$3.8 million in increased medical affairs and other research activities to support our registrational trials, and$9.8 million in increased manufacturing to support product registration and increased clinical expenses for startup activities for FALCON and the extension trials for our registrational programs, which were offset by decreased clinical expenses for fully enrolled and completed studies. Research and development expenses increased by 37% during 2018 compared to 2017. The increase was primarily due to an increase in clinical and manufacturing activities, primarily from increases totaling$24.9 million for CARDINAL,PHOENIX , and part 2 of MOXIe, offset by decreases totaling$10.3 million in clinical and manufacturing activities related to REVEAL, MOTOR, and RTA 901, which were completed in 2017. Additionally, research and development expenses increased by$4.8 million in medical affairs activities in our bardoxolone clinical programs,$4.6 million in personnel and equity compensation expenses to support growth in our development activities, and$1.8 million in additional discovery activities. Research and development expenses, as a percentage of total expenses, was 41%, 75%, and 75% for 2019, 2018, and 2017, respectively. The decrease in 2019 compared to 2018 was primarily due to the reacquired license rights of$124.4 million incurred during 2019 and to increased general and administrative expenses during related to rent, insurance premiums, and other office expenses.
Reacquired License Rights
Reacquired license rights increased by 100% during 2019 compared to 2018. The increase was due to the Reacquisition Agreement we entered into with AbbVie inOctober 2019 to reacquire the development, manufacturing, and commercialization rights provided in the AbbVie License Agreement and the Collaboration Agreement. For a complete discussion of accounting for reacquired license rights, see Note 3, Collaboration Agreements of Notes to Consolidated Financial Statements contained in this Annual Report on Form 10-K. 100
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General and Administrative Expenses
General and administrative expenses increased by 78% during 2019 compared to 2018. The increase was primarily due to$19.3 million in increased personnel and equity compensation expenses and$5.6 million in increased rent, director and officer insurance premiums, and other office expenses to support growth in our development activities. General and administrative expenses increased by 41% during 2018 compared to 2017. The increase was primarily due to$4.3 million in personnel, consulting, and equity compensation expenses to support growth in our development activities,$3.6 million sublicense fees and other expenses from the achievement of the KKC milestone, and$2.2 million in commercial research activities. General and administrative expenses, as a percentage of total expenses, was 19%, 25%, and 25% for 2019, 2018, and 2017, respectively. Although general and administrative expenses increased during 2019 as discussed above, as a percentage of total expenses, general and administrative expenses decreased overall in 2019 compared to 2018, primarily due to the reacquired license rights of$124.4 million incurred during 2019.
Other Income (Expense), Net
Other income (expense), net increased by 36% during the 2019 compared to 2018. The increase was primarily due to$5.0 million in additional interest expense that was attributable to borrowing additional amounts under the Term Loans inJune 2018 andDecember 2019 , which was offset by$2.7 million in increased interest income earned due to increases in our cash balance from the Term Loans and our follow-on public offering in the fourth quarter of 2019. Other income (expense), net increased by 382% during the 2018 compared to 2017. The increase was primarily due to$4.7 million in additional interest expense that was attributable to borrowing additional amounts under the Term A Loan inJune 2018 , which was offset by$2.8 million in increased interest income earned due to increases in our cash balance from the Term A Loan and our follow-on public offering that occurred inJuly 2018 .
Provision (Benefit) for Taxes
Provision (benefit) for taxes on income were immaterial during 2019, 2018, and 2017.
Liquidity and Capital Resources
Since our inception, we have funded our operations primarily through collaboration and license agreements, the sale of preferred and common stock, and secured loans. To date, we have raised gross cash proceeds of$476.6 million through the sale of convertible preferred stock and$780.0 million from payments under license and collaboration agreements. We also obtained$894.7 million in net proceeds from our IPO and follow-on offerings of our Class A common stock and$151.6 million in net proceeds from the Amended Restated Loan Agreement. We have not generated any revenue from the sale of any products. As ofDecember 31, 2019 , we had available cash and cash equivalents of approximately$664.3 million . Our cash and cash equivalents are invested in accordance with our investment policy, primarily with a view to liquidity and capital preservation. 101
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Cash Flows
The following table sets forth the primary sources and uses of cash for the years endedDecember 31 : 2019 2018 2017 (in thousands) Net cash (used in) provided by: Operating activities$ (251,151 ) $ (83,783 ) $ (83,256 ) Investing activities (2,673 ) (679 ) (343 ) Financing activities 580,358 292,472 128,647
Net increase in cash and cash equivalents
Operating Activities Net cash used in operating activities was$251.2 million for the year endedDecember 31, 2019 , consisting primarily of net loss of$290.2 million adjusted for non-cash items including stock-based compensation expense of$26.4 million , depreciation and amortization expense of$2.3 million , and a net increase in operating assets and liabilities of$10.3 million . The significant items in the change in operating assets that impacted our use of cash in operations include increases in accrued direct research and other current and long-term liabilities of$12.0 million due to activities directly related to our clinical trials and other activities to support our registrational trials, an increase in payables to collaborators of$216.9 million primarily due to the remaining payable due to AbbVie for the reacquisition of development, manufacturing, and commercialization rights, a decrease in accounts payable of$2.1 million due to timing of payments, and a decrease in deferred revenue of$216.3 million . The decrease in deferred revenue is due to the ratable recognition of approximately$25.2 million in revenue offset by the write off of the$191.1 million deferred revenue balance related to the Collaboration Agreement, after our performance obligations were terminated under the Reacquisition Agreement. Net cash used in operating activities was$83.8 million for the year endedDecember 31, 2018 , consisting primarily of net loss of$80.5 million adjusted for non-cash items including stock-based compensation expense of$10.6 million , depreciation and amortization expense of$1.2 million , loss on extinguishment of debt of$1.0 million , and a net decrease in operating assets and liabilities of$16.1 million . The significant items in the change in operating assets and liabilities include an increase of prepaid expenses and other current assets of$1.1 million due to prepayments on trial and other operating expenses and reimbursements due from KKC, an increase in accrued direct research and other current liabilities of$4.4 million due to clinical and manufacturing activities, an increase in accounts payable of$2.0 million due to timing of vendor payment, and a decrease in deferred revenue of$21.4 million . The decrease in deferred revenue relates to the ratable recognition of revenue over the expected term of the performance obligations under our collaboration agreements with AbbVie and KKC, which resulted in recognition of$51.4 million of license and milestone revenue, offset by the achievement of regulatory milestone of$30.0 million related to the KKC Agreement, which was recognized as deferred revenue. Net cash used in operating activities was$83.3 million for the year endedDecember 31, 2017 , consisting primarily of net loss of$47.7 million adjusted for non-cash items including stock-based compensation expense of$6.5 million , depreciation and amortization expense of$0.6 million , and a net decrease in operating assets and liabilities of$42.7 million . The significant items in the change in operating assets and liabilities include an increase of prepaid expenses and other current assets of$1.3 million due to prepayments on trial and other operating expenses and reimbursements due from KKC, an increase in accrued direct research and other current liabilities of$7.0 million due to clinical trial activities, a decrease in accounts payable of$1.8 million due to timing of vendor payment, and a decrease in deferred revenue of$46.6 million . The decrease in deferred revenue relates to the timing of upfront payments and ratable recognition of revenue over the expected term of the performance obligations under our collaboration agreements with AbbVie and KKC, resulting in recognition of$46.6 million of license and milestone revenue.
Investing Activities
Net cash used in investing activities was
102
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Net cash used in investing activities of
Financing Activities
Net cash provided by financing activities for the year endedDecember 31, 2019 was$580.4 million , primarily due to net proceeds of$492.4 million from our follow-on public offering and$75.0 million from the Amended Restated Loan Agreement. Net cash provided by financing activities for the year endedDecember 31, 2018 was$292.5 million , primarily due to net proceeds of$232.9 million from our follow-on public offering and$57.7 million from the Restated Loan Agreement. Net cash provided by financing activities for the year endedDecember 31, 2017 was$128.6 million , primarily due to net proceeds of$108.5 million from our follow-on public offering and$19.5 million from the Amended Loan Agreement.
Operating Capital Requirements
To date, we have not generated any revenue from product sales. We do not know when or whether we will generate any revenue from product sales. We do not expect to generate significant revenue from product sales unless and until we obtain regulatory approval of and commercialize one or more of our current or future product candidates. We anticipate that we will continue to generate losses for the foreseeable future, and we expect the losses to increase as we continue the development of, and seek regulatory approvals for, our product candidates, and begin to commercialize any approved products. We are subject to all the risks related to the development and commercialization of novel therapeutics, and we may encounter unforeseen expenses, difficulties, complications, delays, and other unknown factors that may adversely affect our business. We continue to incur additional costs associated with operating as a public company. We anticipate that we will need substantial additional funding in connection with our continuing operations.
On
OnOctober 15, 2019 , we entered into the 2019 Lease Agreement, relating to the lease of approximately 327,400 square feet of office and laboratory space located inPlano, Texas . The term of the Lease is estimated to commence mid-2022, when construction is completed, and continue for 16 years, with up to 10 years of extension at our option. The initial annual base rent will be determined based on the project cost, subject to an initial annual cap of approximately$13.3 million , which may increase in certain circumstances. Beginning in the third lease year, the base rent will increase 1.95% per annum each year. In addition to the annual base rent, we will pay for taxes, insurance, utilities, operating expenses, assessments under private covenants, maintenance and repairs, certain capital repairs and replacements, and building management fees. OnOctober 9, 2019 , we and AbbVie entered into the Reacquisition Agreement pursuant to which we reacquired the development, manufacturing, and commercialization rights concerning our proprietary Nrf2 activator product platform originally licensed to AbbVie in the AbbVie License Agreement and the Collaboration Agreement. In exchange for such rights, we will pay AbbVie$330.0 million , of which$100.0 million was paid as ofDecember 31, 2019 ,$150.0 million is payable onJune 30, 2020 , and$80.0 million is payable onNovember 30, 2021 . We will also pay AbbVie an escalating, low single-digit royalty on worldwide net sales, on a product-by-product basis, of omaveloxolone and an identified list of certain next-generation Nrf2 activators. The termination of our deferred revenue balance will not have an impact on our cash flow.
In
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program in connection with the
Our longer term liquidity requirements will require us to raise additional capital, such as through additional equity, debt, or royalty financings or collaboration arrangements. Our future capital requirements will depend on many factors, including the receipt of milestones under our KKC Agreement and the timing of our expenditures related to clinical trials. We believe our existing cash and cash equivalents will be sufficient to enable us to fund our operations through the end of 2021. However, we anticipate opportunistically raising additional capital before that time through equity offerings, collaboration or license agreements, additional debt, or royalty financings in order to maintain adequate capital reserves. In addition, we may choose to raise additional capital at any time for the further development of our existing product candidates and may also need to raise additional funds sooner to pursue other development activities related to additional product candidates. Decisions about the timing or nature of any financing will be based on, among other things, our perception of our liquidity and of the market opportunity to raise equity, debt, or royalty financing. Additional securities may include common stock, preferred stock, or debt securities. We may explore strategic collaborations or license arrangements for any of our product candidates. If we do explore any arrangements, there can be no assurance that any agreement will be reached, and we may determine to cease exploring a potential transaction for any or all of the assets at any time. If an agreement is reached, there can be no assurance that any such transaction would provide us with a material amount of additional capital resources. Until we can generate a sufficient amount of revenue from our product candidates, if ever, we expect to finance future cash needs through public or private equity or debt offerings, commercial loans, royalty financings, and collaboration or license transactions. Additional capital may not be available on reasonable terms, if at all. If we are unable to raise additional capital in sufficient amounts or on terms acceptable to us, we may have to significantly delay, scale back, or discontinue the development or commercialization of one or more of our product candidates. If we raise additional funds through the issuance of additional equity or debt securities, it could result in dilution to our existing stockholders or increased fixed payment obligations, and any such securities may have rights senior to those of our common stock. If we incur indebtedness, we could become subject to covenants that would restrict our operations and potentially impair our competitiveness, such as limitations on our ability to incur additional debt, limitations on our ability to acquire, sell, or license intellectual property rights, and other operating restrictions that could adversely affect our ability to conduct our business, and any such debt could be secured by some or all of our assets. Any of these events could significantly harm our business, financial condition, and prospects. Our forecast of the period through which our financial resources will be adequate to support our operations is a forward-looking statement and involves risks and uncertainties, and actual results could vary as a result of a number of factors. We have based this estimate on assumptions that may prove to be wrong, and we could utilize our available capital resources sooner than we currently expect. Our future funding requirements, both near- and long-term, will depend on many factors, including, but not limited to:
• the scope, rate of progress, results, and cost of our clinical
trials, preclinical testing, and other activities related to the development of our product candidates; • the number and characteristics of product candidates that we pursue; • the costs of development efforts for our product candidates that are not subject to reimbursement from our collaborators; • the costs necessary to obtain regulatory approvals, if any, for our product candidates inthe United States and other
jurisdictions, and
the costs of post-marketing studies that could be required by regulatory authorities in jurisdictions where approval is obtained; • the continuation of our existing collaboration with KKC and entry into new collaborations and the receipt of any collaboration payments; • the time and unreimbursed costs necessary to commercialize products in territories in which our product candidates are approved for sale; 104
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• the revenue from any future sales of our products for which we are entitled to a profit share, royalties, and milestones;
• the level of reimbursement or third-party payor pricing available to
our products; • the costs of obtaining third-party commercial supplies of our products, if any, manufactured in accordance with regulatory requirements; • the costs associated with any potential loss or corruption of our information or data in a cyberattack on our computer system; • the costs associated with being a public company; and • the costs we incur in the filing, prosecution, maintenance, and defense of our patent portfolio and other intellectual property rights.
If we cannot expand our operations or otherwise capitalize on our business opportunities because we lack sufficient capital, our business, financial condition, and results of operations could be materially adversely affected.
Contractual Obligations and Commitments
Contractual Obligations
As of
Payments due by period Less than 1 to 3 4 to 5 1 year years years Total (unaudited) (in thousands) Operating lease obligations(1)$ 3,649 $ 7,986 $ -$ 11,635 Outstanding term loan - 122,708 32,292 155,000 Payable to collaborators 150,000 80,000 - 230,000
Total contractual obligations
(1) Total minimum future lease payments for the
not commenced as of
financial statement, as we do not yet control of the underlying
assets. The lease is expected to commence mid-2022 with lease initial
lease term of 16 years.
Clinical Trials
As ofDecember 31, 2019 , we have several on-going clinical trials in various stages. Under agreements with various CROs and clinical trial sites, we incur expenses related to clinical trials of our product candidates and potential other clinical candidates. The timing and amounts of these disbursements are contingent upon the achievement of certain milestones, patient enrollment, and services rendered or as expenses are incurred by the CROs or clinical trial sites. Therefore, we cannot estimate the potential timing and amount of these payments and they have been excluded from the table above.
Critical Accounting Policies and Significant Judgments and Estimates
Our management's discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance withUnited States generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, and expenses and the disclosure of contingent assets and liabilities in our financial statements. On an ongoing basis, we evaluate our estimates and judgments, including those related to revenue recognition, accrued research and development expenses, income taxes, and stock-based compensation. We base our estimates on historical experience, known trends and events, and various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments 105
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about the carrying values 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 described in more detail in Note 2 of Notes to Consolidated Financial Statements appearing elsewhere in this Annual Report, we believe the following accounting policies to be most critical to understanding the judgments and estimates used by management in the preparation of our financial statements. Revenue Recognition We currently recognize revenue generated primarily from licensing fees received under our collaborative licensing agreements with AbbVie and KKC and reimbursements for expenses from KKC. The terms of the agreements include non-refundable upfront fees, funding of research and development activities, payments based upon achievement of milestones, and royalties on net product sales. Under Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (Topic 606), an entity recognizes revenue when its customer obtains control of promised goods or services, in an amount that reflects the consideration which the entity expects to receive in exchange for those goods or services. To determine revenue recognition for arrangements that an entity determines are within the scope of Topic 606, the entity performs the following five steps: (i) identify the promised goods or services in the contract with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price, including the constraint on variable consideration; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when or as the entity satisfies a performance obligation. At contract inception, we assess the goods or services promised within each contract, determine those that are performance obligations, and assess whether each promised good or service is distinct. We then recognize as revenue the amount of the transaction price that is allocated to the respective performance obligation when or as the performance obligation is satisfied. Licenses of intellectual property: If a license to our intellectual property is determined to be distinct from the other performance obligations identified in the arrangement, we recognize revenue from non-refundable, up-front fees allocated to the license when the license is transferred to the customer, and the customer can use and benefit from the license. For licenses that are bundled with other promises, we utilize judgment to assess the nature of the combined performance obligation to determine whether the combined performance obligation is satisfied over time or at a point in time and, if over time, the appropriate method of measuring progress for purposes of recognizing revenue from non-refundable, up-front fees. We evaluate the measure of progress each reporting period and, if necessary, adjust the measure of performance and related revenue recognition. Milestone payments: At the inception of each arrangement that includes milestone payments, we evaluate whether the milestones are considered probable of being achieved and estimate the amount to be included in the transaction price using the most likely amount method. If it is probable that a significant revenue reversal would not occur, the value of the associated milestone (such as a regulatory submission by us) is included in the transaction price, which is then allocated to each performance obligation. Milestone payments that are not within our control, such as approvals from regulators, are not considered probable of being achieved until those approvals are received. At the end of each subsequent reporting period, we re-evaluate the probability of achievement of such development milestones and, if necessary, adjust our estimate of the overall transaction price. Any such adjustments are recorded on a cumulative catch-up basis, which would affect license, collaboration, and other revenues and earnings in the period of adjustment and in future periods through the end of the performance obligation period. Royalties: For arrangements that include sales-based royalties, including milestone payments based on the level of sales, and where the license is deemed to be the predominant item to which the royalties relate, we recognize revenue at the later of (a) when the related sales occur, or (b) when the performance obligation to which some or all of the royalty has been allocated has been satisfied (or partially satisfied). To date, we have not recognized any royalty revenue resulting from any of its licensing arrangements. 106 -------------------------------------------------------------------------------- Manufacturing Supply Services: Arrangements that include a promise for future supply of drug substance or drug product for either clinical development or commercial supply at the customer's discretion are generally considered options. We assess if these options provide a material right to the licensee and, if so, they are accounted for as separate performance obligations. If we are entitled to additional payments when the customer exercises these options, any additional payments are recorded when the customer obtains control of the goods, which is upon delivery. For a complete discussion of accounting for collaborative licensing agreements, see Note 3, Collaboration Agreements of Notes of Consolidated Financial Statements contained in this Annual Report on Form 10-K. Our revenue to date has been generated primarily from licensing fees received under our collaborative licensing agreements with AbbVie and KKC and reimbursements for expenses from KKC. The terms of the agreements include non-refundable upfront fees, funding of research and development activities, payments based upon achievement of milestones, and royalties on net product sales.
Research and Development Costs
All research and development costs are expensed as incurred, including costs for drug supplies used in research and development or clinical trials, property and equipment acquired specifically for a finite research and development project, and nonrefundable deposits incurred at the initiation of research and development activities. Research and development costs consist principally of costs related to clinical trials managed directly by us and through CROs, manufacture of clinical drug products for clinical trials, preclinical study costs, discovery research expenses, facilities costs, salaries, and related expenses.
As part of the process of recording research and development costs, we are required to estimate and accrue expenses, the largest of which are research and development expenses. This process involves the following:
• communicating with appropriate internal personnel to identify services that have been performed on our behalf and estimating the level of
service performed and the associated cost incurred for the service when
we have not yet been invoiced or otherwise notified of actual cost;
• estimating and accruing expenses in our consolidated financial statements as of each balance sheet date based on facts and circumstances known to us at the time; and
• periodically confirming the accuracy of our estimates with service
providers and making adjustments, if necessary.
Examples of estimated research and development expenses that we accrue include:
• payments to CROs in connection with preclinical and toxicology studies
and clinical trials; • payments to investigative sites in connection with clinical trials; • payments to CMOs in connection with the production of clinical trial materials; and • professional service fees for consulting and related services. We base our expense accruals related to clinical trials on our estimates of the services received and efforts expended pursuant to contracts with multiple research institutions and CROs that conduct and manage clinical trials on our behalf. The financial terms of these agreements vary from contract to contract and may result in uneven payment flows. Payments under some of these contracts depend on factors such as the successful enrollment of patients and the completion of clinical trial milestones. In accruing costs, we estimate the time period over which services will be performed and the level of effort to be expended in each period. If we do not identify costs that we have begun to incur or if we underestimate or overestimate the level of services performed or the costs of these services, our actual expenses could differ from our estimates. To date, we have not experienced significant changes in our estimates of accrued research and development expenses after a reporting period. However, due to the nature of estimates, we cannot assure you that we will not 107
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make changes to our estimates in the future as we become aware of additional information about the status or conduct of our clinical trials and other research activities.
Income Taxes
We account for income taxes and the related accounts under the liability method. Deferred tax assets and liabilities are determined based on differences between the financial statement and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that are expected to be in effect when the differences are expected to reverse. The measurement of a deferred tax asset is reduced, if necessary, by a valuation allowance if it is more likely than not that some portion or all of the deferred tax asset will not be realized. Realization of deferred tax assets is generally dependent upon future earnings, if any, the timing and amount of which are uncertain. As ofDecember 31, 2019 , based on known factors, we cannot conclude that it is more likely than not that the remaining deferred tax assets will be utilized, and we have recorded a valuation allowance to fully offset its deferred tax assets. We account for uncertain tax positions in accordance with the provisions of ASC 740, Income Taxes. We recognize tax benefit for uncertain tax positions if we believe it is more likely than not that the position will be upheld on audit based solely on the technical merits of the tax position. We evaluate uncertain tax positions after consideration of all available information.
Stock-Based Compensation
We measure and recognize compensation expense for all stock option and restricted stock awards based on the estimated fair value of the award on the grant date. We use the Black-Scholes option pricing model to estimate the fair value of stock option awards. The fair value is recognized as expense, over the requisite service period, which is generally the vesting period of the respective award, on a straight-line basis when the only condition to vesting is continued service. If vesting is subject to a market or performance condition, recognition is based on the derived service period of the award. Expense for awards with performance conditions is estimated and adjusted on a quarterly basis based upon the assessment of the probability that the performance condition will be met. Use of the Black-Scholes option-pricing model requires management to apply judgment under highly subjective assumptions. These assumptions include:
• Expected term -The expected term represents the period that the
stock-based awards are expected to be outstanding and is based on the
average period the stock options are expected to be outstanding and was
based on our historical information of the options exercise patterns and
post-vesting termination behavior.
• Expected volatility -Since we do not have sufficient trading history to
estimate the volatility of our common stock, the expected volatility was
estimated based on our own historical volatility since our IPO and the
average volatility for comparable publicly traded biopharmaceutical
companies. When selecting comparable publicly traded biopharmaceutical
companies on which we based our expected stock price volatility, we
selected companies with comparable characteristics to us, including
enterprise value, risk profiles, position within the industry, and
historical share price information sufficient to meet the expected life
of the stock-based awards.
• Risk-free interest rate -The risk-free interest rate is based on the
United States Treasury zero coupon issues in effect at the time of grant
for periods corresponding with the expected term of option.
• Expected dividend -We have no plans to pay dividends on our common
stock. Therefore, we used an expected dividend yield of zero.
We will continue to use judgment in evaluating the expected volatility and expected terms utilized for our stock-based compensation calculations on a prospective basis. We account for forfeitures of share-based awards when they occur.
108 -------------------------------------------------------------------------------- Stock option and restricted stock awards have been granted or sold at fair value to nonemployees, in connection with research and consulting services provided to us, and to employees, in connection with Stock Purchase and Restriction Agreements. Equity awards generally vest over terms of four or five years. For employees, stock-based compensation expense is recorded ratably through the vesting period for each stock option or tranche of restricted stock award. For option awards with performance conditions, we evaluate the probability of the number of shares that are expected to vest and adjust compensation expense to reflect the number of shares expected to vest and the cumulative vesting period met to date. The weighted-average assumptions used in the Black-Scholes option pricing model were as follows: Years Ended December 31 2019 2018 2017 Dividend yield - % - % - % Volatility 73.73 % 72.77 % 75.14 % Risk-free interest rate 2.18 % 2.79 % 2.19 %
Expected term of options (in years) 6.23 6.35 6.37
Weighted average grant date fair value
Leases We determine if an arrangement is a lease at inception. Lease assets represents our right to use an underlying asset for the lease term, and lease liabilities represent our obligation to make lease payments arising from the lease. These assets and liabilities are initially recognized at the lease commencement date based on the present value of lease payments over the lease term calculated using its incremental borrowing rate based on the information available at commencement unless the implicit rate is readily determinable. Lease assets also include upfront lease payments, lease incentives paid, and direct costs incurred and exclude lease incentives received. The lease term used to calculate the lease assets and related lease liabilities includes the options to extend or terminate the lease when it is reasonably certain that we will exercise those options. Lease expense for operating leases is recognized on a straight-line basis over the expected lease term as an operating expense while the expense for finance leases is recognized as depreciation expense over the expected lease term unless there is a transfer of title or purchase option reasonably certain of exercise. We will account for each separate lease component separately from the nonlease components. The depreciable life of lease assets and leasehold improvements is limited by the expected lease term unless there is a transfer of title or purchase option reasonably certain of its exercise.
Leases with an initial term of 12 months or less are not recorded on the balance sheet, and the expense for these short-term leases and operating leases is recognized on a straight-line basis over the lease term.
Off-Balance Sheet Arrangements
Since our inception, we have not had any relationships with unconsolidated organizations or financial partnerships, such as structured finance or special purpose entities that would have been established for the purpose of facilitating off-balance sheet arrangements, and we have not engaged in any other off-balance sheet arrangements, as defined in the rules and regulations of theSEC .
Recent Accounting Pronouncements
For a discussion of recent accounting pronouncements, please see Note 2 of Notes to Consolidated Financial Statements contained in this Annual Report on Form 10-K. 109
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