News Column

INTRA-CELLULAR THERAPIES, INC. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

August 12, 2014

You should read the following in conjunction with our unaudited condensed consolidated financial statements and the related notes thereto that appear elsewhere in this Quarterly Report on Form 10-Q and the audited consolidated financial statements and notes thereto and under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K filed on March 25, 2014. In addition to historical information, the following discussion and analysis includes forward-looking information that involves risks, uncertainties and assumptions. Our actual results and the timing of events could differ materially from those anticipated by these forward-looking statements as a result of many factors, including those discussed under "Risk Factors" in our Annual Report on Form 10-K filed on March 25, 2014.



Overview

We are a biopharmaceutical company focused on the discovery and clinical development of innovative, small molecule drugs that address underserved medical needs in neuropsychiatric and neurological disorders by targeting intracellular signaling mechanisms within the central nervous system, or CNS. Our lead product candidate, ITI-007, is in late phase clinical development as a first-in-class treatment for schizophrenia. Results from our Phase 2 trial are included in "Business-Our Clinical Programs-ITI-007 Program" under Item 1 of our Annual Report on Form 10-K filed on March 25, 2014. In June 2014, we had discussions with the U.S. Food and Drug Administration, or FDA, regarding our plans to initiate our Phase 3 clinical program of ITI-007 in schizophrenia. Following this meeting with the FDA, we are proceeding with Phase 3 development of ITI-007 for the treatment of schizophrenia. We plan to conduct two randomized, double-blind, placebo-controlled Phase 3 clinical trials of ITI-007 in patients with acutely exacerbated schizophrenia, with over 400 patients in each trial. Subject to finalizing the trial protocols and arrangements with clinical trial sites, we intend to initiate the first Phase 3 clinical trial in schizophrenia in the second half of 2014 and a second Phase 3 clinical trial in early 2015. In the first Phase 3 trial, we plan to randomize patients to two doses of ITI-007 (60mg or 40mg) or placebo over a 4-week treatment duration. We currently expect that the second Phase 3 trial will be conducted for a 6-week treatment duration. Subject to initiation of these trials as planned and timely enrollment, we anticipate that the results of the first Phase 3 clinical trial of ITI-007 in patients with schizophrenia could be available as early as the fourth quarter of 2015. Subject to further discussions with the FDA, we also plan to initiate separate additional trials in bipolar disorder in 2015. We expect that the planned trials in bipolar disorder will overlap in time with the clinical conduct of the planned trials in schizophrenia. In addition to our Phase 3 clinical trials, we will need to complete other clinical and non-clinical trials and manufacturing and pre-commercialization activities necessary to support the submission of a planned New Drug Application, or NDA, for ITI-007 in schizophrenia, which we currently expect could occur at the end of 2016 or the beginning of 2017. In addition, in March 2014, we announced the initiation of ITI-007-200, a Phase 1/2 clinical trial designed to evaluate the safety, tolerability and pharmacokinetics of low doses of ITI-007 in healthy geriatric subjects and in patients with dementia, including Alzheimer's disease. The commencement of this study marks an important milestone in our strategy to develop low doses of ITI-007 for the treatment of behavioral disturbances associated with dementia and related disorders. We expect that initial data from the trial will be available in the second half of 2014. We are also pursuing clinical development of ITI-007 for the treatment of additional CNS diseases and disorders. At the lowest doses, ITI-007 has been demonstrated to act primarily as a potent 5-HT2A serotonin receptor antagonist. As the dose is increased, additional benefits are derived from the engagement of additional drug targets, including modest dopamine receptor modulation and modest inhibition of serotonin transporters. We believe that combined interactions at these receptors may provide additional benefits above and beyond selective 5-HT2A antagonism for treating agitation, aggression and sleep disturbances in diseases that include dementia, Alzheimer's disease and autism spectrum disorders, while avoiding many of the side effects associated with more robust dopamine receptor antagonism. As the dose of ITI-007 is further increased, leading to moderate dopamine receptor modulation, inhibition of serotonin transporters, and indirect glutamate modulation, these actions complement the complete blockade of 5-HT2A serotonin receptors. At a dose of 60 mg, ITI-007 has been shown effective in treating the symptoms associated with schizophrenia, and we believe this higher dose range will be useful for the treatment of bipolar disorder, major depressive disorder and other neuropsychiatric diseases. Given the potential utility for ITI-007 and follow-on compounds to treat these additional indications, we may investigate, either on our own or with a partner, agitation, aggression and sleep disturbances in additional diseases that include autism spectrum disorders; major depressive disorder; intermittent explosive disorder; non-motor symptoms and motor complications associated with Parkinson's disease; and post-traumatic stress disorder. We hold exclusive, worldwide commercialization rights to ITI-007 and a family of compounds from Bristol-Myers Squibb Company pursuant to an exclusive license. We have a second major program called ITI-002 that has yielded a portfolio of compounds that selectively inhibits the enzyme phosphodiesterase 1, or PDE1. We have licensed the lead compound in the ITI-002 portfolio, ITI-214, and other compounds in that portfolio, to Takeda Pharmaceutical Company Limited, or Takeda. ITI-214 is the first compound in its class to successfully advance into Phase 1 clinical trials and is being developed for the treatment of cognitive impairment associated with schizophrenia, or CIAS, and other disorders. Other compounds in the PDE1 portfolio outside the Takeda collaboration are being advanced for the treatment of other indications, including non-CNS therapeutic areas.



Our pipeline also includes pre-clinical programs that are focused on advancing drugs for the treatment of cognitive dysfunction, in both schizophrenia and Alzheimer's disease, and for disease modification and the treatment of neurodegenerative disorders, including Alzheimer's disease.

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Since inception, we have devoted all of our efforts and resources to our research and development activities. We have incurred significant net losses since inception. As of June 30, 2014, our accumulated deficit was $66.6 million. We expect to continue incurring substantial losses for the next several years as we continue to develop our clinical and pre-clinical drug candidates and programs. Our operating expenses are comprised of research and development expenses and general and administrative expenses. We have not generated any revenue from product sales to date and we do not expect to generate revenues from product sales for at least the next several years. Our revenues for the six months ended June 30, 2014 and the fiscal years ended December 31, 2013 and 2012 have been from the license and collaboration agreement with Takeda. In addition, we have received and may continue to receive grants from U.S. government agencies and foundations.



Our corporate headquarters and research facility are located in New York, New York.

Results of Operations Revenues



The following discussion summarizes the key factors our management believes are necessary for an understanding of our financial statements.

We have not generated any revenue from product sales to date and we do not expect to generate revenues from product sales for at least the next several years. Our revenues for the six months ended June 30, 2014 and 2013 have been from the license and collaboration agreement with Takeda. In addition, we have received and may continue to receive grants from U.S. government agencies and foundations. We expect our revenues for the next several years to consist of limited reimbursable costs incurred for patent prosecutions and to a lesser extent reimbursements related to our collaboration with Takeda under the license and collaboration agreement. In addition, we expect to receive possible milestone payments under the license and collaboration agreement, but these are not assured at this time and would not be significant enough to fund operations for a meaningful period of time. Expenses The process of researching and developing drugs for human use is lengthy, unpredictable and subject to many risks. We are unable with any certainty to estimate either the costs or the timelines in which those costs will be incurred. We have one project, ITI-007 for the treatment of schizophrenia, which consumes a large proportion of our current, as well as projected, resources. In addition, in March 2014, we announced the initiation of ITI-007-200, a Phase 1/2 clinical trial designed to evaluate the safety, tolerability and pharmacokinetics of low doses of ITI-007 in healthy geriatric subjects and in patients with dementia, including Alzheimer's disease. We intend to pursue other disease indications that ITI-007 may address, but there are large costs associated with pursuing FDA approval for those indications, which would include the cost of additional clinical trials. Our other projects, exclusive of the Takeda collaboration, are still in the pre-clinical stages, and will require extensive funding not only to complete pre-clinical testing, but to enter into and complete clinical trials. Expenditures that we incur on these projects will be subject to availability of funding in addition to the funding required for the advancement of ITI-007. Any failure or delay in the advancement of ITI-007 could require us to re-allocate resources from our other projects to the advancement of ITI-007, which could have a significant material adverse impact on the advancement of these other projects and on our results of operations. Our operating expenses are comprised of (i) research and development expenses and (ii) general and administrative expenses. Our research and development costs are comprised of:



internal recurring costs, such as labor and fringe benefits, materials and

supplies, facilities and maintenance costs; and



fees paid to external parties who provide us with contract services, such

as pre-clinical testing, manufacturing and related testing, and clinical

trial activities.

General and administrative expenses are incurred in three major categories:

salaries and related benefit costs; patent, legal and professional costs; and office and facilities overhead. We expect that research and development expenses will increase substantially as we prepare for and enter into Phase 3 clinical trials for ITI-007 for patients with exacerbated schizophrenia. We also expect that our general and administrative costs will increase substantially from prior periods primarily due to the increased costs associated with being a public reporting entity, which would include adding additional personnel. We have granted options to purchase 888,000 shares of our common stock in the current year and will be recognizing expense associated with these options over the next two years in both the research and development and general and administrative expense 17



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categories. We expect this non-cash expense to be material and affect quarter to quarter and year to date comparisons in the upcoming year. We expect to continue to grant stock options in the future, which will increase our stock-based compensation expense in future periods.



The following table sets forth our revenues and operating expenses for the three and six month periods ended June 30, 2014 and 2013:

Three Months Ended June 30, Six Months Ended June 30, 2014 2013 2014 2013 (Unaudited) (Unaudited) (In Thousands) (In Thousands) Revenues $ 219 $ 643 $ 387$ 1,242 Expenses Research and Development 2,710 7,788 5,539 12,740 General and Administrative 2,121 903 4,034 1,950 4,831 8,691 9,573 14,690 Net Loss $ (4,534 )$ (8,277 )$ (9,077 )$ (13,916 )



Comparison of Three and Six Month Periods Ended June 30, 2014 and June 30, 2013

Revenues

Revenue decreased for the six months ended June 30, 2014 as compared to the six months ended June 30, 2013 by approximately $854,000, or 69%, due primarily to the recognition of previously deferred revenue relating to the collaboration agreement with Takeda and lower reimbursable costs under the research agreement with Takeda in 2014, both associated with the Takeda agreement. Revenue decreased for the three months ended June 30, 2014 as compared to the three months ended June 30, 2013 by approximately $424,000, or 66%, due primarily to the prior year recognition of revenue previously deferred relating to the collaboration agreement with Takeda and lower reimbursable patent costs, offset in part by higher reimbursable costs under the research agreement with Takeda in 2014 compared to 2013.



Research and Development Expenses

Research and development expenses decreased for the three and six month periods ended June 30, 2014 as compared to the three and six month periods ended June 30, 2013 by approximately $5.1 million, or 65%, and $7.2 million, or 57%, respectively. The decreases in the three and six month periods are due almost exclusively to costs associated with outside clinical testing for our ITI-007 Phase 2 clinical trial that was completed in late 2013, with no such costs incurred in 2014. Partially offsetting the decreases in the three and six month period ended June 30, 2014 were expenses of approximately $1.0 million and $1.8 million, respectively, relating to the manufacturing and other clinical and non-clinical testing of our ITI-007 product candidate and to the costs associated with our ITI-007-200 Phase 1/2 clinical trial in dementia patients totaling approximately $372,000 and $1.4 million in the three and six month period ended June 30, 2014, respectively. The research and development expenses incurred for amounts payable to external parties comprise a significant portion of our research and development expenses during the three and six months ended June 30, 2014 and 2013. We incurred expenses of approximately $3.8 million and $11.3 million during the six months ended June 30, 2014 and 2013, respectively, for amounts payable to external parties who manufactured, tested and performed clinical trial activities for all of our projects. During the same periods, our internal research and development expenses were approximately $1.7 million and $1.5 million, respectively. During the three month periods ended June 30, 2014 and 2013, we incurred expenses of approximately $1.7 million and $7.0 million, respectively, for amounts payable to external parties who manufactured, tested and performed clinical trial activities for all of our projects. During the same periods, our internal research and development expenses were approximately $920,000 and $740,000, respectively. As of June 30, 2014, we employed 14 full time personnel in our research and development group. The clinical development work related to ITI-007 requires the largest portion of our resources and, consequently, comprises the majority of our spending. We spent approximately $4.0 million and $9.4 million on direct costs for the development of ITI-007 during six months ended June 30, 2014 and 2013, respectively, and $1.9 million and $5.2 million during the three months ended June 30, 2014 and 2013, respectively. As development of ITI-007 progresses, we anticipate costs for ITI-007 to increase considerably in the next several years as we conduct Phase 3 and other clinical trials. We are also required to complete non-clinical testing to obtain FDA approval and manufacture material needed for clinical trial use, which includes non-clinical testing of the drug product and the creation of an inventory of drug product in anticipation of possible FDA approval. 18



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We currently have several projects in addition to ITI-007 that are in the research and development stages. These are in the areas of cognitive dysfunction and the treatment of neurodegenerative diseases, including Alzheimer's disease, among others. We have used internal resources and incurred expenses not only in relation to the development of ITI-007 but on these additional projects as well. We have not, however, reported these costs on a project by project basis, as they are broadly spread among these projects. The external costs for these projects have been minimal and are reflected in the amounts discussed in this section "-Research and Development Expenses." In previous years we also incurred costs that were both reimbursable and non-reimbursable under the license and collaboration agreement with Takeda. For the six months ended June 30, 2014 and 2013, we incurred approximately $15,000 and $53,000, respectively, on direct costs that were billable to Takeda and for the three months ended June 30, 2014 and 2013 we incurred approximately $15,000 and $10,000, respectively, on direct costs that were billable to Takeda. We anticipate that these costs will be minimal in the future as the research portion of the license and collaboration agreement concluded in February 2014.The research and development process necessary to develop a pharmaceutical product for commercialization is subject to extensive regulation by numerous governmental authorities in the United States and other countries. This process typically takes years to complete and requires the expenditure of substantial resources. The steps required before a drug may be marketed in the United States generally include the following:



completion of extensive pre-clinical laboratory tests, animal studies, and

formulation studies in accordance with the FDA's Good Laboratory Practice,

or GLP, regulations;



submission to the FDA of an Investigational New Drug application, or IND,

for human clinical testing, which must become effective before human clinical trials may begin;



performance of adequate and well-controlled human clinical trials to

establish the safety and efficacy of the drug for each proposed indication;



submission to the FDA of a New Drug Application, or NDA, after completion

of all clinical trials; satisfactory completion of an FDA pre-approval inspection of the



manufacturing facility or facilities at which the active pharmaceutical

ingredient, or API, and finished drug product are produced and tested to

assess compliance with current Good Manufacturing Practices, or cGMPs; satisfactory completion of FDA inspections of clinical trial sites to



assure that data supporting the safety and effectiveness of product

candidates has been generated in compliance with Good Clinical Practices;

and



FDA review and approval of the NDA prior to any commercial marketing or

sale of the drug in the United States.

The successful development of our product candidates and the approval process requires substantial time, effort and financial resources, and is uncertain and subject to a number of risks. We cannot be certain that any of our product candidates will prove to be safe and effective, will meet all of the applicable regulatory requirements needed to receive and maintain marketing approval, or will be granted marketing approval on a timely basis, if at all. Data from pre-clinical studies and clinical trials are susceptible to varying interpretations that could delay, limit or prevent regulatory approval or could result in label warnings related to or recalls of approved products. We, the FDA, or other regulatory authorities may suspend clinical trials at any time if we or they believe that the subjects participating in such trials are being exposed to unacceptable risks or if such regulatory agencies find deficiencies in the conduct of the trials or other problems with our product candidates. Other risks associated with our product candidates are described in the section entitled "Risk Factors" in our Annual Report on Form 10-K filed with the SEC on March 25, 2014, as updated from time to time in our other periodic and current reports filed with the SEC.



General and Administrative Expenses

General and administrative expenses increased for the six month period ended June 30, 2014 as compared to the six month period ended June 30, 2013 by approximately $2.1 million, or 107%. The increase is primarily the result of higher professional fees, directors and officers' insurance costs, and board of director compensation fees, which are due to the activities associated with being a public company, with the remainder comprised primarily of higher salary and benefit expenses. Salaries and related benefit costs for our executive, finance and administrative functions for the six months ended June 30, 2014 and 2013 constituted approximately 33% and 47%, respectively, of our total general and administrative costs. General and administrative expenses also include patent costs, some of which are reimbursed by Takeda, legal, accounting and other professional fees and, to a lesser extent, facilities and general office-related overhead. The increase for the three month period ended June 30, 2014 as compared to the three month period ended June 30, 2013 was approximately $1.2 million, or 135%, and is primarily the result of professional fees, directors and officers' insurance costs and board of director compensation fees, which are due to the activities associated with being a public company, with the remainder comprised primarily of higher salary and fringe expenses. Salaries and related benefit costs for our executive, finance and administrative functions for the three months ended June 30, 2014 and 2013 constituted approximately 35% and 51%, 19



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respectively, of our total general and administrative costs. We expect all of these costs to increase significantly as we expand our operations, including hiring of additional personnel, and continue to be subject to the reporting requirements of being a public company.



Liquidity and Capital Resources

Through June 30, 2014, we have provided funds for our operations by obtaining approximately $265.9 million of cash primarily through the public and private offering of our common stock and other securities, grants from government agencies and foundations and payments received under the license and collaboration agreement with Takeda. We do not believe that grant revenue will be a significant source of funding in the near future. We expect that reimbursements of our development costs by Takeda will decline going forward, and we do not expect such reimbursements to be a significant source of funding in the future. As of June 30, 2014, we had a total of $140.5 million in cash and cash equivalents and available-for-sale investment securities, and approximately $2.7 million of short-term liabilities consisting entirely of short-term liabilities from operations. Excluding the increase in net cash of approximately $115.4 million from the public offering which closed on February 5, 2014, we spent approximately $12.2 million in cash and reduced working capital by approximately $8.4 million for the six months ended June 30, 2014. This use of working capital is due primarily to funding recurring operating expenses and the preparation for additional clinical trials and non-clinical testing, including manufacturing related activities. We expect to use cash of up to $30.0 million during the remainder of 2014. This is expected to be due primarily to recurring expenses and for costs to produce, develop and validate materials to be used in clinical and non-clinical studies related to ITI-007. We expect to begin to incur significant expenditures in the remainder of 2014 and beyond as we plan to initiate a Phase 3 clinical trial in patients with acutely exacerbated schizophrenia and other planned clinical and non-clinical trials. While we believe that our existing cash, cash equivalents and investment securities, together with interest on cash balances, will be sufficient to fund our operating expenses and capital expenditure requirements through early 2016, we will require significant additional financing in the future to continue to fund our operations. In particular, we anticipate that we will need to secure funding to complete the planned additional clinical and non-clinical trials, manufacturing and pre-commercialization activities needed for potential regulatory approval and commercialization of ITI-007 in patients with acute exacerbated schizophrenia, our Phase 1/2 clinical trial of ITI-007 in healthy geriatric subjects and in patients with dementia, including Alzheimer's disease, for further development of ITI-007 in patients with bipolar disorder and other indications, and for development of our other product candidates. We have incurred losses in every year since inception with the exception of 2011, when we received an up-front fee and a milestone payment related to our agreement with Takeda. These losses have resulted in significant cash used in operations. During the six months ended June 30, 2014 and 2013, our net cash used in operating activities was approximately $12.1 million and $9.2 million, respectively. While we have several research and development programs underway, the ITI-007 program has advanced the furthest and will continue to consume increasing amounts of cash for conducting clinical trials and the testing and manufacturing of product material. As we continue to conduct these activities necessary to pursue FDA approval of ITI-007 and our other product candidates, we expect the amount of cash needed to fund operations to increase significantly over the next several years. On March 31, 2014, we entered into a long-term lease for approximately 12,000 square feet of useable laboratory and office space located at 430 East 29th Street, New York, New York 10016, which we expect to occupy as our headquarters on or about February 2015. The lease has a term of five years and three months. We expect that our facility related costs will increase moderately when the lease commences in 2015. We seek to balance the level of cash, cash equivalents and investments on hand with our projected needs and to allow us to withstand periods of uncertainty relative to the availability of funding on favorable terms. Until we can generate significant revenues from operations, we will need to satisfy our future cash needs through public or private sales of our equity securities, sales of debt securities, the incurrence of debt from commercial lenders, strategic collaborations, licensing a portion or all of our product candidates and technology and, to a lesser extent, grant funding. We cannot be sure that future funding will be available to us when we need it on terms that are acceptable to us, or at all. We sell securities and incur debt when the terms of such transactions are deemed favorable to us and as necessary to fund our current and projected cash needs. The amount of funding we raise through sales of our common stock or other securities depends on many factors, including, but not limited to, the status and progress of our product development programs, projected cash needs, availability of funding from other sources, our stock price and the status of the capital markets. Due to the recent volatile nature of the financial markets and, in particular, the adverse impact on market capitalization and valuation of biotechnology companies, equity and debt financing may be difficult to obtain. In addition, any unfavorable development or delay in the progress of our ITI-007 program could have a material adverse impact on our ability to raise additional capital. 20



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To the extent that we raise additional capital through the sale of equity or convertible debt securities, the ownership interest of our existing stockholders will be diluted, and the terms may include liquidation or other preferences that adversely affect the rights of our stockholders. Debt financing, if available, may involve agreements that include covenants limiting or restricting our ability to take specific actions, such as incurring debt, making capital expenditures or declaring dividends. If adequate funds are not available to us on a timely basis, we may be required to: (1) delay, limit, reduce or terminate pre-clinical studies, clinical trials or other clinical development activities for one or more of our product candidates, including our lead product candidate ITI-007 as well as our other pre-clinical stage product candidates; (2) delay, limit, reduce or terminate our discovery research or pre-clinical development activities; or (3) enter into licenses or other arrangements with third parties on terms that may be unfavorable to us or sell, license or relinquish rights to develop or commercialize our product candidates, technologies or intellectual property at an earlier stage of development and on less favorable terms than we would otherwise agree. Our cash is maintained in checking accounts, money market accounts, money market funds, certificates of deposit, commercial paper, corporate notes and corporate bonds at major financial institutions. Due to the current low interest rates available for these instruments, we are earning limited interest income. Our investment portfolio has not been adversely impacted by the problems in the credit markets that have existed over the last several years, but there can be no assurance that our investment portfolio will not be adversely affected in the future.



Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements.

Critical Accounting Policies and Estimates

The discussion and analysis of our financial condition and results of operations are based on our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States, or GAAP. The preparation of these financial statements requires management to make estimates and assumptions that affect reported amounts of assets and liabilities as of the date of the balance sheet and reported amounts of revenues and expenses for the periods presented. Judgments must also be made about the disclosure of contingent liabilities. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. These estimates and assumptions form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Management makes estimates and exercises judgment in revenue recognition and stock-based compensation. Actual results may differ from those estimates and under different assumptions or conditions.



We believe that the following critical accounting policies affect management's more significant judgments and estimates used in the preparation of our financial statements:

Revenue Recognition

Revenue is recognized when all terms and conditions of the agreements have been met, including persuasive evidence of an arrangement, delivery has occurred or services have been rendered, price is fixed or determinable and collectability is reasonably assured. We are reimbursed for certain costs incurred on specified research projects under the terms and conditions of grants, collaboration agreements, and awards. We record the amount of reimbursement as revenues on a gross basis in accordance with ASC Topic 605-45, Revenue Recognition/Principal Agent Considerations. We are the primary obligor with respect to purchasing goods and services from third-party suppliers, are obligated to compensate the service provider for the work performed, and have discretion in selecting the supplier. Provisions for estimated losses on research grant projects and any other contracts are made in the period such losses are determined. We have entered into arrangements involving the delivery of more than one element. Each required deliverable is evaluated to determine whether it qualifies as a separate unit of accounting. For us, this determination is generally based on whether the deliverable has "stand-alone value" to the customer. We adopted this accounting standard on a prospective basis for all Multiple-Deliverable Revenue Arrangements, or MDRAs, entered into on or after January 1, 2011, and for any MDRAs that were entered into prior to January 1, 2011, but materially modified on or after that date. The adoption of this accounting standard did not have a material impact on our results of operations for the three and six months ended June 30, 2014 and 2013, or on our financial positions as of those dates. We adopted ASC Topic 605-28, Milestone Method. Under this guidance, we recognize revenue contingent upon the achievement of a substantive milestone in its entirety in the period the milestone is achieved. Substantive milestone payments are recognized upon achievement of the milestone only if all of the following conditions are met: the milestone payments are non-refundable; 21



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achievement of the milestone involves a degree of risk and was not reasonably assured at the inception of the arrangement;



substantive effort on our part is involved in achieving the milestone;

the amount of the milestone payment is reasonable in relation to the



effort expended or the risk associated with achievement of the milestone;

and a reasonable amount of time passes between the up-front license payment



and the first milestone payment, as well as between each subsequent

milestone payment.

Determination as to whether a payment meets the aforementioned conditions involves management's judgment. If any of these conditions are not met, the resulting payment would not be considered a substantive milestone, and therefore, the resulting payment would be considered part of the consideration for the single unit of accounting and be recognized as revenue as such performance obligations are performed under either the proportional performance or straight-line methods, as applicable. In addition, the determination that one such payment was not a substantive milestone could prevent us from concluding that subsequent milestone payments were substantive milestones and, as a result, any additional milestone payments could also be considered part of the consideration for the single unit of accounting and would be recognized as revenue as such performance obligations are performed under either the proportional performance or straight-line methods, as applicable.



Stock-Based Compensation

Stock-based payments are accounted for in accordance with the provisions of ASC Topic 718, Compensation-Stock Compensation. The fair value of share-based payments is estimated, on the date of grant, using the Black-Scholes-Merton option-pricing model, or the Black-Scholes model. The resulting fair value is recognized ratably over the requisite service period, which is generally the vesting period of the option. For all awards granted with time-based vesting conditions, expense is amortized using the straight-line attribution method. For awards that contain a performance condition, expense is amortized using the accelerated attribution method. As stock-based compensation expense recognized in the statements of operations for the three and six months ended June 30, 2014 and 2013 is based on share-based awards ultimately expected to vest, it has been reduced for estimated forfeitures. ASC Topic 718 requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Pre-vesting forfeitures are based on our historical experience for the fiscal years ended December 31, 2013 and 2012 and have not been material. We utilize the Black-Scholes model for estimating fair value of our stock options granted. Option valuation models, including the Black-Scholes model, require the input of subjective assumptions, and changes in the assumptions used can materially affect the grant date fair value of an award. These assumptions include the risk-free rate of interest, expected dividend yield, expected volatility and the expected life of the award. Expected volatility rates are based on historical volatility of the common stock of comparable publicly traded entities and other factors due to the lack of historic information of our common stock. The expected life of stock options is the period of time for which the stock options are expected to be outstanding. Given the lack of historic exercise data, the expected life is determined using the "simplified method" which is defined as the midpoint between the vesting date and the end of the contractual term. The risk-free interest rates are based on the U.S. Treasury yield for a period consistent with the expected term of the option in effect at the time of the grant. We have not paid dividends to our stockholders since our inception and do not plan to pay cash dividends in the foreseeable future. Therefore, we have assumed an expected dividend rate of zero. Given the absence of an active market for our common stock during 2012 and 2013, the exercise price of the stock options on the date of grant was determined and approved by the board of directors using several factors, including progress and milestones achieved in our business development and performance, the price per share of our convertible preferred stock offerings and general industry and economic trends. In establishing the estimated fair value of our common stock, we considered the guidance set forth in American Institute of Certified Public Accountants Practice Guide, "Valuation of Privately-Held-Company Equity Securities Issued as Compensation." Under ASC Topic 718, the cumulative amount of compensation cost recognized for instruments classified as equity that ordinarily would result in a future tax deduction under existing tax law shall be considered to be a deductible difference in applying ASC Topic 740, Income Taxes. The deductible temporary difference is based on the compensation cost recognized for financial reporting purposes; however, these provisions currently do not impact us, as all the deferred tax assets have a full valuation allowance. 22



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Since we had net operating loss carryforwards as of June 30, 2014 and 2013, no excess tax benefits for the tax deductions related to share-based awards were recognized in the statements of operations. Equity instruments issued to non-employees are accounted for under the provisions of ASC Topic 718 and ASC Topic 505-50, Equity/Equity-Based Payments to Non-Employees. Accordingly, the estimated fair value of the equity instrument is recorded on the earlier of the performance commitment date or the date the services required are completed and are marked to market during the service period.



Recently Issued Accounting Pronouncements

We review new accounting standards to determine the expected financial impact, if any, that the adoption of each such standard will have. For the recently issued accounting standards that we believe may have an impact on our financial statements, see "Recently Issued Accounting Pronouncements" in our Annual Report on Form 10-K for the year ended December 31, 2013 filed on March 25, 2014.



Certain Factors That May Affect Future Results of Operations

The Securities and Exchange Commission encourages companies to disclose forward-looking information so that investors can better understand a company's future prospects and make informed investment decisions. This Quarterly Report on Form 10-Q contains such "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve known and unknown risks, uncertainties and other important factors which may cause our actual results, performance or achievements to be materially different from any future results, performances or achievements expressed or implied by the forward-looking statements. Forward-looking statements include, but are not limited to, statements about: the accuracy of our estimates regarding expenses, future revenues, capital requirements and the need for additional financing; the initiation, cost, timing, progress and results of our development activities, pre-clinical studies and clinical trials; the timing of and our ability to obtain and maintain regulatory approval of our existing product candidates, any product candidates that we may develop, and any related restrictions, limitations, and/or warnings in the label of any approved product candidates; our plans to research, develop and commercialize our product candidates; our collaborators' election to pursue research, development and commercialization activities; our ability to obtain future reimbursement and/or milestone payments from our collaborators; our ability to obtain and maintain intellectual property protection for our product candidates; our ability to successfully commercialize our product candidates; the performance of our third-party suppliers and manufacturers and our ability to obtain alternative sources of raw materials; our ability to obtain additional financing; our use of the proceeds from our public offering in February 2014 and our private placement in August 2013; our expectations regarding the time during which we will be an emerging growth company under the JOBS Act; and our ability to attract and retain key scientific or management personnel. Words such as "may," "anticipate," "estimate," "expect," "may," "project," "intend," "plan," "believe," "potential," "predict," "project," "likely," "will," "would," "could," "should," "continue" and words and terms of similar substance used in connection with any discussion of future operating or financial performance, identify forward-looking statements. All forward-looking statements are management's present expectations of future events and are subject to a number of risks and uncertainties that could cause actual results to differ materially and adversely from those described in the forward-looking statements. These risks include, but are not limited to, those set forth under the heading "Risk Factors" in our Annual Report on Form 10-K filed on March 25, 2014. In light of these assumptions, risks and uncertainties, the results and events discussed in the forward-looking statements contained in this Quarterly Report on Form 10-Q or in any document incorporated by reference might not occur. Stockholders are cautioned not to place undue reliance on the forward-looking statements, which speak only as of the date of this Quarterly Report on Form 10-Q. We are not under any obligation, and we expressly disclaim any obligation, to update or alter any forward-looking statements, whether as a result of new information, future events or otherwise. All subsequent forward-looking statements attributable to the Company or to any person acting on its behalf are expressly qualified in their entirety by the cautionary statements contained or referred to in this section.


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Source: Edgar Glimpses


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