Arcus Biosciences, Inc. - Quarter Report: 2020 June (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

For the quarterly period ended June 30, 2020

OR

For the transition period from _____________to _______________

Commission File Number: 001-38419

Arcus Biosciences, Inc.

(Exact Name of Registrant as Specified in its Charter)

Registrant’s telephone number, including area code: (510) 694-6200

Securities registered pursuant to Section 12(b) of the Act:

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

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

As of July 31, 2020, the registrant had 64,906,328 shares of common stock, $0.0001 par value per share, outstanding.

Table of Contents

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PART I—FINANCIAL INFORMATION

Item 1. Financial Statements.

ARCUS BIOSCIENCES, INC.

Condensed Consolidated Balance Sheets

(In thousands, except share and per share amounts)

(unaudited)

The accompanying notes are an integral part of these condensed consolidated financial statements.

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ARCUS BIOSCIENCES, INC.

Condensed Consolidated Statements of Operations and Comprehensive Loss

(In thousands, except share and per share amounts)

(unaudited)

The accompanying notes are an integral part of these condensed consolidated financial statements.

2

ARCUS BIOSCIENCES, INC.

Condensed Consolidated Statements of Stockholders’ Equity

(In thousands, except share and per share amounts)

(unaudited)

The accompanying notes are an integral part of these condensed consolidated financial statements.

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ARCUS BIOSCIENCES, INC.

Condensed Consolidated Statements of Cash Flows

(In thousands)

(unaudited)

The accompanying notes are an integral part of these condensed consolidated financial statements.

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ARCUS BIOSCIENCES, INC.

Notes to Condensed Consolidated Financial Statements

Note 1. Organization

Description of Business

Arcus Biosciences, Inc. (the Company) is a clinical-stage biopharmaceutical company focused on creating best-in-class cancer therapies. The Company’s initial focus has been on well-characterized biological pathways with significant scientific data supporting their importance. Since its inception in 2015, the Company has built a robust and highly efficient drug discovery capability to create highly differentiated small molecules, which the Company is developing in combination with its in-licensed monoclonal antibodies through rationally designed, indication-specific, adaptive clinical trial designs.

Liquidity and Capital Resources

As of June 30, 2020, the Company had cash and investments of $462.5 million, which are cash, cash equivalents, and investments in marketable securities, which the Company believes will be sufficient to fund its planned operations for a period of at least twelve months following the filing date of this report.

Note 2. Significant Accounting Policies

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (U.S. GAAP) for interim financial information and pursuant to Form 10-Q and Article 10 of Regulation S-X of the Securities and Exchange Commission (SEC). Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the Company’s opinion, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation of the results of operations and cash flows for the periods presented have been included.

Operating results for the six months ended June 30, 2020 are not necessarily indicative of the results that may be expected for the year ending December 31, 2020 or for any future period. The balance sheet as of December 31, 2019 has been derived from audited consolidated financial statements at that date but does not include all of the information required by U.S. GAAP for complete financial statements. Certain reclassifications have been made to prior period amounts to conform to the current year presentation. “Accrued interest receivable,” which was previously reported as “Prepaid expenses and other current assets”, and “Accrued research and development expense”, which was previously reported as “Other accrued liabilities” on the consolidated balance sheets, are now reported as separate line items.

The accompanying condensed consolidated financial statements and related financial information should be read in conjunction with the audited consolidated financial statements and the related notes thereto for the year ended December 31, 2019 included in the Company’s Annual Report on Form 10-K filed with the SEC on March 5, 2020.

The Company is an “emerging growth company,” as defined in the Jumpstart Our Business Startups Act of 2012, or the JOBS Act, and will remain an emerging growth company until December 31, 2020. Under the JOBS Act, the Company elected the extended transition period for complying with new or revised accounting standards. At June 30, 2020 the Company determined that it will become a large accelerated filer at December 31, 2020 and in the process will no longer qualify as an emerging growth company. The Company will adopt any accounting pronouncements deferred under the extended transition period election on or before December 31, 2020.

Principles of Consolidation

The Company established a wholly-owned subsidiary in Australia in 2017 and a wholly-owned subsidiary in Ireland in 2019. The condensed consolidated financial statements include the Company’s accounts and those of its wholly-owned subsidiaries. All intercompany accounts, transactions and balances have been eliminated.

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Use of Estimates

The preparation of the Company’s condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, as well as related disclosures of contingent assets and liabilities. Estimates were used to determine the value of stock-based awards and other issuances, accruals for research and development costs, useful lives of long-lived assets, and uncertain tax positions. Actual results could differ materially from the Company’s estimates.

Cash Equivalents and Short-Term Investments

Cash equivalents include marketable securities having an original maturity of three months or less at the time of purchase. Short-term investments have maturities of greater than three months and up to twelve months at the time of purchase. Collectively, cash equivalents, short-term and long-term investments are considered available-for-sale and are recorded at fair value. Unrealized gains and losses are recorded in accumulated other comprehensive loss. Realized gains and losses are included in interest and other income, net in the condensed consolidated statements of operations and comprehensive income or loss. The basis on which the cost of a security that is sold or an amount that is reclassified out of accumulated other comprehensive income or loss into earnings is determined using the specific identification method.

Reconciliation of Cash, Cash Equivalents, and Restricted Cash as Reported in Condensed Consolidated Statements of Cash Flows

Restricted cash at June 30, 2020 and December 31, 2019 represents cash balances held as security in connection with the Company’s facility lease agreements. The following table provides a reconciliation of cash, cash equivalents, and restricted cash within the condensed consolidated balance sheets to the total shown in the condensed consolidated statements of cash flows (in thousands):

Concentration of Credit Risk

Cash equivalents, short-term and long-term investments are financial instruments that potentially subject the Company to concentrations of credit risk. The Company invests in money market funds, treasury bills and notes, government bonds, commercial paper and corporate notes. The Company limits its credit risk associated with cash equivalents, short-term and long-term investments by placing them with banks and institutions it believes are credit worthy and in highly rated investments.

Research and Development Expenses

Research and development costs are expensed as incurred. Research and development expenses consist primarily of personnel costs for the Company’s research and development employees, costs incurred to third-party service providers for the conduct of research, preclinical and clinical studies, laboratory supplies and equipment maintenance costs, product license fees, consulting and other related expenses.

The Company estimates research, preclinical and clinical study expenses based on services performed, pursuant to contracts with third-party research and development organizations that conduct and manage research, preclinical and clinical activities on its behalf. The Company estimates these expenses based on discussions with internal management personnel and external service providers as to the progress or stage of completion of services and the contracted fees to be paid for such services. If the actual timing of the performance of services or the level of effort varies from the original estimates, the Company will adjust the accrual accordingly. Payments associated with licensing agreements to acquire licenses to develop, use, manufacture and commercialize products that have not reached technological feasibility and do not have alternative future use are expensed as incurred. Payments made to third parties under these arrangements in advance of the performance of the related services by the third parties are recorded as prepaid expenses until the services are rendered.

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Stock-Based Compensation

Stock-based awards granted include stock options and restricted stock awards with time-based vesting. ASC 718 requires the recognition of compensation expense, using a fair value-based method, for costs related to all stock-based payments. The Company’s determination of the fair value of stock options with time-based vesting on the date of grant utilizes the Black-Scholes option-pricing model, and is impacted by the Company’s common stock price as well as other variables including, but not limited to, expected term that options will remain outstanding, expected common stock price volatility over the term of the option awards, risk-free interest rates and expected dividends. Compensation expense associated with restricted stock awards is based on the fair value of common stock on the date of grant.

Income Taxes

On March 18, 2020, the Families First Coronavirus Response act (FFCR Act), and on March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) were each enacted in response to the COVID-19 pandemic. The FFCR Act and the CARES Act contain numerous tax-related provisions relating to refundable payroll tax credits, deferment of employer side social security payments, net operating loss carryback periods, alternative minimum tax credit refunds, modifications to the net interest deduction limitations and technical corrections to tax depreciation methods for qualified improvement property. On June 29, 2020 California State Assembly Bill 85 (the Trailer Bill) was enacted which suspends the use of California net operating loss (NOL) deductions and certain tax credits, including research and development tax credits, for the 2020, 2021, and 2022 tax years.

The FFCR Act, CARES Act and Trailer Bill did not have a material impact on the Company’s condensed consolidated financial statements as of June 30, 2020; however, the Company continues to examine the impacts the FFCR Act, CARES Act and Trailer Bill may have on its business, results of operations, financial condition and liquidity.

Recently Adopted Accounting Standards

In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. ASU 2019-12 reduces costs and complexity of applying accounting standards while maintaining the usefulness of the information provided to users of financial statements. While not required to be adopted until 2021 for most calendar year public business entities, early adoption is permitted for any financial statements not yet issued. The Company early adopted this ASU as of January 1, 2020, with an immaterial impact on its financial statements.

Recently Issued Accounting Standards or Updates Not Yet Effective

In February 2016, the FASB issued ASU No. 2016-02 (Topic 842), Leases (ASU 2016-02). ASU 2016-02 requires an entity to recognize assets and liabilities arising from a lease for both financing and operating leases. The ASU will also require new qualitative and quantitative disclosures to help investors and other financial statement users better understand the amount, timing, and uncertainty of cash flows arising from leases. In July 2018, the FASB issued ASU No. 2018-10, Codification Improvements to Topic 842, Leases and ASU No. 2018-11, Leases (Topic 842): Targeted Improvements, which offers a practical expedient for transitioning at the adoption date. The Company is required to adopt these ASUs for its year ended December 31, 2020, with an effective date of January 1, 2020. The Company expects to adopt the standard using the modified retrospective approach which requires a cumulative-effect adjustment to retained earnings for adjustments prior to January 1, 2020. The Company also expects to adopt certain practical expedients provided by ASU 2018-11. The Company is in the process of implementing its plan, which includes the identification of its lease population and implementing changes to existing process that will be required to meet the requirements of the new standard. The adoption of Topic 842 is expected to impact the Company’s condensed consolidated financial statements as the Company has certain operating lease arrangements for which it is the lessee. The Company is currently evaluating the impact the adoption of Topic 842 will have on its financial position and results of operations but anticipates the recognition of additional material assets and corresponding material liabilities on its condensed consolidated balance sheet related to leases. The adoption of this accounting standard update is also expected to impact the Company’s condensed consolidated financial statement disclosures.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which modifies the measurement and recognition of credit losses for most financial assets and certain other instruments. The ASU updates the guidance for measuring and recording of current expected credit losses on financial assets measured at amortized cost by replacing the “incurred loss” model with an “expected loss” model. Accordingly, these financial assets will be presented at the net amount expected to be collected. The ASU also requires that credit losses related to available-for-sale debt securities be recorded as an allowance through net income rather than reducing the carrying amount under the current, other-than-temporary-impairment model. The Company is required to adopt ASU 2016-13 for its year ended December 31, 2020, with an effective date of January 1, 2020. The Company expects to adopt the standard using the modified retrospective approach which requires a cumulative-effect adjustment to accumulated deficit for adjustments prior to January 1, 2020. The adoption of this standard is not expected to have a material impact on the Company’s condensed consolidated financial statements.

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In August 2018, the FASB issued ASU No.2018-13 (Topic 820), Fair Value Measurement. ASU 2018-13 modifies the disclosure requirements on fair value measurement in Topic 820. The Company is required to adopt ASU 2018-13 by December 31, 2020, with an effective date of January 1, 2020. The Company expects to adopt the standard on December 31, 2020. The adoption of this standard is not expected to have a material impact on the Company’s condensed consolidated financial statements.

In August 2018, the FASB issued ASU No.2018-15 (Subtopic 350-40), Intangibles – Goodwill and Other – Internal-Use Software. ASU 2018-15 requires an entity in a hosting arrangement that is a service contract to follow the guidance in Subtopic 350-40 to determine which implementation costs to capitalize as an asset related to internal-use software. The Company is required to adopt ASU 2018-15 by December 31, 2020, with an effective date of January 1, 2020. The Company expects to adopt the standard on December 31, 2020. The adoption of this standard is not expected to have a material impact on the Company’s condensed consolidated financial statements.

In November 2018, the FASB issued ASU No. 2018-18 (Topic 808), Collaborative Arrangements. ASU 2018-18 clarifies that certain transactions between collaborative arrangement participants should be accounted for as revenue under ASC 606 when the collaborative arrangement participant is a customer in the context of a unit of account and precludes recognizing as revenue consideration received from a collaborative arrangement participant if the participant is not a customer. The Company is required to adopt ASU 2018-18 by December 31, 2020, with an effective date of January 1, 2020. The adoption of this standard is not expected to have a material impact on the Company’s condensed consolidated financial statements.

Note 3. Fair Value Measurements

Financial assets and liabilities are recorded at fair value. The accounting guidance for fair value provides a framework for measuring fair value, clarifies the definition of fair value and expands disclosures regarding fair value measurements. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the reporting date. The accounting guidance establishes a three-tiered hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value as follows:

Level 1—Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date.

Level 2—Inputs (other than quoted market prices included in Level 1) are either directly or indirectly observable for the asset or liability through correlation with market data at the measurement date and for the duration of the instrument’s anticipated life.

Level 3—Inputs reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model.

Assets and liabilities measured at fair value are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires management to make judgments and consider factors specific to the asset or liability.

During the periods presented, the Company has not changed the manner in which it values assets and liabilities that are measured at fair value. The Company recognizes transfers between levels of the fair value hierarchy as of the end of the reporting period. There were no transfers within the hierarchy as of June 30, 2020 and December 31, 2019. The following tables set forth the Company’s financial instruments that were measured at fair value on a recurring basis by level within the fair value hierarchy (in thousands):

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Classified as (with contractual maturities):

Investments in marketable securities are classified as available-for-sale. At June 30, 2020 and December 31, 2019, the balance in the Company’s accumulated other comprehensive loss comprised activity related to the Company’s available-for-sale marketable securities. There were immaterial and no realized gains or losses recognized on the sale or maturity of available-for-sale marketable securities as of June 30, 2020 and December 31, 2019, respectively, and as a result, the Company did not reclassify any amounts out of accumulated other comprehensive loss for the periods then ended. The Company has a limited number of available-for-sale marketable securities in loss positions as of June 30, 2020, which the Company does not intend to sell and has concluded it will not be required to sell before recovery of the amortized cost for the investment at maturity. The fair value and amortized cost of investments in marketable securities by major security type as of June 30, 2020 and December 31, 2019 are presented in the tables that follow (in thousands):

Note 4. Accrued Liabilities

Accrued liabilities consisted of the following (in thousands):

Note 5. Equity Investment

In 2016, the Company purchased approximately 3.6 million shares of common stock of PACT Pharma, Inc. (PACT Pharma), a privately funded, early-stage biopharmaceutical company focused on adoptive cell therapy, and 1.0 million shares of Series A preferred stock. The Company determined the fair value of such investment to be insignificant to the Company’s 2016 financial statements given the start-up nature of operations of PACT Pharma, and it was recorded at a nominal amount. The Company also received certain warrants to purchase PACT Pharma common stock exercisable upon PACT Pharma’s achievement of certain valuation thresholds pursuant to a Master Services Agreement between the Company and PACT Pharma (the PACT Agreement), which agreement has since expired. The Company determined PACT Pharma to be a variable interest entity, and that the Company has a variable interest in PACT. However, because the Company is not the primary beneficiary of PACT Pharma, it is not required to consolidate the results of operations of PACT Pharma within its condensed consolidated financial statements.

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The Company’s investment in PACT Pharma is accounted for as an equity method investment, and as a result the Company records its share of PACT Pharma’s operating results in interest and other income, net, in its condensed consolidated statements of operations and comprehensive loss. The investment balance was zero at June 30, 2020 and December 31, 2019.

In January and June 2020, PACT Pharma issued shares in its Series C and Series C-1 preferred stock financings. The Company did not participate in these financings, and therefore its equity ownership percentage in PACT Pharma decreased. As a result of the dilution in its equity ownership percentage and an increase in PACT Pharma’s estimated fair value per share, the Company realized a $0.2 million and $1.5 million gain on deemed sale from equity method investee during the three and six months ended June 30, 2020, respectively. After applying a total of $0.1 and $0.9 million in losses accumulated in prior periods when the equity investment balance was zero, the Company recorded a gain of $0.1 million and $0.6 million for the three and six months ended June 30, 2020, respectively.

The Company’s share of PACT Pharma’s losses for the for the three and six months ended June 30, 2020 exceeded the gains on deemed sale recognized as a result of the Series C and Series C-1 financings. Since the Company has no obligation to provide cash financing to PACT Pharma, no additional losses are being recorded beyond the investment’s carrying amount. The Company recorded $0.1 million and $0.6 million for its share of PACT Pharma’s operating losses for the three and six months ended June 30, 2020, respectively. The Company recorded $0.4 million and $0.8 million for its share of PACT Pharma’s operating losses for the three or six months ended June 30, 2019, respectively . The unrecognized equity method losses in excess of the Company’s investment was $0.6 million as of June 30, 2020.

At June 30, 2020 and December 31, 2019, the Company determined the fair value of the warrants to be insignificant to the condensed consolidated financial statements.

Note 6. License and Collaboration Agreements

Taiho Pharmaceutical Co., Ltd

In September 2017, the Company and Taiho entered into an option and license agreement (the Taiho Agreement) to collaborate on the potential development and commercialization of certain investigational products from the Company’s portfolio in Japan and certain other territories in Asia (excluding China) (the Taiho Territory). The Taiho Agreement provides Taiho with exclusive options in the Taiho Territory, over a five-year period (the Option Period), to obtain an exclusive development and commercialization license to clinical stage investigational products from the Company’s programs (each, an Arcus Program).

In consideration for the exclusive options and other rights contained in the Taiho Agreement, Taiho agreed to make non-refundable, non-creditable cash payments to the Company totaling $35.0 million, of which the Company received $25.0 million during 2017. An additional $5.0 million was received in 2018 and the remaining $5.0 million was received in 2019.  

In the event that the Company has not initiated IND enabling studies for at least five Arcus Programs prior to the expiration of the Option Period, Taiho may elect to extend the Option Period, up to a maximum of seven years, subject to an extension fee. For each option that Taiho elects to exercise, Taiho will be obligated to make an option exercise payment of between $3.0 million to $15.0 million, depending on the development stage of the applicable Arcus Program for which the option is exercised. In addition, the Taiho Agreement provides that the Company is eligible to receive additional clinical and regulatory milestones totaling up to $130.0 million per Arcus Program, and it will be eligible to receive contingent payments of up to $145.0 million per Arcus Program associated with the achievement of specified levels of Taiho net sales in the Taiho Territory.

In addition, the Company will receive royalties ranging from high single-digits to mid-teens on net sales of licensed products in the Taiho Territory. Royalties will be payable on a licensed product-by-licensed product and country-by-country basis during the period of time commencing on the first commercial sale of a licensed product in a country and ending upon the later of: (a) ten (10) years from the date of first commercial sale of such licensed product in such country; and (b) expiration of the last-to-expire valid claim of the Company’s patents covering the manufacture, use or sale or exploitation of such licensed product in such country (the Royalty Term).

The Company evaluated the Taiho Agreement under ASC 606 and determined that the current performance obligations consist of (1) the research and development services, in which the Company will use commercially reasonable efforts to initiate IND enabling studies for at least five Arcus Programs, as well as further develop such Arcus Programs during the term of the Agreement, and (2) the obligation to participate on the joint steering committee. These deliverables are non-contingent in nature. The Company determined that the obligation to participate in the joint steering committee does not have stand-alone value to Taiho because the committee’s primary purpose is to monitor and govern the research and development activities and, hence, it is inseparable from the research and development services.

The Company’s assessment of the transaction price included an analysis of amounts it expected to receive, which at contract inception consisted of the upfront cash payment of $20.0 million due upon contract execution in September 2017, a $5.0 million payment due within 30 days of contract execution, an anniversary payment of $5.0 million due in 2018, and a final anniversary payment of $5.0 million due in 2019. All payments were made by Taiho as they became due and payable so given this successful collection history, the Company considers the entire $35.0 million in non-refundable fees to be the initial transaction price.

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The Company determined that the combined performance obligation of the research and development services and the obligation to participate on the joint steering committee are satisfied over time. The Company uses a time-elapsed input method to measure progress toward satisfying its performance obligation, which is the method the Company believes most faithfully depicts the Company’s performance in transferring the promised services during the time period in which Taiho has access to the Company’s research and development activities. Accordingly, the transaction price of $35.0 million is being recognized using this input method over the estimated performance period of five years.

The Company also concluded that, at the inception of the agreement, Taiho’s exclusive options are not considered material rights as the options do not contain a significant and incremental discount. The Company therefore excludes the exclusive options from the initial transaction price and accounts for them as separate contracts. In 2018, Taiho exercised its option to the Company’s adenosine receptor antagonist program, including etrumadenant (formerly referred to as AB928), for a fee of $3.0 million, which was recognized by the Company as revenue during the year ended December 31, 2018 under Topic 605. The adoption of Topic 606 in 2019 had no effect on the revenue recognized for this fee. In 2019, Taiho exercised its option to the Company’s anti-PD-1 antibody program, including zimberelimab (formerly referred to as AB122) for a fee of $8.0 million. The Company identified one performance obligation, the delivery of the license, which was completed in 2019. The transaction price was determined to be the payment of $8.0 million, which was recognized by the Company as licensing revenue during the year ended December 31, 2019 under Topic 606. Upon the option exercises, Taiho gained sole responsibility for the development and commercialization of the licensed products from within the programs in the Taiho Territory.

The Company also determined that the clinical and regulatory milestone payments under the Taiho Agreement are variable consideration under Topic 606 which need to be added to the transaction price when it is probable that a significant revenue reversal will not occur. Based on the nature of the clinical and regulatory milestones, such as the regulatory approvals which are not within the Company’s control, the Company will not consider achievement of such milestones to be probable until the uncertainty associated with the milestones has been resolved. When it is probable that a significant reversal of revenue will not occur, the milestone payment will be added to the transaction price, which will then be allocated to each performance obligation, on a relative standalone selling price basis, for which the Company recognizes revenue. As of June 30, 2020, no clinical or regulatory milestones had been achieved under the Taiho Agreement.

The Company also considers the contingent payments due from Taiho upon the achievement of specified sales volumes to be similar to royalty payments. The Company considers the license to be the predominant item to which the royalties relate. The Company will recognize revenue at the later of (i) when the related sales occur, or (ii) when the performance obligation to which some or all of the royalty has been allocated has been satisfied (or partially satisfied). As of June 30, 2020, no sales milestone or royalty revenue has been recognized.

The Taiho Agreement shall remain in effect until expiry of all Royalty Terms for the licensed products, in each case subject to certain exceptions.

The Company recognized a total of $1.8 million of revenue under the Taiho Agreement during each of the three months ended June 30, 2020 and 2019, and $3.5 million of revenue during each of the six months ended June 30, 2020 and 2019. Revenue recognized under the Taiho Agreement related to the non-refundable upfront research and development fees received in prior periods. As of June 30, 2020, the Company recorded deferred revenue, current and deferred revenue, noncurrent of $7.0 million and $8.5 million, respectively, in its condensed consolidated balance sheet.

Changes in Deferred Revenue Balances

The Company recognized the following revenue as a result of changes in the deferred revenue balance during the period below (in thousands):

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WuXi Biologics License Agreement

The Company entered into a license agreement (the WuXi Agreement) with WuXi Biologics (Cayman) Inc. (WuXi Biologics) in August 2017, as subsequently amended in June 2019 and March 2020, in which the Company obtained an exclusive license to develop, use, manufacture, and commercialize products including an anti-PD-1 antibody worldwide except for Greater China and Thailand. From the inception of the WuXi Agreement through June 30, 2020, the Company has made upfront and milestone payments of $26.0 million and incurred sub-license fees of $1.2 million. The Company also incurred a $5.0 million payment obligation in the second quarter of 2020 upon its achievement of a development milestone. These payments were recorded as research and development expense, as the products had not reached technological feasibility and do not have an alternative future use. The WuXi Agreement also provides for additional clinical and regulatory milestone payments, commercialization milestone payments of up to $375.0 million, and tiered royalty payments to be made to WuXi Biologics that range from the high single-digits to low teens of net sales by the Company of licensed products.

The Company incurred $5.0 million in development milestone expense under the WuXi Agreement during the three and six months ended June 30, 2020.

Abmuno License Agreement

In December 2016, the Company entered into a license agreement (the Abmuno Agreement) with Abmuno Therapeutics LLC (Abmuno) for a worldwide exclusive license to develop, use, manufacture, and commercialize products that include an anti-TIGIT antibody, including domvanalimab (formerly referred to as AB154). Under the Abmuno Agreement, the Company has made upfront and milestone payments totaling $6.6 million as of December 31, 2019. The Abmuno Agreement also provides for additional clinical, regulatory and commercialization milestone remaining payments of up to $101.0 million as of June 30, 2020.

No upfront or milestone payments were made under the Abmuno Agreement during the three and six months ended June 30, 2020 and 2019, respectively.

Genentech Collaboration Agreement

In December 2019, the Company and Genentech, through F. Hoffmann-La Roche Ltd (collectively, Genentech) entered into a Master Clinical Collaboration Agreement (the Genentech Agreement) pursuant to which the parties may conduct combination clinical studies involving Genentech’s monoclonal antibody, atezolizumab (TECENTRIQ®) and the Company’s investigational products. Pursuant to the Genentech Agreement, the parties entered into Trial Supplements for the evaluation of etrumadenant (formerly referred to as AB928) and atezolizumab utilizing the MORPHEUS platform in two separate study indications: second and third line metastatic colorectal cancer; and first line metastatic pancreatic cancer. The Company and Genentech will each supply their respective investigational products for use in the collaboration studies and will share a portion of the development costs under specific terms as set forth in the agreement.

No expense was incurred on this collaboration for the three and six months ended June 30, 2020.

Strata Collaboration Agreement

On April 30, 2019, the Company and Strata Oncology, Inc. (Strata) entered into a Co-Development and Collaboration Agreement (the Strata Agreement) to pursue a clinical development collaboration utilizing Strata’s precision drug development platform and proprietary biomarkers to evaluate zimberelimab, the Company’s clinical-stage anti-PD-1 antibody, in patients in a tumor-agnostic fashion.

Under the terms of the Strata Agreement, the parties will share a portion of development costs for the clinical collaboration under specified terms. Strata is eligible to receive $2.5 million upon the achievement of a development milestone, as well as regulatory and commercial milestones of up to $125.0 million and up to double-digit royalties on U.S. net sales of zimberelimab in the biomarker-identified indication. From the inception of the Agreement through June 30, 2020, the Company has made a milestone payment of $2.5 million and has incurred expenses of $2.0 million, of which $0.4 million had been reimbursed by Strata as development cost sharing. These amounts were recorded within research and development expense.

As further consideration in connection with the Strata Agreement, the Company issued to Strata 1,257,651 restricted shares of its common stock with an initial measured fair value of $15.0 million, which are subject to vesting based upon the achievement of specified regulatory milestones within certain timelines. Expense relating to the restricted shares subject to these milestones is recognized if it is considered probable that the associated shares will vest. The probability of achievement is assessed at the end of each quarterly period. As of June 30, 2020, the Company determined that none of the restricted shares were probable of vesting and, as a result, no compensation expense related to the restricted shares has been recognized to date.

For the three and six months ended June 30, 2020, the Company incurred expenses pursuant to the Strata Agreement of $0.6 million and $1.0 million, respectively. Of these expenses, $0.1 million and $0.2 million have been reimbursed by Strata as development cost sharing for the three and six months ended June 30, 2020, respectively. Net expenses related to this co-development agreement are recorded within research and development expenses.

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Note 7. Stockholders’ Equity

In June 2020, pursuant to a shelf registration statement on Form S-3 that was filed in May 2020, the Company issued 12,650,000 shares of its common stock at $27.50 per share in an underwritten public offering (the May 2020 Public Offering). The total number of shares sold consisted of 11,000,000 base shares and an additional 1,650,000 shares sold pursuant to the underwriters’ option exercise. Net proceeds from the May 2020 Public Offering were approximately $326.2 million after deducting underwriting discounts, commissions and other offering expenses.

Note 8. Stock-Based Compensation

In March 2018, the Company adopted the 2018 Equity Incentive Plan (2018 Plan). The 2018 Plan replaced the Company’s 2015 Stock Plan (2015 Plan) and 3,570,000 shares were reserved under the 2018 Plan, along with any shares remaining available for issuance under the Company’s 2015 Plan or outstanding awards under its 2015 Plan that subsequently expire, lapse unexercised or are forfeited to or repurchased by the Company.

In January 2020, the Company adopted the 2020 Inducement Plan (2020 Plan). Under the 2020 Plan, 3,000,000 shares were reserved for issuance.

Restricted Stock Units

In June 2020, the Company issued a total of 658,950 shares of common stock under restricted stock agreements to its employees and directors under the 2018 Plan. At the date of grant, the shares had an estimated weighted average fair value of $29.41 per share. Under the terms of the restricted stock agreements, shares vest annually over four years for employees and over 12 months for directors.

Total stock-based compensation expense was recognized in the condensed consolidated statements of operations and comprehensive loss as follows (in thousands):

Note 9. Net Loss per Share

The following table sets forth the computation of basic and diluted net loss per share (in thousands, except share and per share data):

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The following outstanding potentially dilutive securities were excluded from the computation of diluted net loss per share for the periods presented because including them would have been antidilutive:

Note 10. Commitments

Leases

The Company leases laboratory and office space in Hayward, California under non-cancelable operating leases that expire in 2025, subject to an option by the Company to extend the lease term. In June 2020, the Company entered into a lease amendment for 36,303 square feet of additional space in Hayward, California, that is expected to commence January 2021 for an eight-year term with minimum lease payments of $10.1 million. The lease amendment provides for one eight-year extension period.

Note 11. Subsequent Events

On May 27, 2020, the Company entered into an Option, License and Collaboration Agreement (Gilead Collaboration Agreement), Common Stock Purchase Agreement (the Purchase Agreement), and Investor Rights Agreement, each with Gilead Sciences, Inc. (Gilead). The transaction closed on July 13, 2020 following expiration of the antitrust waiting period. Upon closing, Gilead made an upfront payment of $175 million pursuant to the Gilead Collaboration Agreement, Gilead made an equity investment of approximately $200 million in the Company by purchasing 5,963,029 shares of Arcus common stock at a per share price of $33.54 pursuant to the Purchase Agreement, and the Company appointed Gilead’s designee, Merdad Parsey, M.D., Ph.D., to the Company’s Board of Directors pursuant to the Investor Rights Agreement.

Pursuant to the terms of the Gilead Collaboration Agreement, Gilead has an exclusive license to develop and commercialize zimberelimab (formerly referred to as AB122) in certain markets and obtained exclusive options to acquire an exclusive license to develop and commercialize all of the Company’s current and future clinical programs during the 10-year collaboration term and, for those programs that enter clinical development prior to the end of the collaboration term, for up to an additional three years thereafter. Gilead may exercise its option, on a program-by-program basis, upon payment of an option fee that ranges from $200 million to $275 million per program for the Company’s current clinical programs, and $150 million per program for all other programs that enter clinical development. If Gilead exercises its option with respect to the Company’s TIGIT program, the Company is also eligible to receive up to $500 million in potential U.S. regulatory approval milestones with respect to domvanalimab (formerly referred to as AB154).

Upon Gilead’s exercise of its option to a program, the two companies will co-develop and equally share global development costs, subject to certain opt-out rights of the Company, expense caps on the Company’s spending and true-up adjustments. For each optioned program, provided the Company has not exercised its opt-out rights, the Company has an option to co-promote in the United States with equal sharing of related profits and losses. Gilead has the right to exclusively commercialize any optioned programs outside of the U.S., subject to the rights of the Company’s existing partners to any territories, and Gilead will pay to the Company tiered royalties as a percentage of revenues ranging from the high teens to the low twenties. Gilead will further provide ongoing research and development support of up to $400 million over the collaboration term.

Pursuant to the Purchase Agreement and the Investor Rights Agreement, Gilead has the right, at its option, to purchase additional shares from the Company, up to a maximum of 35% of the Company’s then-outstanding voting common stock, from time to time over the next five years, at a purchase price equal to the greater of a 20% premium to market (based on a trailing five-day average closing price) at the time Gilead exercises such option, and the $33.54 initial purchase price. The Investor Rights Agreement also includes a three-year standstill and a two-year lockup and provides Gilead with registration rights commencing at the end of the lockup period, pro rata participation rights in certain future financings and the right to designate two individuals to be appointed to the Company’s Board of Directors.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

You should read the following discussion and analysis of our financial condition and results of operations together with our unaudited condensed consolidated financial statements and notes thereto in Part I, Item 1 of this Quarterly Report on Form 10-Q and with our audited consolidated financial statements and notes thereto for the year ended December 31, 2019, and management’s discussion and analysis, included in our Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission (SEC) on March 5, 2020. This discussion and other parts of this report contain forward-looking statements that involve risk and uncertainties, such as statements of our plans, objectives, expectations, and intentions. Our actual results could differ materially from those discussed in these forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in the section of this report entitled “Risk Factors.”

Overview

We are a clinical-stage biopharmaceutical company focused on creating best-in-class cancer therapies. Our initial focus has been on well-characterized biological pathways with significant scientific data supporting their importance. We have built a robust and highly efficient drug discovery capability to create highly differentiated small molecules, which we have the ability to develop in combinations with our monoclonal antibodies through rationally designed, indication-specific, adaptive clinical trial designs. Our vision is to create, develop and commercialize highly differentiated combination cancer therapies that have the potential to cure.

We currently have four investigational products in clinical development. We hold worldwide development and commercialization rights to each of these investigational products with the exception of zimberelimab, for which we hold rights outside of China and Thailand. Taiho Pharmaceutical Co., Ltd. (Taiho) has a time-limited option to exclusively license the development and commercialization rights to each of our programs for Japan and certain other territories in Asia (excluding China), which they have exercised with respect to our adenosine receptor antagonist program, including etrumadenant (formerly referred to as AB928), and our anti-PD-1 program, including zimberelimab. Gilead Sciences, Inc. (Gilead) has a time-limited option to obtain an exclusive license to all of our current and future clinical programs, subject to the rights of our existing partners to any territories. Upon closing of our Option, License and Collaboration Agreement with Gilead (the Gilead Collaboration Agreement), Gilead obtained an exclusive license to our zimberelimab program.

Etrumadenant (formerly referred to as AB928), our small molecule dual A_2a/A_2b adenosine receptor antagonist, is in clinical development, and is being evaluated in four Phase 1b expansion studies in specific cancer indications: advanced colorectal cancer, triple negative breast cancer, EGFR-mutated lung cancer, and prostate cancer; two collaboration studies with Genentech utilizing their MORPHEUS Phase 1b/2 platform in third-line metastatic colorectal cancer and first-line metastatic pancreatic cancer; a Phase 1b/2 multi-cohort platform trial in participants with metastatic castrate resistant prostate cancer; and a Phase 1b trial in participants with colorectal cancer.

AB680, our small-molecule CD73 inhibitor, is in a Phase 1/1b study for the treatment of first-line metastatic pancreatic cancer. This study consists of a safety dose-escalation portion, followed by an enrollment expansion to evaluate the combination of AB680, zimberelimab (our anti-PD-1 antibody) and the standard-of-care chemotherapies gemcitabine and nab-paclitaxel.

Domvanalimab (formerly referred to as AB154), our in-licensed anti-TIGIT monoclonal antibody, is in Phase 2 development for the treatment of first-line metastatic non-small cell lung cancer in combination with zimberelimab and etrumadenant (formerly referred to as AB928).

Zimberelimab (formerly referred to as AB122), our in-licensed anti-PD-1 monoclonal antibody, is the cornerstone of our combination strategy. In addition to the combination studies with zimberelimab described above, we are also evaluating zimberelimab as monotherapy in a tumor-agnostic, biomarker-selected Phase 1b trial.

Gilead Collaboration

On May 27, 2020, we entered into an Option, License and Collaboration Agreement (Gilead Collaboration Agreement), Common Stock Purchase Agreement (the Purchase Agreement), and Investor Rights Agreement, each with Gilead Sciences, Inc. (Gilead). The transaction closed on July 13, 2020 following expiration of the antitrust waiting period. Upon closing, Gilead made an upfront payment of $175 million pursuant to the Gilead Collaboration Agreement, Gilead made an equity investment of approximately $200 million in us by purchasing 5,963,029 shares of our common stock at a per share price of $33.54 pursuant to the Purchase Agreement, and we appointed Gilead’s designee, Merdad Parsey, M.D., Ph.D., to our Board of Directors pursuant to the Investor Rights Agreement.

Pursuant to the terms of the Gilead Collaboration Agreement, Gilead has an exclusive license to develop and commercialize zimberelimab (formerly referred to as AB122) in certain markets and obtained exclusive options to acquire an exclusive license to develop and commercialize all of our current and future clinical programs during the 10-year collaboration term and, for those programs that enter clinical development prior to the end of the collaboration term, for up to an additional three years thereafter. Gilead may exercise its option, on a program-by-program basis, upon payment of an option fee that ranges from $200 million to $275

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million per program for our current clinical programs, and $150 million per program for all other programs that enter clinical development. If Gilead exercises its option with respect to our TIGIT program, we are also eligible to receive up to $500 million in potential U.S. regulatory approval milestones with respect to domvanalimab (formerly referred to as AB154).

Upon Gilead’s exercise of its option to a program, the two companies will co-develop and equally share global development costs, subject to certain of our opt-out rights, expense caps on our spending and true-up adjustments. For each optioned program, provided we have not exercised our opt-out rights, we have an option to co-promote in the United States with equal sharing of related profits and losses. Gilead has the right to exclusively commercialize any optioned programs outside of the U.S., subject to the rights of our existing partners to any territories, and Gilead will pay to us tiered royalties as a percentage of revenues ranging from the high teens to the low twenties. Gilead will further provide ongoing research and development support of up to $400 million over the collaboration term.

Pursuant to the Purchase Agreement and the Investor Rights Agreement, Gilead has the right, at its option, to purchase additional shares from us, up to a maximum of 35% of our then-outstanding voting common stock, from time to time over the next five years, at a purchase price equal to the greater of a 20% premium to market (based on a trailing five-day average closing price) at the time Gilead exercises such option, and the $33.54 initial purchase price. The Investor Rights Agreement also includes a three-year standstill and a two-year lockup and provides Gilead with registration rights commencing at the end of the lockup period, pro rata participation rights in certain future financings and the right to designate two individuals to be appointed to our Board of Directors.

COVID-19 Pandemic

The degree to which COVID-19 impacts our business operations, research and development programs and financial condition will depend on future developments, including new information which may emerge concerning the duration and/or severity of the outbreak and any resurgences, actions by government authorities to contain the spread of the virus, and when and to what extent normal economic and operating conditions can resume. Our management is actively monitoring this health crisis and its effects on our operations, key vendors and workforce.

In mid-March, we voluntarily transitioned our employees, including our laboratory-based personnel, to work-from-home prior to the institution of state and local shelter-in-place orders. Most of our non-laboratory operations, including the conduct and management of our clinical trials and the contract manufacturing organizations engaged in CMC activities on our behalf, were easily and quickly transitioned to remote work arrangements. However, we were not able to transition our laboratory operations to work-from-home and only arranged for limited outsourcing of our discovery activities to third-party research organizations. In late June, we began to transition our laboratory-based personnel back into our facilities; however, our laboratories are operating at reduced capacity due to employee safety measures, such as social distancing requirements and shift work. Our non-laboratory-based personnel continue to work remotely.

Entering 2020, we anticipated that our discovery-stage programs would lead to the advancement of two new molecules into clinical studies in the first quarter of 2021. Based upon current timelines, the first program that we expect to advance into clinical studies remains on-track to meet this objective. The suspension of our laboratory operations has delayed the advancement of the second of these two discovery-stage programs into clinical studies; however, the magnitude of this delay is not yet known.

Despite the public health and mandatory self-quarantine measures in force during the second quarter, we continued to see relatively robust enrollment across our ongoing Arcus-sponsored studies. However, we continue to expect that this pandemic will result in delays to some of our clinical programs, particularly in initiating new studies and/or new investigational sites due to diversion of their resources away from necessary start-up activities, and by limiting the ability of investigational sites to conduct all activities associated with our ongoing studies. For example, the circumstances may hinder their ability to screen patients for enrollment. We are collaborating with our investigational sites to implement measures to minimize disruptions to patients and ensure continued access to treatment, in accordance with health authority guidance.

With respect to manufacturing and supply, we believe we currently have sufficient drug supply for our ongoing clinical studies. Our third-party contract manufacturers continue to operate at or near normal levels and, at this time and subject to further COVID-19 implications, we do not anticipate any disruptions to our drug supply chain.

The full impact of the COVID-19 outbreak continues to evolve and is highly uncertain and subject to change. In connection with our resumption of laboratory operations, we instituted regular COVID-19 testing services in order to minimize the risk to our employees. These additional operating costs, along with the absence of any furlough or measures to reduce personnel costs despite reduced laboratory capacity, will have a negative impact on our operations and financial condition. We do not expect the forward impact will be material due to adjustments in operations that we have made. However, there are many uncertainties around the COVID pandemic and future developments, which are unpredictable, may result in a material, negative impact to our operations and financial condition.

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Components of Operating Results

Collaboration and License Revenue

Under the Taiho Agreement, we recognize revenue from the upfront and annual payments for research and development services performed by us to develop our investigational products and from option exercise payments upon Taiho’s exercise of options during the Option Period.

Operating Expenses

Research and Development Expenses

Our research and development expenses consist of expenses incurred in connection with the research and development of our pipeline programs. These expenses include payroll and personnel expenses, including stock-based compensation for our employees, laboratory supplies, product licenses, consulting costs, contract research, pre-clinical and clinical expenses, and depreciation. We expense both internal and external research and development costs as they are incurred. We record advance payments for services that will be used or rendered for future research and development activities as prepaid expenses and recognize them as an expense as the related services are performed.

We do not allocate our costs by investigational product, as a significant amount of research and development expenses include internal costs, such as payroll and other personnel expenses, and certain external costs that are not recorded at the investigational product level. In particular, with respect to internal costs, several of our departments support multiple research and development programs, and we do not allocate those costs by investigational product.

We expect our research and development expenses to increase substantially during the next few years due to our Gilead collaboration and as we seek to complete existing clinical trials and advance our programs into later-stage clinical trials, pursue regulatory approval for our investigational products, and advance other programs into the clinic. Later-stage clinical trials typically include a larger number of subjects, are of a longer duration and include more geographic regions. As we advance our clinical-stage programs and prepare to seek regulatory approval, we will also need to conduct certain validation activities with respect to our manufacturing processes for the investigational products in each program. Moreover, in order to maximize the potential of our collaboration with Gilead, we believe it will be important to grow our discovery capabilities and pipeline. As a result, we expect our preclinical, clinical, and contract manufacturing expenses to increase significantly relative to what we have incurred to date. The level of our future research and development investment will depend on a number of factors and uncertainties, including clinical outcomes from our ongoing clinical trials, whether our collaborators opt into any of our programs, the amount of opt-in and milestone payments we receive from our collaborators, and the breadth of any joint development program agreed to with Gilead for programs they opt into. In addition, under our license agreements with WuXi Biologics (Cayman) Inc. (WuXi Biologics) and Abmuno Therapeutics LLC (Abmuno), and our co-development and collaboration agreement with Strata Oncology, Inc. (Strata), we may be required to pay additional clinical and regulatory milestone payments based on the development progress of zimberelimab and domvanalimab (formerly known as AB154). Therefore, we are unable to predict the timing or the final cost to complete our clinical programs or validation of our manufacturing and supply processes and delays may occur due to numerous factors. Factors that could cause or contribute to delays or additional costs include, but are not limited to, those discussed in “Risk Factors.”

General and Administrative Expenses

General and administrative expenses consist principally of personnel-related costs including payroll and stock-based compensation for personnel in executive, finance, human resources, information technology, business and corporate development, and other administrative functions. Our general and administrative expenses also include professional fees for legal, consulting, and accounting services, rent and other facilities costs, fixed asset depreciation, and other general operating expenses not otherwise classified as research and development expenses.

We anticipate that our general and administrative expenses will increase substantially during the next few years as we support our growing research and development activities, including due to staff expansion, additional occupancy costs, and other costs associated with increased infrastructure needs.

Interest and Other Income, Net

Interest and other income, net consists primarily of interest earned on our investments in fixed-income marketable securities.

Gain on Deemed Sale from Equity Method Investee

Gain on deemed sale from equity method investee consists of a gain related to the dilution of our investment in PACT Pharma, Inc. (PACT Pharma) occurring upon PACT Pharma’s new issuances of equity securities in which we do not participate on a pro rata basis or at all.

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Share of Loss from Equity Method Investee

Share of loss from equity method investee consists of our share of loss recorded in connection with our equity method investment in PACT Pharma, Inc. (PACT Pharma).

Critical Accounting Policies, Significant Judgments and Use of Estimates

Our condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP). The preparation of these condensed consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements, as well as the reported revenue and expenses incurred during the reporting periods. Our estimates are based on our historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We believe that the accounting policies relating to revenue recognition, clinical trial accruals and stock-based compensation reflect the more significant estimates and assumptions used in the preparation of our condensed consolidated financial statements.

There have been no significant changes in our critical accounting policies and estimates during the six months ended June 30, 2020, as compared to the critical accounting policies and estimates disclosed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our Annual Report on Form 10-K for the year ended December 31, 2019 and more fully described in Note 2 of the accompanying condensed consolidated financial statements.

Results of Operations

Three Months Ended June 30, 2020 and 2019

The following table summarizes our results of operations for the three months ended June 30, 2020 and 2019 (in thousands):

*Not meaningful

Collaboration and License Revenue

Collaboration and license revenue was $1.8 million for the three months ended June 30, 2020 and 2019 and relates to our license and collaboration agreement with Taiho.

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Research and Development Expenses

Research and development expenses increased $10.7 million, or 43%, from $25.0 million for the three months ended June 30, 2019 to $35.7 million for the three months ended June 30, 2020. The increase in research and development expenses was due to a $6.3 million increase in manufacturing costs required to supply our clinical studies, an increase of $3.8 million in clinical costs for our ongoing clinical studies, and an increase of $3.9 million in employee compensation costs primarily due to additional headcount, approximately $1.5 million of which consists of non-cash stock-based compensation. Those increases were partially offset by a decrease of $2.5 million due to the achievement of certain development milestones which resulted in expenses of $5.0 million pursuant to the terms of our WuXi Agreement, compared to a $7.5 million milestone payment to WuXi that was recorded in the same period in the prior year. We also saw a decrease of $1.2 million in lab supplies and equipment due to decreased lab activities caused by shelter-in-place orders amid the COVID pandemic.

General and Administrative Expenses

General and administrative expenses increased $5.5 million, or 93%, from $5.9 million for the three months ended June 30, 2019 to $11.4 million for the three months ended June 30, 2020. The increase in general and administrative expenses was due to $2.0 million in legal and accounting expenses largely incurred as a result of our collaboration agreement with Gilead, as well as $1.9 million in consulting expenses driven largely by corporate development activities. We also incurred increased expense of $1.3 million in employee compensation costs primarily due to additional headcount, approximately $0.8 million of which consists of non-cash stock-based compensation.

Interest and Other Income, Net

Interest and other income, net decreased $1.2 million or 80%, from $1.5 million for the three months ended June 30, 2019 to $0.3 million for the three months ended June 30, 2020. The decrease was primarily due to lower interest income resulting from lower investment yields on our portfolio of marketable fixed-income securities and lower average cash and investment balances in the three months ended June 30, 2020 as compared to the same period in the prior year.

Gain on Deemed Sale from Equity Method Investee

Gain on deemed sale from equity method investee was $0.1 million for the three months ended June 30, 2020 due to a gain recorded in connection with PACT Pharma’s Series C-1 preferred financing in June 2020 in which we did not participate.

Share of Loss from Equity Method Investee

Share of loss from equity method investee was $0.1 million for each of the three months ended June 30, 2020 and 2019 due to equity method losses resulting from PACT’s expanding operations.

Six Months Ended June 30, 2020 and 2019

The following table summarizes our results of operations for the six months ended June 30, 2020 and 2019 (in thousands):

*Not meaningful

Collaboration and License Revenue

Collaboration and license revenue was $3.5 million for the six months ended June 30, 2020 and 2019 and relates to our license and collaboration agreement with Taiho.

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Research and Development Expenses

Research and development expenses increased $18.2 million, or 45%, from $40.6 million for the six months ended June 30, 2019 to $58.8 million for the six months ended June 30, 2020. The increase in research and development expenses was due to an increase of $8.5 million in clinical costs for our ongoing clinical studies, an increase of $6.9 million in employee compensation costs primarily due to additional headcount, approximately $2.4 million of which consists of non-cash stock-based compensation, and a $5.9 million increase in manufacturing costs required to supply our clinical studies. Those increases were partially offset by a decrease of $2.5 million due to the achievement of certain development milestones which resulted in expenses of $5.0 million pursuant to the terms of our WuXi Agreement, compared to a $7.5 million milestone payment to WuXi that was recorded in the same period in the prior year. We also saw a decrease of $1.4 million in lab supplies and equipment due to decreased lab activities caused by shelter-in-place orders amid the COVID pandemic.

General and Administrative Expenses

General and administrative expenses increased $7.5 million, or 70%, from $10.9 million for the six months ended June 30, 2019 to $18.4 million for the six months ended June 30, 2020. The increase in general and administrative expenses was due to $2.3 million in legal and accounting expenses largely incurred as a result of our collaboration agreement with Gilead, as well as $2.4 million in consulting expenses driven largely by corporate development activities. We also incurred increased expense of $2.4 million in employee compensation costs primarily due to additional headcount, approximately $1.7 million of which consists of non-cash stock-based compensation, and a $0.5 million increase in expenses driven by investments in information technology and network security.

Interest and Other Income, Net

Interest and other income, net decreased $2.1 million or 69%, from $3.0 million for the six months ended June 30, 2019 to $0.9 million for the six months ended June 30, 2020. The decrease was primarily due to lower interest income resulting from lower investment yields on our portfolio of marketable fixed-income securities and lower average cash and investment balances during the six months ended June 30, 2020 as compared to the same period in the prior year.

Gain on Deemed Sale from Equity Method Investee

Gain on deemed sale from equity method investee was $0.6 million for the six months ended June 30, 2020 due to gains recorded in connection with PACT Pharma’s Series C and Series C-1 preferred financings in January 2020 and June 2020, respectively, in which we did not participate.

Share of Loss from Equity Method Investee

Share of loss from equity method investee was $0.6 million and $0.8 million for the six months ended June 30, 2020 and 2019, respectively, due to equity method losses resulting from PACT’s expanding operations.

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Liquidity and Capital Resources

To date, we have financed our operations primarily through net proceeds of $226.2 million from private placements of convertible preferred stock, $46.0 million in proceeds from the Taiho Agreement, net proceeds of $124.7 million from our initial public offering of our common stock in March 2018, and $326.2 million of net proceeds in our May 2020 Public Offering. As of June 30, 2020, we had $462.5 million of cash, cash equivalents, and investments in marketable securities. Our cash and investments are held in a variety of interest-bearing instruments, including money market funds, U.S. government treasury obligations, U.S. government agency securities, and investments in corporate securities. In addition, in July 2020 we received $375.0 million from Gilead upon the closing of the transactions under the Collaboration Agreement and Purchase Agreement with Gilead.

Based on our existing business plan, we believe that our existing cash, cash investments, and short-term investments will be sufficient to fund our planned level of operations through at least the next 12 months following the filing date of this report.

We may require additional capital to complete the development and any commercialization of our investigational products. Our future capital requirements will depend on many factors, including:

If we raise additional funds by issuing equity securities, our stockholders may experience dilution. Any future debt financing into which we enter may impose upon us additional covenants that restrict our operations, including limitations on our ability to incur liens or additional debt, pay dividends, repurchase our common stock, make certain investments and engage in certain merger, consolidation or asset sale transactions. Any debt financing or additional equity that we raise may contain terms that are not favorable to us or our stockholders. If we are unable to raise additional funds when needed, we may be required to delay, reduce, or terminate some or all of our development programs and clinical trials. We may also be required to sell or license to others rights to our investigational products in certain territories or indications that we would prefer to develop and commercialize ourselves.

See “Risk Factors” for additional risks associated with our substantial capital requirements.

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Summary Condensed Consolidated Statement of Cash Flows

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

Cash Used in Operating Activities

Net cash used in operating activities for the six months ended June 30, 2020 increased by $18.6 million to $55.2 million as compared to $36.6 million for the same period in the prior year. The increase in cash used is primarily due to the $27.1 million increase in our net loss to $72.8 million. The change in our net loss is primarily a result of our expanded clinical development activities and general and administrative costs incurred to support our operations. The overall increase in cash used is partially offset by year-over-year changes in non-cash items, including $4.1 million of increased expense from stock-based compensation. Additional increase in cash used resulted from changes in our asset and liability balances due to the timing of payments to or from our vendors and collaborators.

Cash Provided by (Used In) Investing Activities

Cash provided by (used in) investing activities was a $47.0 million use of cash for the six months ended June 30, 2020 compared to $41.0 million provided by investing activities for the same period in the prior year. The change in cash flow from investing activities was primarily due to purchases and maturities of our investments in fixed-income marketable securities, as we invested proceeds from our May 2020 Public Offering.

Cash Provided by Financing Activities

Cash provided by financing activities was $329.5 million for the six months ended June 30, 2020 compared to an immaterial amount of cash provided in the same period in the prior year. The increase in cash provided is primarily due to cash received from our May 2020 Public Offering, net of direct offering costs, as well as funds received during the six months ended June 30, 2020 for issuance of common stock pursuant to equity award plans.

Contractual Obligations and Commitments

In June 2020, we entered into a lease amendment for an additional 36,303 square feet of research and development offices in Hayward, California, that is expected to commence in January 2021 for an eight-year term with minimum lease payments of $10.1 million. The lease amendment provides for one eight-year extension period. Other than this lease, there have been no material changes outside the ordinary course of business during the six months ended June 30, 2020, as compared to those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2019.

JOBS Act Accounting Election

We are an “emerging growth company,” as defined in the Jumpstart Our Business Startups Act of 2012, or the JOBS Act, and will remain an emerging growth company until December 31, 2020. Under the JOBS Act, we elected the extended transition period for complying with new or revised accounting standards. At June 30, 2020 we determined that we will become a large accelerated filer at December 31, 2020 and in the process will no longer qualify as an emerging growth company. We will adopt any accounting pronouncements deferred under this election on or before December 31, 2020.

Off-Balance Sheet Arrangements

Since our inception, we have not engaged in any off-balance sheet arrangements, as defined in the rules and regulations of the SEC.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk.

The market risk inherent in our financial instruments and in our financial position represents the potential loss arising from adverse changes in interest rates, exchange rates, or general market and economic conditions. Our market risks have not changed materially from those discussed in our Annual Report on Form 10-K filed with the SEC on March 5, 2020. We do not believe that inflation, interest rate changes, exchange rate fluctuations, or general market and economic conditions had a significant impact on our results of operations for any periods presented herein.

Item 4. Controls and Procedures.

Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Securities Exchange Act of 1934 (Exchange Act) reports is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission, and that such information is accumulated and communicated to management, including our Chief Executive Officer and Principal Financial & Accounting Officer, as appropriate, to allow timely decisions regarding required disclosure.

A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues, if any, within an organization have been detected. Accordingly, our disclosure controls and procedures are designed to provide reasonable, not absolute, assurance that the objectives of our disclosure control system are met.

As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Principal Financial & Accounting Officer, of the effectiveness of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. Based upon, and as of the date of this evaluation, our Chief Executive Officer and Principal Financial & Accounting Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting during the quarter ended June 30, 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II—OTHER INFORMATION

Item 1. Legal Proceedings.

We are not currently a party to any material legal proceedings. From time to time, we may become involved in legal proceedings arising in the ordinary course of our business. Regardless of outcome, litigation can have an adverse impact on us due to defense and settlement costs, diversion of management resources, negative publicity, reputational harm and other factors.

Item 1A. Risk Factors.

You should consider carefully the following risk factors, together with all the other information in this report, including our condensed consolidated financial statements and notes thereto, and in our other public filings with the SEC, including our Annual Report on Form 10-K filed with the SEC on March 5, 2020. The occurrence of any of the following risks could harm our business, financial condition, results of operations and/or growth prospects or cause our actual results to differ materially from those contained in forward-looking statements we have made in this report and those we may make from time to time. You should consider all of the risk factors described when evaluating our business.

Risks Related to the Impact of COVID-19

The impact of the COVID-19 pandemic and related risks could have a material adverse impact on our research and development programs and financial condition.  

The degree to which COVID-19 impacts our business operations, research and development programs and financial condition will depend on future developments, including new information which may emerge concerning the duration and/or severity of the outbreak and any resurgences, actions by government authorities to contain the spread of the virus, and when and to what extent normal economic and operating conditions can resume. We expect that this pandemic will result in delays to some of our clinical programs, as well as to our discovery programs, but we are unable to predict the extent of any such delays or impact. Our laboratory-based operations were suspended due to shelter-in-place orders in force during the second quarter of 2020, which will affect our ability to meet some of our discovery and preclinical milestones and timelines. In late June, we began to transition our laboratory-based personnel back into our facilities, however, our laboratories are operating at reduced capacity due to employee safety measures, such as social distancing requirements and shift work.

The full impact of the COVID-19 outbreak continues to evolve and is highly uncertain and subject to change. In connection with our resumption of laboratory operations, we instituted regular COVID-19 testing services in order to minimize the risk to our employees. These additional operating costs, along with the absence of any furlough or measures to reduce personnel costs despite reduced laboratory capacity, will have an adverse impact on our financial condition.

In addition, the impact of the COVID-19 pandemic, including governmental and other actions to combat it such as the imposition of the shelter-in-place and other public health orders, may exacerbate the effects of the risks described below.

Risks Related to our Limited Operating History, Financial Position and Capital Requirements

We are an early-stage immuno-oncology company with a limited operating history. We have incurred net losses since our inception and anticipate that we will continue to incur significant losses for the foreseeable future. We have never generated any revenue from product sales and may never be profitable.

We are an early-stage immuno-oncology company with a limited operating history that may make it difficult to evaluate the success of our business to date and to assess our future viability. All of our investigational products are in early development, and none have been approved for commercial sale. We have never generated any revenue from product sales and have incurred net losses each year since we commenced operations. For the six months ended June 30, 2020 and the year ended December 31, 2019, our net losses were $72.8 million and $84.7 million, respectively. As of June 30, 2020, we had an accumulated deficit of $278.2 million. We expect that it will be several years, if ever, before we have an investigational product ready for commercialization. We expect to incur increasing levels of operating losses over the next several years and for the foreseeable future as we advance our investigational products. Our prior losses, combined with expected future losses, have had and will continue to have an adverse effect on our stockholders’ equity (deficit) and working capital.

To become and remain profitable, we must develop and eventually commercialize a product with significant market potential. This will require us to be successful in a range of challenging activities, including completing preclinical studies and clinical trials of our investigational products, obtaining marketing approval for these investigational products, manufacturing, marketing and selling those products for which we may obtain marketing approval and satisfying any post-marketing requirements. We may never succeed in these activities and, even if we succeed in commercializing one or more of our investigational products, we may never generate

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revenues that are significant or large enough to achieve profitability. In addition, as a young business, we may encounter unforeseen expenses, difficulties, complications, delays and other known and unknown challenges. If we do achieve profitability, we may not be able to sustain or increase profitability on a quarterly or annual basis and we will continue to incur substantial research and development and other expenditures to develop and market additional investigational products. Our failure to become and remain profitable would decrease the value of the company and could impair our ability to raise capital, maintain our research and development efforts, expand our business or continue our operations. A decline in the value of our company could also cause our stockholders to lose all or part of their investment.

We may need to obtain additional funding to finance our operations and complete the development and any commercialization of our investigational products. If we do not receive substantial opt-in, milestone or royalty payments from our existing collaboration agreements, or are unable to raise additional capital when needed, we may be forced to restrict our operations or delay, reduce or eliminate our product development programs.

The development of biopharmaceutical investigational products is capital intensive. Since our inception, we have used substantial amounts of cash to fund our operations and expect our expenses to increase substantially during the next few years as our investigational products enter and advance through preclinical studies and clinical trials and we expand our clinical, regulatory, quality and manufacturing capabilities. In addition, if we obtain marketing approval for any of our investigational products, we expect to incur significant commercialization expenses related to marketing, sales, manufacturing and distribution.

As of June 30, 2020, we had $462.5 million of cash, cash equivalents and short-term investments. In addition, upon closing of the Gilead Collaboration Agreement, common stock purchase agreement and investor rights agreement with Gilead, we received an upfront payment of $175 million and equity investment of approximately $200 million. While we believe that our cash position will be sufficient to fund our planned level of operations through at least the next 12 months, our future capital requirements will depend on many factors, including:

We cannot guarantee that future financing will be available in sufficient amounts or on terms acceptable to us, if at all. Any additional fundraising efforts may divert our management from their day-to-day activities, which may adversely affect our ability to develop and commercialize our investigational products. If we are unable to raise capital when needed or on attractive terms, we would be forced to delay, reduce or eliminate our research and development programs or future commercialization efforts.

Raising additional capital may cause dilution to our stockholders, restrict our operations or require us to relinquish rights to our

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technologies or investigational products.

Until such time, if ever, as we can generate substantial product revenue, we expect to finance our cash needs through a combination of equity offerings, debt financings, collaborations, strategic alliances and licensing arrangements. To the extent that we raise additional capital through the sale of equity or convertible debt securities, our stockholders’ ownership interests will be diluted and the terms of these securities may include liquidation or other preferences that adversely affect their rights as common stockholders. Debt financing, if available, may involve agreements that include covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making capital expenditures or declaring dividends. If we raise funds through additional collaborations, strategic alliances or licensing arrangements with third parties, we may have to relinquish valuable rights to our technologies, future revenue streams, research programs or investigational products or grant licenses on terms that may not be favorable to us. If we are unable to raise additional funds through equity or debt financings when needed, we may be required to delay, limit, reduce or terminate our product development or future commercialization efforts or grant rights to develop and market investigational products that we would otherwise prefer to develop and market ourselves.

Risks Related to the Discovery and Development of our Investigational Products

We are early in our development efforts. If we are unable to develop, obtain regulatory approval for and commercialize our investigational products, or experience significant delays in doing so, our business will be materially harmed.

We have no products approved for sale and our clinical-stage investigational products are in the early stages of clinical trials. We may subsequently learn of certain information or data that the FDA may request, which may necessitate conducting additional preclinical studies or generating additional information at significant cost in terms of both time and expense, including under a clinical hold imposed on an investigational new drug application (IND). Even if we conducted the additional studies or generated the additional information requested, the FDA could disagree that we have satisfied their requirements, all of which will cause significant delays and expense to our programs.

As we advance our clinical programs, we will need to expand our clinical operations, quality and regulatory capabilities to support these activities. In part because of our limited infrastructure, experience conducting clinical trials as a company and regulatory interactions, we cannot be certain that our clinical trials will be completed on time, that our planned clinical trials will be initiated on time, if at all, that our planned development programs would be acceptable to the FDA or other comparable foreign regulatory authorities, or that, if approval is obtained, such investigational products can be successfully commercialized.

Our ability to generate product revenue, which we do not expect will occur for many years, if ever, will depend heavily on our ability to successfully complete the above activities and any other activities required for the successful development and eventual commercialization of one or more of our investigational products. The success of our investigational products will further depend on factors such as:

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If we do not achieve one or more of these factors in a timely manner, we could experience significant delays or an inability to successfully commercialize our investigational products, which would materially harm our business.

Clinical drug development is a lengthy, expensive and uncertain process. The results of preclinical studies and early clinical trials are not always predictive of future results. Any investigational product that we advance into clinical trials may not achieve favorable results in later clinical trials, if any, or receive marketing approval.

The research and development of drugs and biological products is an extremely risky industry. Only a small percentage of investigational products that enter the development process ever receive marketing approval. Before obtaining marketing approval from regulatory authorities for the sale of any investigational product, we must complete preclinical development and then conduct extensive clinical trials to demonstrate the safety and efficacy of our investigational products in humans. Clinical testing is expensive, can take many years to complete and its outcome is uncertain.

The results of preclinical and early clinical trials of our investigational products and other products with the same mechanism of action may not be predictive of the results of later-stage clinical trials. Clinical trial failure may result from a multitude of factors including flaws in study design, dose selection, placebo effect, patient enrollment criteria and failure to demonstrate favorable safety or efficacy traits. As such, failure in clinical trials can occur at any stage of testing. A number of companies in the biopharmaceutical industry have suffered setbacks in the advancement of clinical trials due to lack of efficacy or adverse safety profiles, notwithstanding promising results in earlier trials. Based upon negative or inconclusive results, we may decide, or regulators may require us, to conduct additional clinical trials or preclinical studies. In addition, data obtained from clinical trials are susceptible to varying interpretations, and regulators may not interpret our data as favorably as we do, which may further delay, limit or prevent marketing approval. In particular, results from uncontrolled trials, meaning trials in which there is no control group such as a placebo group, are inherently difficult to interpret. Clinical trials evaluating two or more investigational products in combination that have not yet been approved can compound these difficulties. As a key element of our strategy is the development of intra-portfolio combinations, many of our clinical trials will test more than one investigational products in uncontrolled studies, such as the clinical trials in our Phase 1/1b program for etrumadenant (formerly referred to as AB928) in which we are evaluating etrumadenant in combination with zimberelimab. Furthermore, as more investigational products within a particular class of drugs proceed through clinical development to regulatory review and approval, the amount and type of clinical data that may be required by regulatory authorities may increase or change.

We currently have four investigational products in clinical development and their risk of failure is high. We are unable to predict if these investigational products or any of our future investigational products that advance into clinical trials will prove safe or effective in humans or will obtain marketing approval. If we are unable to complete preclinical or clinical trials of current or future investigational products, due to safety concerns, or if the results of these trials are not satisfactory to convince regulatory authorities of their safety or efficacy, we will not be able to obtain marketing approval for commercialization. Even if we are able to obtain marketing approvals for any of our investigational products, those approvals may be for indications that are not as broad as desired or may contain other limitations that would adversely affect our ability to generate revenue from sales of those products. Moreover, if we are not able to differentiate our product against other approved products within the same class of drugs, or if any of the other circumstances described above occur, our business would be materially harmed and our ability to generate revenue from that class of drugs would be severely impaired.

Enrollment and retention of subjects in clinical trials is expensive and time consuming, can be made more difficult or rendered impossible by competing treatments, clinical trials of competing investigational products, and public health epidemics, each of which could result in significant delays and additional costs in our product development activities, or in the failure of such activities.

We may encounter delays in enrolling, or be unable to enroll and maintain, a sufficient number of subjects to complete any of our clinical trials. Patient enrollment and retention in clinical trials is a significant factor in the timing of clinical trials and depends on many factors, including the size of the patient population required for analysis of the trial’s primary endpoints, the nature of the trial protocol, our ability to recruit clinical trial investigators with the appropriate competencies and experience, the existing body of safety and efficacy data with respect to the investigational product, the number and nature of competing products or investigational products and ongoing clinical trials of competing investigational products for the same indication, the proximity of subjects to clinical trial sites, the eligibility criteria for the clinical trial and our ability to obtain and maintain subject consents.

For example, enrollment of oncology subjects in our zimberelimab clinical trial may be hampered by nivolumab from Bristol-Myers Squibb and pembrolizumab from Merck, both of which are approved and on the market. Subjects may opt to be treated with an

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approved product rather than our anti-PD-1 antibody investigational product. In addition, Roche/Genentech have initiated Phase 3 trials with their anti-TIGIT antibody, which could reduce the number of clinical sites and subjects available for our Phase 2 trial evaluating our own anti-TIGIT antibody, AB154. Similarly, we are aware that AstraZeneca is conducting a broad clinical program with its A_2aR antagonist in metastatic castration-resistant prostate cancer (mCRPC), and we may compete for clinical sites and enrollment in this patient population, which may adversely impact the rate of enrollment and the timely completion of our Phase 1/1b trials evaluating etrumadenant (formerly AB928) in mCRPC.

Public health outbreaks, such as the COVID-19 (coronavirus) pandemic, are also expected to adversely impact our clinical trial operations. We anticipate that the limited resources available at investigational sites will limit their ability to conduct and report all patient assessments and hinder their ability to collect all patients samples, which may impact our ability to assess the activity of our investigational products in a timely manner.

Furthermore, any negative results that we may report in clinical trials of our investigational products may make it difficult or impossible to recruit and retain subjects in other clinical trials of that same investigational product. Delays in patient enrollment may result in increased costs or may affect the timing or outcome of the planned clinical trials, which could prevent completion of these trials and adversely affect our ability to advance the development of our investigational products. Failures in planned subject enrollment or retention may result in increased costs or program delays and could render further development impossible.

If we do not achieve our product development goals in the time frames we announce and expect, the commercialization of our investigational products may be delayed, our share price may decline and our commercial prospects may be adversely affected.

Drug development is inherently risky and uncertain. The actual timing of our development milestones can vary significantly compared to our estimates, in some cases for reasons beyond our control, for any number of reasons, including: