Cyclerion Therapeutics, Inc. - Quarter Report: 2020 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended March 31, 2020

or

For the transition period from             to

Commission File Number 001-38787

CYCLERION THERAPEUTICS, INC.

(Exact Name of Registrant as Specified in its Charter)

(857) 327-8778

Registrant’s Telephone Number, Including Area Code

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 x     No o

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 x    No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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.    o

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

As of May 1, 2020, the registrant had 27,754,894 shares of common stock, no par value, outstanding.

CYCLERION PHARMACEUTICALS, INC.

QUARTERLY REPORT ON FORM 10-Q

FOR THE QUARTER ENDED MARCH 31, 2020

TABLE OF CONTENTS

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This report contains forward-looking statements within the meaning of the federal securities laws, which statements involve substantial risks and uncertainties. All statements in this report, other than statements of historical facts, including statements about future events, financing plans, financial position, business strategy, budgets, projected costs, plans and objectives of management for future operations, are forward-looking statements that involve certain risks and uncertainties. Use of the words “may,” “might,” “will,” “would,” “could,” “should,” “believes,” “estimates,” “projects,” “potential,” “expects,” “plans,” “seeks,” “intends,” “evaluates,” “pursues,” “anticipates,” “continues,” “designs,” “impacts,” “affects,” “forecasts,” “target,” “outlook,” “initiative,” “objective,” “designed,” “priorities,” “goal” or the negative of those words or other similar expressions may identify forward-looking statements that represent our current judgment about possible future events, but the absence of these words does not necessarily mean that a statement is not forward-looking.

Forward-looking statements are based on our current expectations and assumptions regarding our business, the economy and other future conditions. Because forward-looking statements relate to the future, by their nature, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict. As a result, our actual results may differ materially from those contemplated by the forward-looking statements. Important factors that could cause actual results to differ materially from those in the forward-looking statements include regional, national or global political, economic, business, competitive, market and regulatory conditions and the following:

See the “Risk Factors” section in Item 1A of our annual report on Form 10-K for the fiscal year ended December 31, 2019, and elsewhere in this Quarterly Report on Form 10-Q for a further description of these and other factors. We caution you that the risks, uncertainties and other factors referenced above may not contain all of the risks, uncertainties and other factors that are important to you. In addition, we cannot assure you that we will realize the results, benefits or developments that we expect or anticipate or, even if substantially realized, that they will result in the consequences or affect us or our business in the way expected. There can be no assurance that (i) we have correctly measured or identified all of the factors affecting our business or the extent of these factors’ likely impact, (ii) the available information with respect to these factors on which such analysis is based is complete or accurate, (iii) such analysis is correct or (iv) our strategy, which is based in part on this analysis, will be successful. All forward-looking statements in this report apply only as of the date of this report or as of the date they were made and, except as required by applicable law, we undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future developments or otherwise.

Cyclerion Therapeutics, Inc.

Condensed Consolidated Balance Sheets

(In thousands except share and per share data)

 (Unaudited)

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

Cyclerion Therapeutics, Inc.

Condensed Consolidated and Combined Statements of Operations and Comprehensive Loss

(In thousands except per share data)

(Unaudited)

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

Cyclerion Therapeutics, Inc.

Condensed Consolidated and Combined Statements of Stockholders’ Equity (Deficit)

(In thousands except share data)

(Unaudited)

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

Cyclerion Therapeutics, Inc.

Condensed Consolidated and Combined Statements of Cash Flows

(In thousands)

(Unaudited)

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

Cyclerion Therapeutics, Inc.

Notes to the Condensed Consolidated and Combined Financial Statements

(Unaudited)

1. Nature of Business

Nature of Operations

Cyclerion Therapeutics, Inc. (“Cyclerion” or the “Company”) is a clinical-stage biopharmaceutical company harnessing the power of soluble guanylate cyclase (“sGC”) pharmacology to discover, develop and commercialize breakthrough treatments for serious and orphan diseases. Cyclerion’s focus is enabling the full therapeutic potential of next-generation sGC stimulators. The Company’s strategy rests on a solid scientific foundation that is enabled by our people and capabilities, external collaborations, and a responsive capital allocation approach.

Cyclerion GmbH, a wholly owned subsidiary, was incorporated in Zug, Switzerland on May 3, 2019. Cyclerion GmbH is an operational entity with one employee who is the Company’s Chief Innovation Officer. The functional currency is the Swiss franc.

The Separation

On April 1, 2019, Ironwood Pharmaceuticals, Inc. (“Ironwood”) completed the previously announced separation of its sGC business, and certain other assets and liabilities, into a separate, independent publicly traded company by way of a pro-rata distribution of all of the outstanding shares of common stock of Cyclerion Therapeutics, Inc. through a dividend distribution of one share of the Company’s common stock, with no par value per share, for every 10 shares of Ironwood common stock held by Ironwood stockholders as of the close of business on March 19, 2019, the record date for the Distribution (the entire transaction being the “Separation”). As a result of the Separation, the Company became an independent public company and commenced trading under the symbol “CYCN” on the Nasdaq Global Select Market on April 2, 2019.

In connection with the Separation, on March 30, 2019, the Company entered into certain agreements with Ironwood to provide a framework for the Company’s relationship with Ironwood following the Separation, including, among others, the Separation Agreement, Tax Matters Agreement, and Employee Matters Agreement (“EMA”).

In addition, in connection with the Separation, on April 1, 2019, the Company entered into a Development Agreement, an Ironwood Transition Services Agreement, a Cyclerion Transition Services Agreement and an Intellectual Property License Agreement with Ironwood.

On April 2, 2019, the Company issued 11,817,165 shares in a private placement (the “Private Placement”) of common stock to accredited investors for gross proceeds of $175 million (net proceeds of approximately $165 million).

Basis of Presentation

The Company did not operate as a separate, stand-alone entity for the prior interim period covered by the interim condensed consolidated and combined financial statements. The Company’s condensed consolidated balance sheets as of March 31, 2020 and December 31, 2019, condensed consolidated and combined statements of operations and comprehensive loss and statements of cash flows for the three months ended March 31, 2020 consist of the condensed consolidated balances and activity of Cyclerion as prepared on a stand-alone basis. The Company’s condensed consolidated and combined statements of operations and comprehensive loss and statements of cash flows for the three months ended March 31, 2019 have been prepared on a “carve out” basis.

The unaudited condensed consolidated and combined financial statements reflect the historical results of the operations, financial position and cash flows of Cyclerion, in conformity with United States generally accepted accounting principles (“U.S. GAAP”).

The accompanying unaudited condensed consolidated and combined financial statements reflect the condensed consolidated and combined financial position and condensed consolidated and combined results of operations of the Company as an independent, publicly-traded company for the period after the Separation on April 1, 2019. The unaudited condensed consolidated and combined financial statements also reflect the financial position and results of operations of the Company as a combined reporting entity of Ironwood for periods prior to the Separation.

For periods prior to the Separation, the unaudited condensed consolidated and combined financial statements of Cyclerion reflect the assets, liabilities, and expenses directly attributable to Cyclerion, as well as allocations of certain corporate level expenses, deemed necessary to fairly present the results of operations and cash flows of Cyclerion, as discussed further below. As such, these allocations may not be indicative of the actual amounts that would have been recorded had Cyclerion operated as an independent, publicly traded company for the years presented.

Prior to the Separation, Cyclerion was dependent upon Ironwood for all of its working capital and financing requirements, as Ironwood used a centralized approach to cash management and financing its operations. There were no cash amounts specifically attributable to Cyclerion for the historical periods presented; therefore, there is no cash reflected for historical periods in the condensed consolidated and combined financial statements. Accordingly, cash and cash equivalents, debt or related interest expense have not been allocated to Cyclerion in the historical financial statements. Financing transactions related to Cyclerion are accounted for as a component of net parent investment in the historical combined balance sheets and as a financing activity on the accompanying combined statements of cash flows.

Prior to the Separation, Cyclerion’s combined financial statements included an allocation of expenses related to certain Ironwood corporate functions, including senior management, legal, human resources, finance, information technology and quality assurance. These expenses were allocated to Cyclerion based on direct usage or benefit where identifiable, with the remainder allocated pro-rata based on project related costs, headcount or other measures. These allocations may not be indicative of the actual expense that would have been incurred had Cyclerion operated as an independent, publicly traded company for the periods presented.

Prior to the Separation, the combined balance sheets of Cyclerion included assets and liabilities that were allocated principally on a specific identification basis and net parent investment was shown in lieu of stockholders’ equity. As a result of the Separation, the Company’s net parent investment balance was reclassified to paid-in capital.

Going Concern

At each reporting period, the Company evaluates whether there are conditions or events that raise substantial doubt about the Company’s ability to continue as a going concern within one year after the date that the financial statements are issued. The Company’s evaluation entails analyzing prospective operating budgets and forecasts for expectations of the Company’s cash needs and comparing those needs to the current cash and cash equivalent balances. The Company is required to make certain additional disclosures if it concludes substantial doubt exists and it is not alleviated by the Company’s plans or when its plans alleviate substantial doubt about the Company’s ability to continue as a going concern.

The Company has experienced negative operating cash flows for all historical periods presented. The Company expects these losses to continue into the foreseeable future as the Company continues the development and clinical testing of the product candidates, olinciguat and IW-6463, and its discovery research programs. On April 2, 2019, the Company received gross proceeds of $175 million (net proceeds of approximately $165 million) from the Private Placement.

After considering the Company’s current research and development plans and the timing expectations related to the progress of its programs, and after considering its existing cash and cash equivalents as of March 31, 2020, the Company did not identify conditions or events that would raise substantial doubt about the Company’s ability to continue as a going concern within one year from the date these financial statements were issued.

2. Summary of Significant Accounting Policies

The accounting policies of the Company are set forth in Note 2. Summary of Significant Accounting Policies to the consolidated and combined financial statements contained in the Company’s 2019 annual report on Form 10-K. The Company includes herein certain updates to those policies.

Leases

The Company has a property lease for its headquarters location at 301 Binney Street, Cambridge, MA (the “Master Lease”). The Company determines if an arrangement is a lease at the inception of the contract. The asset component of the Company’s operating leases is recorded as operating lease right-of-use (“ROU”) assets, and the liability component is recorded as current portion of operating lease liabilities and operating lease liabilities, net of current portion, in the Company’s consolidated balance sheets.

ROU assets and operating lease liabilities are recognized based on the present value of lease payments over the lease term at the commencement date. The Company uses an incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments if an implicit rate of return is not provided with the lease contract. Operating lease right-of-use assets are adjusted for incentives received.

Lease cost is recognized on a straight-line basis over the lease term, and includes amounts related to short-term leases. Variable lease costs that do not depend on an index or rate are recognized as incurred.

ROU assets and operating lease liabilities are remeasured upon certain modifications to leases using the present value of remaining lease payments and estimated incremental borrowing rate upon lease modification. The difference between the remeasured ROU assets and the operating lease liabilities are recognized as a gain or loss in operating expenses. The Company reviews any changes to its lease agreements for potential modifications and/or indicators of impairment of the respective ROU asset.

On October 18, 2019, the Company entered into an agreement to sublease 15,700 rentable square feet of its Master Lease to a subtenant. Sublease income is recognized on straight-line basis over the term of the sublease agreement and is recorded net of the related rent expense from the Master Lease within interest and other income in the condensed consolidated and combined statements of operations and comprehensive loss. In sublease agreements that contain non-monetary consideration, the Company estimates the fair market value of the non-monetary consideration received using market data and recognizes it on a straight-line basis over the sublease term. Variable lease consideration that does not depend on an index or rate is allocated to a non-lease component and is recognized over time in accordance with the pattern of transfer. No modification or impairment was deemed to have occurred by entering into the sublease agreement because the Company was not released, either fully or in part, from its obligations under the Master Lease. See Note 8, Leases.

On February 28, 2020 the Company entered into an amendment to our Master Lease at 301 Binney Street in Cambridge, Massachusetts (the “Lease Amendment”). The Lease Amendment provided for the partial termination of the Company's rights and obligations with respect to a portion of the leased premises of approximately 40,000 rentable square feet. The Company will continue to lease approximately 74,000 rentable square feet under terms of the amended lease. The Lease Amendment was determined to be a lease modification that qualified as a change of accounting on the existing lease and not a separate contract. As such, the ROU assets and operating lease liabilities were remeasured using an incremental borrowing rate at the date of modification and the Company recorded a gain of approximately $2.1 million as a component of operating expenses. No impairment of the ROU asset was deemed to have occurred. See Note 8, Leases.

New Accounting Pronouncements

From time to time, new accounting pronouncements are issued by the Financial Accounting Standards Board (“FASB”) or other standard setting bodies that are adopted by the Company as of the specified effective date. Except as discussed elsewhere in the notes to the condensed consolidated and combined financial statements, the Company did not adopt any new accounting pronouncements during the three months ended March 31, 2020 that had a material effect on its condensed consolidated and combined financial statements.

In June 2016, the FASB issued ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”). ASU 2016-13 will change how companies account for credit losses for most financial assets and certain other instruments. For trade receivables, loans and held-to-maturity debt securities, companies will be required to recognize an allowance for credit losses rather than reducing the carrying value of the asset. Subsequent to the issuance of ASU 2016-13, the FASB issued ASU No. 2019-04, Codification Improvements to Topic 326, Financial Instruments—Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments (“ASU 2019-04”), ASU No. 2019-05, Financial Instruments—Credit Losses (Topic 326): Targeted Transition Relief (“ASU 2019-05”) to provide additional guidance on the adoption of ASU 2016-13, ASU No. 2019-10, Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842) (“ASU 2019-10”), ASU No. 2019-11, Codification Improvements to Topic 326, Financial Instruments-Credit Losses (“ASU 2019-11”) and ASU No. 2020-02, Financial Instruments—Credit Losses (Topic 326) and Leases (Topic 842)("ASU 2020-02"). ASU 2019-04 added Topic 326, Financial Instruments—Credit Losses, and made several amendments to the codification and also modified the accounting for available-for-sale debt securities. ASU 2019-05 provides targeted transition relief by providing an option to irrevocably elect the fair value option for certain financial assets previously measured at amortized cost basis. ASU 2019-10 aligned the effective dates of certain major updates not yet effective to conform to the FASB’s new philosophy of staggering major updates between large public companies and all other entities. ASU 2019-11’s major provisions included additional clarifications and practical expedients related to expected recoveries for purchased assets with credit deterioration, troubled debt restructuring, accrued interest receivables, and other areas when adopting ASU 2016-13. ASU 2020-02 provided amendments to the Topic 326 including a new section related to credit losses measured at amortized cost and a clarification to Topic 842 and is effective when adopting other areas of Financial Instruments-Credit Losses Topic 326. As a public business entity that qualifies as a smaller reporting company, ASU 2016-13, ASU 2019-04 and ASU 2019-05 are effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. Early adoption is permitted. The Company is currently evaluating the potential impact that the adoption of these ASUs will have on the Company’s financial position and results of operations.

In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (“ASU 2018-13”): Disclosure Framework—Changes to the Disclosure Requirement for Fair Value Measurement (“ASU 2018-13”) which amends the disclosure requirements for fair value measurements. The amendments in ASU 2018-13 are effective for fiscal years beginning after December 15, 2019, with early adoption permitted. The Company adopted ASU 2018-13 in the first quarter of 2020 and the adoption of this standard did not have a material impact on the Company’s financial position or results of operations.

In August 2018, the FASB issued ASU No. 2018-15, Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement that is a Service Contract (“ASU 2018-15”). ASU 2018-15 requires a customer in a cloud computing arrangement that is a service contract to follow the internal-use software guidance in ASC 350-40, Intangibles—Goodwill and Other—Internal Use Software (ASC 350-40), to determine which implementation costs to capitalize as assets or expense as incurred. The internal-use software guidance in ASC 350-40 requires that certain costs incurred during the application development stage be capitalized and other costs incurred during the preliminary project and post-implementation stages be expensed as they are incurred. A customer’s accounting for the hosting component of the arrangement is not affected by this guidance. The amendments in ASU 2018-15 are effective for fiscal years beginning after December 15, 2019, with early adoption permitted. The Company adopted ASU 2018-15 in the first quarter of 2020 and the adoption of this standard did not have a material impact on the Company’s financial position or results of operations.

No other accounting standards known by the Company to be applicable to it that have been issued by the FASB or other standard-setting bodies and that do not require adoption until a future date are expected to have a material impact on the Company’s condensed consolidated and combined financial statements upon adoption.

3. Related Party Transactions

Relationship with Ironwood

Prior to April 1, 2019, the Company was managed and operated in the normal course of business under Ironwood. Ironwood became a related party when Mark Currie, Ironwood’s former Chief Scientific Officer and the Company’s President, joined Ironwood’s board in April 2019 following the Separation.

Certain shared costs were allocated to the Company and reflected as expenses in the Company’s stand-alone combined financial statements for periods prior to the Separation. The expenses reflected in the condensed combined financial statements for periods prior to the Separation may not be indicative of expenses that will be incurred by the Company in the future.

(a) Corporate costs

Ironwood incurred significant corporate costs for services provided to Cyclerion. These costs included expenses for information systems, accounting, other financial services (such as treasury, audit and purchasing), human resources, legal, facilities and Separation-related costs.

A portion of these costs benefited Cyclerion and have been allocated to Cyclerion using a pro-rata method based on project related costs, headcount, or other measures that management believes are consistent and reasonable. This methodology is applied consistently between periods, however the magnitude of the allocation will vary based on the relationship of Cyclerion costs compared to those of Ironwood’s other operations.

The corporate costs allocated to Cyclerion, prior to the Separation, and included in the combined statements of operations was approximately $6.8 million for the three months ended March 31, 2019 and was included in general and administrative expenses.

(b) Cash Management and Financing

Cyclerion participated in Ironwood’s centralized cash management and financing programs prior to the Separation. Disbursements were made through centralized accounts payable systems operated by Ironwood. Cash receipts were transferred to centralized accounts, also maintained by Ironwood. As cash is disbursed and received by Ironwood, it was accounted for by Cyclerion through net parent investment. All obligations were financed by Ironwood and financing decisions were determined by central Ironwood treasury operations until the Separation.

Other Transactions with Ironwood

As part of the Separation from Ironwood, the Company entered into Transition Services Agreements and a Development Agreement with Ironwood.

Under the Transition Services Agreements, the Company provides certain services to Ironwood, and Ironwood provides certain services to the Company, each related to corporate functions such as finance, procurement, facilities and development for a period of up to two years from the date of the Separation, unless earlier terminated or extended by mutual agreement. These services are charged to and from Ironwood and are recorded as part of operating expenses. The net charge to operating expenses for the Transition Services Agreements was de minimis for the three months ended March 31, 2020. All services provided to and from the Company under the Transition Services Agreements were completed as of March 31, 2020 and the agreements were terminated.

Under the Development Agreement, the Company provides certain research and development services to Ironwood at mutually agreed upon rates and the amounts earned are recorded as revenue from related party. Such research and development activities are governed by a joint steering committee composed of representatives of both Ironwood and the Company. The Company recorded approximately $1.0 million in revenue from related party for services provided under the Development Agreement for the three months ended March 31, 2020.

In accordance with the Separation Agreement, there were certain other transactions and adjustments post-Separation between the Company and Ironwood. The total amount due from Ironwood at March 31, 2020 and December 31, 2019 was approximately $1.0 million and $1.5 million, respectively, primarily from the Development Agreement, and is reflected as related party accounts receivable. The total amount due to Ironwood was de minimis at March 31, 2020 and approximately $0.1 million at December 31, 2019.

Peter Hecht, Ironwood’s former Chief Executive Officer and the Chief Executive Officer and board member of Cyclerion, donated 2.5 million of his shares of Ironwood common stock to American Endowment Foundation for the creation of a donor advised fund that divested these shares to invest $34.0 million in Cyclerion as part of the financing transaction completed by Cyclerion on April 2, 2019. Mark Currie has invested $4.0 million in Cyclerion as part of this financing. Dr. Currie and certain other investors have funded a portion of their investment through sales of Ironwood common stock.

Other Related Party Transactions

During the three months ended March 31, 2020, the Company paid approximately $0.1 million to a related party which it engaged to provide research and development transaction support services. The entity became a related party when Mark Currie, the Company’s President, joined its board in January 2020. There was a de minimis amount due to the related party at March 31, 2020 and December 31, 2019.

4. Fair Value of Financial Instruments

The Company’s cash equivalents are generally classified within Level 1 of the fair value hierarchy. The following tables presents information about the Company’s financial assets measured at fair value on a recurring basis and indicate the level of the fair value hierarchy used to determine such fair values as of March 31, 2020 and December 31, 2019 (in thousands):

5. Property and Equipment

Property and equipment, net consisted of the following (in thousands):

As of March 31, 2020, and December 31, 2019, the Company’s property and equipment was primarily located in Cambridge, Massachusetts.

Depreciation and amortization expense of the Company’s property and equipment was approximately 0.6 million and $0.5 million for the three months ended March 31, 2020 and 2019, respectively. The Company recorded a gain on disposal of property and equipment of less than $0.1 million for the three months ended March 31, 2020 recognized within operating expenses in the condensed consolidated and combined statements of operations and comprehensive loss. Leasehold improvements of $1.5 million were put into service in the three months ended March 31, 2020, of which $0.9 million was included in construction in progress as of December 31, 2019.

6. Accrued Expenses and Other Current Liabilities

Accrued expenses and other current liabilities consisted of the following (in thousands):

7. Commitments and Contingencies

Other Funding Commitments

As of March 31, 2020 and December 31, 2019, the Company had several on-going studies in various clinical trial stages. The Company’s most significant clinical trial expenditures are related to contract research organizations. These contracts are generally cancellable, with notice, at the Company’s option and do not have any significant cancellation penalties.

Guarantees

On September 6, 2018, Cyclerion was incorporated in Massachusetts and its officers and directors are indemnified for certain events or occurrences while they are serving in such capacity. Prior to the Separation, the Company’s officers and directors were similarly indemnified under Delaware law.

The Company enters into certain agreements with other parties in the ordinary course of business that contain indemnification provisions. These typically include agreements with directors and officers, business partners, contractors, clinical sites and customers. Under these provisions, the Company generally indemnifies and holds harmless the indemnified party for losses suffered or incurred by the indemnified party as a result of the Company’s activities. These indemnification provisions generally survive termination of the underlying agreements. The maximum potential amount of future payments the Company could be required to make under these indemnification provisions is unlimited. However, to date the Company has not incurred material costs to defend lawsuits or settle claims related to these indemnification provisions. As a result, the estimated fair value of these obligations is minimal. Accordingly, the Company did not have any liabilities recorded for these obligations as of March 31, 2020 and December 31, 2019.

8. Leases

The FASB issued ASU 2016-02, or the leasing standard or ASC 842, in February 2016. ASU 2016-02 requires lessees to recognize assets and liabilities on the balance sheet for the rights and obligations created by all leases with terms of more than 12 months. ASU 2016-02 also requires certain qualitative and quantitative disclosures designed to give financial statement users information on the amount, timing, and uncertainty of cash flows arising from leases.

On April 1, 2019, the Company entered into the Master Lease, a direct operating lease for its existing premises located at 301 Binney Street, Cambridge, MA consisting of approximately 114,000 rentable square feet of office and lab space on the first and second floors. The Master Lease is for a term of 123 months with two five-year extension options and certain expansion rights. The Master Lease includes a letter of credit, initially in the amount of $7.7 million, posted with the landlord as a security deposit, which is collateralized by a money market account recorded as restricted cash on the Company’s condensed consolidated balance sheets. Cyclerion has also entered into customary non-disturbance arrangements with the building landlord’s mortgagee and with the property ground lessor recognizing Cyclerion’s leasehold interest in this property.

The Master Lease provides for annual base rent of approximately $11.0 million in the first year, which increases on a yearly basis by 3.0% (subject to an abatement of base rent of approximately $2.7 million in the first year of the lease). The Company is obligated to pay the landlord for certain costs, taxes and operating expenses related to the premises, subject to certain exclusions; however, the Company has concluded that these payments are not in-substance fixed payments and therefore are not included in the calculation of the related lease liability and asset under ASC 842. Additionally, the Company has made the policy election to adopt the practical expedient to not separate lease components from non-lease components for the right-to-use asset class of office and laboratory space. This policy election results in the Company accounting for the lease component, the use of the premises, and the non-lease components, which include a property management fee, as a single lease component.

The Company recorded the liability associated with the Master Lease at the present value of the lease payments not yet paid, discounted using the discount rate for the Master Lease established at the commencement date. As the Master Lease does not provide an implicit rate, the Company had to estimate the incremental borrowing rate, or IBR, as of the commencement date. The IBR is defined under ASC 842 as the rate of interest that the Company would have to pay to borrow on a collateralized basis over a similar term for an amount equal to the lease payments in a similar economic environment. The Company determined its IBR to be 10.9% at the time of the agreement, which was used to discount the remaining lease payments over the remaining lease term and recorded a lease liability of $71.3 million on April 1, 2019. This lease liability will be amortized over the remaining lease term in an amount equal to the difference between the cash rent paid and the monthly interest calculated on the remaining lease liability.

The Company had a tenant improvement allowance from the landlord of approximately $2.3 million for certain permitted costs related to the buildout of the premises. The Company is deemed to be the owner of these tenant improvements during the lease term. These $2.3 million of improvements are included in the Company’s property, plant and equipment balances in its consolidated balance sheets as of March 31, 2020 and December 31, 2019 and are depreciated over the shorter of their useful life or the related lease term. The Company received the payment for the tenant allowance in the third quarter of 2019.

On April 1, 2019, the Company recorded a right-of-use asset in the amount $71.3 million. The right-of-use asset is being amortized over the remaining lease term in an amount equal to the difference between the calculated straight-line expense of the total lease payments less the monthly interest calculated on the remaining lease liability.

On February 28, 2020 the Company entered into an amendment to our Master Lease at 301 Binney Street in Cambridge, Massachusetts. The Lease Amendment provides for the partial termination of the Company’s rights and obligations with respect to a portion of the leased premises of approximately 40,000 rentable square feet. The Company will continue to lease approximately 74,000 square feet including the area covered by the subleased premise, discussed below. The Company reduced its remaining lease payments through June 2029 by approximately $41.9 million. In connection with the Lease Amendment, the Company paid $6.3 million for a termination fee and $0.2 million for other initial direct costs, which will be deferred and recognized over the remaining lease term. The Company’s security deposit was reduced by approximately $2.7 million to approximately $5.0 million, which is classified as restricted cash on the Company’s condensed consolidated balance sheet as of March 31, 2020.

The Lease Amendment was determined to be a lease modification that qualified as a change of accounting on the existing lease and not a separate contract. As such, the ROU assets and operating lease liabilities were remeasured using an incremental borrowing rate at the date of modification of 9.7%, which resulted in a reduction of the ROU asset of $21.4 million and a reduction in the operating lease liabilities of $23.5 million. The Company recorded the resulting gain of approximately $2.1 million as a component of operating expenses in the condensed consolidated statement of operations and comprehensive loss for the three months ended March 31, 2020.

The Company recorded an operating lease right-of-use asset of approximately $52.3 million and $68.1 million related to the amended Master Lease in its condensed consolidated balance sheets as of March 31, 2020 and December 31, 2019, respectively. The Company recorded current operating lease liabilities of approximately $2.7 million and $3.4 million, and noncurrent operating lease liabilities of approximately $47.1 million and $70.5 million, related to the amended Master Lease in its condensed consolidated balance sheets as of March 31, 2020 and December 31, 2019, respectively.

Lease cost is recognized on a straight-line basis over the lease term. For the three months ended March 31, 2020, the Company recognized a total of approximately $2.7 million of total lease costs. Variable lease costs not subject to an index or rate are recognized as incurred. For the three months ended March 31, 2020, the Company recognized a total of approximately $1.0 million of variable lease costs related to the Master Lease, as amended.

Supplemental cash flow information related to leases for the three months ended March 31, 2020 is as follows:

On March 31, 2019, the Company entered into a short-term sublease of approximately 24,000 rentable square feet with Ironwood to provide temporary working space for a portion of its workforce while the buildout of the Company’s new premises was being completed. The sublease was for an initial one-month term with several one-month extension options. The Company subleased the space for approximately 1.5 months, vacating the space and terminating the sublease in mid-May 2019. The Company did not incur any rent expense related to the sublease for the three months ended March 31, 2020 and 2019.

On October 18, 2019, the Company entered into an agreement with a third party to sublease 15,700 rentable square feet of its current lease premises under the Master Lease. The sublease will expire on June 30, 2029, unless earlier terminated in accordance with the sublease agreement, and has no extension options. The sublease provides for annual base rent of approximately $1.5 million in the first year, which increases on a yearly basis by 3.0% (subject to an abatement of base rent of approximately $0.7 million for the first six months of the sublease). The sublessee is responsible for its pro rata share of certain costs, taxes and operating expenses related to the subleased space, the consideration for which is variable and is based on the actual operating costs of the lessor. The variable consideration relates exclusively to non-lease components representing such services and will be recognized as incurred. The sublease includes an initial security deposit of $0.5 million, which was provided by the sublessee in the form of a letter of credit, and an additional security deposit of $0.4 million within nine months of the sublease commencement.

As part of the consideration for the sublease, the sublessee will provide licensed rooms within the sublease premises and licensed services to the Company over the sublease term free of charge. The licensed rooms have been excluded from the measurement of the sublease as control of the rooms reverts to the Company. The Company expects to receive the benefit of the licensed rooms and services beginning in late 2020. The Company estimated the fair value of the services to be approximately $4.2 million, which will be recorded on a gross basis as the services are received as a component of research and development costs in the condensed consolidated and combined statements of operations and comprehensive loss.

The Company allocated the consideration in the sublease agreement between the lease and non-lease components based on their relative standalone prices. For the three months ended March 31, 2020, gross sublease income of $0.5 million was recorded. Net sublease income of approximately $0.1 million was recorded in interest and other income in the condensed consolidated and combined statements of operations and comprehensive loss for the three months ended March 31, 2020.

Future minimum lease payments under non-cancelable operating leases under ASC 842 as well as the total future minimum lease payments to be received under the sublease agreement as of March 31, 2020 are as follows:

9. Share-based Compensation Plans

Prior to the Separation, share-based compensation expense was allocated to Cyclerion using a combined specific identification and pro-rata method based on internal project related costs and headcount that management believed were consistent and reasonable.

In connection with the Separation, Cyclerion adopted its own share-based compensation plans. Specifically, Cyclerion adopted the 2019 Employee Stock Purchase Plan (“2019 ESPP”) and the 2019 Equity Incentive Plan (“2019 Equity Plan”). Under the 2019 ESPP, eligible employees may use payroll deductions to purchase shares of stock in offerings under the plan, and thereby acquire an interest in the future of the Company. Under the 2019 Equity Plan, new post-Separation awards, including stock options and restricted stock units (“RSUs”), may be granted to employees of the Company.

Cyclerion also mirrored two of Ironwood’s existing plans, the Amended and Restated 2005 Stock Incentive Plan (“2005 Equity Plan”) and the Amended and Restated 2010 Employee, Director and Consultant Equity Incentive Plan (“2010 Equity Plan). These mirror plans were adopted to facilitate the exchange of Ironwood equity awards for Cyclerion equity awards upon the Separation as part of the equity conversion. As a result of the Separation and in accordance with the EMA, employees of both companies retained their existing Ironwood vested options and received a pro-rata share of Cyclerion options, regardless of which company employed them post-Separation. For employees that were ultimately employed by Cyclerion, unvested Ironwood options and RSUs were converted to unvested Cyclerion options and RSUs.

The conversion of equity awards resulting from the Separation impacted approximately 143 employees and was treated as a Type 1 modification under ASC Topic 718, Share Based Payments, as the awards are expected to vest under the original terms. Incremental compensation expense was measured as the excess, if any, of the fair value of the modified award over the fair value of the original award immediately before its terms were modified. The fair value of RSUs and restricted stock awards was measured using the fair value stock price immediately before and immediately after the modification date which resulted in no incremental compensation expense. The fair value of stock options was measured using the Black-Scholes option pricing method using the appropriate valuation assumptions immediately before and immediately after the modification date. As a result of the modification, Cyclerion recognized a one-time incremental expense of approximately $0.3 million for the vested stock options and will recognize an incremental expense of approximately $7.5 million for the unvested stock options over their remaining vesting period.

The following table provides share-based compensation reflected in the Company’s condensed consolidated and combined statements of operations and comprehensive loss for the three months ended March 31, 2020 and 2019 (in thousands):

For the three months ended March 31, 2020, the Company granted stock options to purchase an aggregate of 165,846 shares, at weighted average grant date fair values per option share of $1.71.

As of March 31, 2020, the unrecognized share-based compensation expense, net of estimated forfeitures, related to all unvested time-based stock options held by Cyclerion’s employees is $22.2 million and the weighted average period over which that expense is expected to be recognized is 2.8 years.

As of March 31, 2020, the unrecognized share-based compensation expense related to stock options containing market conditions held by Cyclerion’s employees is $0.4 million, which is expected to be recognized over a weighted-average period of 4.1 years.

As of March 31, 2020, the unrecognized share-based compensation expense, net of estimated forfeitures, related to all unvested RSUs held by the Company’s employees is $5.3 million and the weighted-average period over which that expense is expected to be recognized is 2.5 years.

10. Loss per share

Basic and diluted net loss per common share is computed by dividing net loss by the weighted average number of common shares outstanding during the period as follows:

For the three months ended March 31, 2020, 7,936,087 shares of common stock related to stock options and 499,644 shares of common stock related to RSUs were excluded from the calculation of diluted net loss per share since the inclusion of such shares would be anti-dilutive.

Prior to April 1, 2019, there were no Cyclerion shares outstanding, as such, the shares outstanding immediately after the distribution and the Private Placement were used to calculate the basic and diluted net loss per share for the three months ended March 31, 2019.

11. Defined Contribution Plan

Prior to the Separation, Ironwood maintained a defined contribution 401(k) Savings Plan in the form of a qualified 401(k) plan for the benefit of substantially all of its employees, which included Ironwood employees who became Cyclerion employees. Compensation expense related to the 401(k) match was allocated to Cyclerion using a pro-rata method based on project-related costs and headcount that management believes are consistent and reasonable.

Subsequent to the Separation, Cyclerion adopted a defined contribution 401(k) Savings Plan similar to the plan in place at Ironwood. The plan assets under the Ironwood defined contribution 401(k) Savings Plan were transferred to the Cyclerion plan. Subject to certain IRS limits, eligible employees may elect to contribute from 1% to 100% of their compensation. Cyclerion contributions to the plan are at the sole discretion of the board of directors. Currently, Cyclerion provides a matching contribution of 75% of the employee’s contributions, up to $6,000 annually.

Included in compensation expense for employees that are directly attributable to Cyclerion is approximately $0.3 million for the three months ended March 31, 2020 and 2019.

12. Workforce Reduction

On October 30, 2019, the Company began a reduction of its current workforce by approximately thirty (30) full-time employees in order to align its resources with its ongoing clinical and preclinical programs, innovation strategy and partnering work. The total one-time costs related to the workforce reduction were approximately $3.0 million. The workforce reduction was substantially completed during the year ended December 31, 2019, in which the Company recorded approximately $2.8 million of severance and benefits costs. The workforce reduction was finalized during the three months ended March 31, 2020, in which the Company recorded approximately $0.2 million in additional severance and benefits costs.

The following table summarizes the accrued liabilities activity recorded in connection with the reduction in workforce for the three months ended March 31, 2020 (in thousands):

The Company recorded $0.6 million in severance and benefits costs related to the February 2019 Ironwood workforce reduction, which was initiated prior to the Separation, for the three months ended March 31, 2019. The remaining accrued balances under this workforce reduction was assumed by Ironwood upon Separation on April 1, 2019.

13. Subsequent Events

On April 21, 2020, the Company received loan proceeds in the amount of approximately $3.5 million pursuant to a promissory note agreement under the Paycheck Protection Program (“PPP”). The PPP, established as part of the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”), provides for loans to qualifying businesses for amounts up to 2.5 times of the average monthly payroll expenses of the qualifying business. In accordance with the note agreement, the loan is scheduled to mature on April 20, 2022, has a stated interest rate of 1.0% per annum, and has payments of principal and interest that are due monthly after a six-month deferral period when interest accrues, but no payments are due.

The loan is subject to all the terms and conditions applicable to all loans made pursuant to the PPP. The loan’s principal and accrued interest are forgivable to the extent that the proceeds are used for eligible purposes, subject to certain limitations, and that the Company maintains its payroll levels over an eight-week period following the loan date. The loan forgiveness amount will be reduced if the Company terminates employees or reduces salaries during the eight-week period. The Company intends to use the proceeds for purposes consistent with the PPP and we believe that a portion of the loan will meet the conditions for loan forgiveness.

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

Forward-Looking Information

The following discussion of our financial condition and results of operations should be read in conjunction with the unaudited condensed consolidated and combined financial statements and the corresponding notes included in this Quarterly Report on Form 10-Q, as well as the audited consolidated and combined financial statements and notes thereto included in our Annual Report on Form 10-K. This discussion contains forward-looking statements that involve significant risks and uncertainties. As a result of many factors, such as those referenced or set forth under “Cautionary Note Regarding Forward-Looking Statements” and “Risk Factors” in Item 1A of this Quarterly Report on Form 10-Q, our actual results may differ materially from those anticipated in these forward-looking statements.

Overview

We are a clinical-stage biopharmaceutical company harnessing the power of soluble guanylate cyclase, or sGC, pharmacology to discover, develop and commercialize breakthrough treatments for serious and orphan diseases. Our focus is enabling the full therapeutic potential of next-generation sGC stimulators. Our strategy rests on a solid scientific foundation that is enabled by our people and capabilities, external collaborations and a responsive capital allocation approach.

We operate in one reportable business segment—human therapeutics.

Separation from Ironwood Pharmaceuticals

On April 1, 2019, Ironwood Pharmaceuticals Inc., or Ironwood, completed the separation of its sGC business, and certain other assets and liabilities, into us as a separate, independent publicly traded company by way of a pro-rata distribution of our common stock through a dividend distribution of one share of our common stock, with no par value per share, for every 10 shares of Ironwood common stock held by Ironwood stockholders as of the close of business on March 19, 2019, the record date for the distribution, which we refer to herein as the Separation. As a result of the Separation, we became an independent public company and commenced trading under the symbol “CYCN” on the Nasdaq Global Select Market on April 2, 2019.

In connection with the Separation, on March 30, 2019, we entered into certain agreements with Ironwood to provide a framework for our relationship with Ironwood following the Separation, including, among others, a Separation Agreement, a Tax Matters Agreement, and an Employee Matters Agreement.

In addition, in connection with the Separation, on April 1, 2019, we entered into a Development Agreement, an Ironwood Transition Services Agreement (which has been terminated), a Cyclerion Transition Services Agreement and an Intellectual Property License Agreement with Ironwood.

On April 2, 2019, we issued 11,817,165 shares of our common stock, in the Private Placement to accredited investors for gross proceeds of $175 million (net proceeds of approximately $165 million).

Our historical condensed consolidated and combined financial statements for the periods prior to the Separation have been derived from Ironwood’s combined financial statements and accounting records and are presented in conformity with United States Generally Accepted Accounting Principles, or U.S. GAAP.

Our historical financial statements may not be indicative of our future performance and do not necessarily reflect what our results of operations, financial condition and cash flows would have been had we operated as a separate, publicly traded company for the periods presented prior to the Separation. The condensed consolidated and combined financial statements prior to the Separation included herein do not reflect any changes that occurred in our financing or operations as a result of the Separation from Ironwood.

Financial Overview

Research and Development Expense. Research and development expenses are incurred in connection with the discovery and development of our product candidates. These expenses consist primarily of the following costs: compensation, benefits and other employee-related expenses, research and development related facilities, third-party contracts relating to nonclinical study and clinical trial activities. All research and development expenses are charged to operations as incurred.

The core of our research and development strategy is to harness the power of sGC pharmacology to develop therapies for serious and orphan diseases. Our portfolio of programs includes:

Olinciguat is a once-daily, orally administered vascular sGC stimulator that is well suited for the potential treatment of sickle cell disease, or SCD. We are conducting a randomized, placebo-controlled, dose-ranging Phase 2 study, STRONG-SCD, that has closed enrollment with 70 participants enrolled from both US and ex-US sites. This study is designed to explore a broad range of tolerated doses and optimize our understanding of the therapeutic potential of olinciguat in SCD. We expect topline data from this study in Q3 2020.

In June 2018, the U.S. Food and Drug Administration, or the FDA, granted Orphan Drug Designation to olinciguat for the treatment of patients with SCD. Orphan Drug Designation provides marketing exclusivity for seven years from the date of the product’s approval for marketing and contributes to a significant reduction in development costs.

Praliciguat is an orally administered, once-daily systemic sGC stimulator that was evaluated in two recently completed Phase 2 proof-of-concept studies: a dose-ranging study in 156 adult patients with diabetic nephropathy, and a study in 196 adult patients with heart failure with preserved ejection fraction (HfpEF), CAPACITY-HfpEF. On October 30, 2019, we released topline results from these studies.

In CAPACITY-HfpEF, the study did not meet statistical significance on its primary endpoint of improved exercise capacity from baseline as compared to placebo, measured by cardiopulmonary exercise testing. There was clear evidence of drug exposure and pharmacological activity as judged by expected reductions in blood pressure. Praliciguat was generally well tolerated. We are discontinuing development of praliciguat in HfpEF.

The study of praliciguat in participants with diabetic nephropathy also did not meet statistical significance on its primary endpoint of reduction in albuminuria from baseline as compared to placebo, measured by urine albumin creatinine ratio. However, there was a trend toward improvement across the total intention-to-treat study population. Praliciguat was generally well tolerated. As previously announced, discussions continue on the out-licensing of praliciguat for late-stage global development and commercialization.

IW-6463 is an orally administered central nervous system-penetrant sGC stimulator that, because it readily crosses the blood-brain barrier, affords an unprecedented opportunity to expand the utility of sGC pharmacology to serious neurodegenerative diseases. On January 13, 2020 we released positive top line results from our first-in-human study of IW-6463. IW-6463 was generally well tolerated in healthy human adults. The study demonstrated IW-6463 penetration across the blood-brain-barrier at levels expected to be pharmacologically active as well as a mild reduction in blood pressure providing evidence of peripheral pharmacological activity. The Company intends to continue development activities for IW-6463. In December 2019 we initiated an ongoing translational pharmacology study in elderly subjects. Topline data from this study is expected in mid-2020.

Discovery Research. Our orally administered liver-targeted sGC stimulator is designed to selectively partition to the liver. By achieving liver concentrations many fold higher than corresponding plasma concentrations, we intend to maximize hepatic pharmacology. In animal models of liver fibrosis treated with systemic sGC stimulators, we have observed reductions in liver fibrosis, inflammation and steatosis, pathophysiological processes that underlie multiple chronic liver diseases.

Our lung-targeted sGC stimulator will be administered via inhalation and will be aimed at realizing the full potential of sGC stimulation in pulmonary diseases by selectively increasing exposure in the lung. By achieving significantly greater selectivity for lung over plasma, we intend to maximize pulmonary pharmacology.

Additional discovery efforts are ongoing and aimed at further expanding the potential of sGC stimulation in disorders of the central nervous system, or CNS.

The following table summarizes our research and development expenses related to our product pipeline, as well as employee and facility related costs allocated to research and development expense, for the three months ended March 31, 2020 and 2019. These product pipeline expenses relate primarily to external costs associated with nonclinical studies and clinical trial costs, which are presented by development candidates.

Securing regulatory approvals for new drugs is a lengthy and costly process. Any failure by us to obtain, or any delay in obtaining, regulatory approvals would materially adversely affect our product development efforts and our business overall.

Given the inherent uncertainties of pharmaceutical product development, we cannot estimate with any degree of certainty how our programs will evolve, and therefore the amount of time or money that would be required to obtain regulatory approval to market them. As a result of these uncertainties surrounding the timing and outcome of any approvals, we are currently unable to estimate precisely when, if ever, our discovery and development candidates will be approved. We invest carefully in our pipeline, and the commitment of funding for each subsequent stage of our development programs is dependent upon the receipt of clear, supportive data.

The successful development of our product candidates is highly uncertain and subject to a number of risks including, but not limited to:

As a result of the factors listed in the “Risk Factors” section in Item 1A of our annual report on Form 10-K for the fiscal year ended December 31, 2019, and elsewhere in this Quarterly Report on Form 10-Q, we are unable to determine the duration and costs to complete current or future nonclinical and clinical stages of our product candidates or when, or to what extent, we will generate revenues from the commercialization and sale of our product candidates. Development timelines, probability of success and development costs vary widely. We anticipate that we will make determinations as to which additional programs to pursue and how much funding to direct to each program on an ongoing basis in response to the data from the studies of each product candidate, the competitive landscape and ongoing assessments of such product candidate’s commercial potential.

General and Administrative Expense. General and administrative expense consists primarily of compensation, benefits and other employee-related expenses for personnel in our administrative, finance, legal, information technology, business development, communications and human resource functions. Other costs include the legal costs of pursuing patent protection of our intellectual property, general and administrative related facility costs, insurance costs and professional fees for accounting and legal services. Certain costs associated with our Separation from Ironwood are included in these expenses. We record all general and administrative expenses as incurred.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations is based upon our condensed consolidated and combined financial statements prepared in accordance with U.S. GAAP. The preparation of these financial statements requires us to make certain estimates and assumptions that may affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated and combined financial statements, and the amounts of expenses during the reported periods. Significant estimates and assumptions in our condensed consolidated and combined financial statements include those related to allocation of expenses, assets and liabilities from Ironwood’s historical financial statements for the periods prior to the Separation, impairment of long-lived assets; income taxes, including the valuation allowance for deferred tax assets; research and development expenses; contingencies and share-based compensation. We base our estimates on our historical experience and on various other assumptions that are believed to be reasonable, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ materially from our estimates under different assumptions or conditions. Changes in estimates are reflected in reported results in the period in which they become known.

We believe that our application of accounting policies requires significant judgments and estimates on the part of management and is the most critical to aid in fully understanding and evaluating our reported financial results. Our significant accounting policies are more fully described in Note 2, Summary of Significant Accounting Policies, of the condensed consolidated and combined financial statements elsewhere in this Quarterly Report on Form 10-Q.

All research and development expenses are expensed as incurred. We defer and capitalize nonrefundable advance payments we make for research and development activities until the related goods are received or the related services are performed. See Note 2, Summary of Significant Accounting Policies, of the condensed consolidated and combined financial statements appearing elsewhere in this Quarterly Report on Form 10-Q.

Results of Operations

For the period prior to the Separation, our condensed consolidated and combined financial statements include an allocation of expenses related to certain Ironwood corporate functions, including senior management, legal, human resources, finance, information technology and quality assurance. These expenses were allocated to Cyclerion based on direct usage or benefit where identifiable, with the remainder allocated pro-rata based on project related costs, headcount or other measures. We considered the allocation methodologies used to be a reasonable and appropriate reflection of the historical Ironwood expenses attributable to us. The expenses reflected in the condensed consolidated and combined financial statements may not be indicative of expenses that will be incurred by us in the future. After the Separation, we began performing these corporate functions using internal resources or purchased services, certain of which were provided by Ironwood under the Transition Services Agreement. The following discussion summarizes the key factors we believed are necessary for an understanding of our consolidated financial statements.

Revenue from related party. The increase in revenue from related party for the three months ended March 31, 2020 compared to the three months ended March 31, 2019 is the result of services performed under the Development Agreement for Ironwood, which was entered into in connection with the Separation.

Research and development expense.  The decrease in research and development expense of approximately $9.6 million for the three months ended March 31, 2020 compared to the three months ended March 31, 2019 was primarily related to a decrease of approximately $2.0 million in employee-related expenses as compared to the allocation of such costs by Ironwood in the prior period, a decrease of approximately $1.0 million in facilities and operating costs allocated to research and development, and a net decrease of approximately $6.6 million in external research costs. The net decrease in external research costs was primarily due to decreases over the periods of approximately $5.6 million associated with the completion of two praliciguat phase 2 proof-of-concept studies, both of which reported top line data on October 30, 2019, $1.3 million associated with olinciguat due to the completion of supporting ancillary studies, and $0.5 million in discovery research. These decreases were partially offset by an increase over the periods of approximately $0.9 million associated with IW-6463 studies.

General and administrative expense.  The decrease in general and administrative expenses of approximately $4.1 million for the three months ended March 31, 2020 compared to the three months ended March 31, 2019 was primarily driven by approximately $3.5 million of non-recurring outsourced professional services and other costs associated with the Separation recorded in the prior period and a decrease of approximately $0.6 million of salaries, bonus and other employee-related costs as compared to the pre-Separation allocation from Ironwood recorded in the prior period.

Gain on lease modification.  The gain on lease modification of $2.1 million recorded in the three months ended March 31, 2020 is related to the Lease Amendment to our Master Lease at 301 Binney Street in Cambridge, Massachusetts that was executed on February 28, 2020.

Interest and other income.  Interest and other income increased by approximately $0.4 million for the three months ended March 31, 2020 compared to the three months ended March 31, 2019 due to the recognition of $0.2 million of interest generated on excess operating funds from investments in U.S. government money market funds in the current period and the recognition of approximately $0.1 million of net sublease income in the current period. There was no interest or sublease income recognized for the three months ended March 31, 2019 because there was no cash allocated to Cyclerion and no lease directly attributed to Cyclerion prior to the Separation.

Liquidity and Capital Resources

Prior to the Separation, the primary source of liquidity for our business was cash flow allocated to Cyclerion from Ironwood. Post Separation, transfers of cash to and from Ironwood related to the Transition Service Agreements, Development Agreement and provisions of the Separation Agreement, have been reflected in the condensed consolidated and combined statement of cash flows.

After giving effect to the completion of the Separation on April 1, 2019, we raised approximately $165 million net of direct financing expenses with the closing of the Private Placement on April 2, 2019. Subsequent to the Separation, we no longer participate in Ironwood’s centralized cash management or receive direct funding from Ironwood.

On March 31, 2020, we had approximately $67.1 million of unrestricted cash and cash equivalents. Our cash equivalents include amounts held in U.S. government money market funds. We invest cash in excess of immediate requirements in accordance with our investment policy, which requires all investments held by us to be at least “AAA” rated or equivalent, with a remaining final maturity when purchased of less than twelve months, so as to primarily achieve liquidity and capital preservation.

Our ability to fund our operations and capital needs will depend on our ongoing ability to generate cash from operations and access to capital markets and other sources of capital, as further described below. We anticipate that our principal uses of cash in the future will be primarily to fund our operations, working capital needs, capital expenditures and other general corporate purposes.

Going Concern

Based on our development plans and clinical stage patient testing and our timing expectations related to the progress of our discovery research programs, we expect that our existing cash and cash equivalents as of March 31, 2020, will be sufficient to fund our planned operating expenses and capital expenditure requirements into the second quarter of 2021, excluding net cash flows from potential business development activities. We have based this estimate on assumptions that may prove to be wrong, particularly as the process of testing drug candidates in clinical trials is costly and the timing of progress in these trials is uncertain.

Cash Flows

The following is a summary of cash flows for the years ended March 31, 2020 and 2019:

Cash Flows from Operating Activities

Net cash used in operating activities was $29.2 million for the three months ended March 31, 2020 compared to $34.3 million for the three months ended March 31, 2019. The decrease in net cash used in operations of $5.1 million primarily relates to a decrease of $17.2 million in our net loss, partially offset by the payment of a $6.3 million termination fee related to the master lease modification in the current year, an increase in working capital accounts of $3.8 million and the recording of a non-cash gain on lease modification of $2.1 million in the current year.

Cash Flows from Investing Activities

Net cash used in investing activities was $1.4 million for the three months ended March 31, 2020 compared to $1.8 million for the three months ended March 31, 2019. The decrease in net cash used in investing activities was primarily from a decrease in purchases of property and equipment, primarily leasehold improvements.

Cash Flows from Financing Activities

Cash provided by financing activities was de minimis for the three months ended March 31, 2020. Cash provided by financing activities for the three months ended March 31, 2019 was approximately $36.1 million, resulting from the cash transferred to us from Ironwood based on changes in our cash used for operations prior to the Separation.

Funding Requirements

We expect our expenses to fluctuate as we advance the preclinical activities and clinical trials of our product candidates. Our expenses will also fluctuate as we:

We believe that our existing cash and cash equivalents as of March 31, 2020 will enable us to fund our planned operating expenses and capital expenditure requirements into the second quarter of 2021 excluding net cash flows from potential business development activities. We have based this estimate on assumptions that may prove to be wrong, and we could exhaust our available capital resources sooner than we expect.

Because of the many risks and uncertainties associated with research, development and commercialization of product candidates, we are unable to estimate the exact amount of our working capital requirements. Our future funding requirements will depend on, and could increase or decrease significantly as a result of, many factors, including the:

A change in any of these or other variables with respect to the development of any of our product candidates could significantly change the costs and timing of the development of that product candidate. Further, our operating plans may change in the future, and we may need additional funds to meet operational needs and capital requirements associated with such operating plans.

Until such time, if ever, as we can generate substantial product revenue, we expect to finance our cash needs through a combination of public or private equity offerings, debt financings, collaborations, strategic alliances or licensing arrangements with third parties. As discussed under the “Risk Factors” in Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2019, to preserve the tax-free treatment of the Separation, we may be barred, in certain circumstances, for a two year period following the Separation, from engaging in certain capital raising transactions. To the extent that we raise additional capital through the sale of equity or convertible debt securities, outstanding equity ownership may be materially diluted, and the terms of securities sold in such transactions could include liquidation or other preferences that adversely affect the rights of holders of common stock. Debt financing and preferred equity financing, if available, may involve agreements that include restrictive covenants that limit our ability to take specified actions, such as incurring additional debt, making capital expenditures or declaring dividends. In addition, debt financing would result in increased fixed payment obligations.

If we raise funds through 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 product candidates or grant licenses on terms that may not be favorable to us.

If we are unable to raise additional funds when needed, we may be required to delay, reduce or eliminate our product development or future commercialization efforts, or grant rights to develop and market product candidates that we would otherwise prefer to develop and market ourselves.

Contractual Commitments and Obligations

Tax-related Obligations

We exclude assets, liabilities or obligations pertaining to uncertain tax positions from our summary of contractual commitments and obligations as we cannot make a reliable estimate of the period of cash settlement with the respective taxing authorities. As of March 31, 2020, we had no uncertain tax positions.

Other Funding Commitments

As of March 31, 2020, we had, and continue to have, several ongoing studies in various clinical trial stages. Our most significant clinical trial spending is with clinical research organizations, or CROs. The contracts with CROs generally are cancellable, with notice, at our option and do not have any significant cancellation penalties.

Transition from Ironwood and Costs to Operate as an Independent Company

Our condensed consolidated and combined financial statements for the period prior to the Separation reflect our operating results and financial position as it was operated by Ironwood, rather than as an independent company. As a result of the Separation, we have incurred additional ongoing operating expenses to operate as an independent, publicly traded, company. These costs include the cost of various corporate headquarters functions, incremental information technology-related costs and incremental costs to operate stand-alone accounting, legal, human resources and other administrative functions. We also incur non-recurring expenses and non-recurring capital expenditures.

We entered into the Ironwood Transition Services Agreement that provided us with certain services and resources related to corporate functions for an initial term of up to two years from the date of the Separation (as applicable). All services provided by Ironwood to the Company under the Ironwood Transition Services Agreement were completed as of March 31, 2020, and it has been terminated.

It is not practicable to estimate the costs that would have been incurred in each of the periods presented in the historical financial statements for the functions described above. Actual costs that would have been incurred if we operated as a stand-alone company for the periods prior to the Separation would have depended on various factors, including organizational design, outsourcing and other strategic decisions related to corporate functions, information technology and back office infrastructure.

Off-Balance Sheet Arrangements

We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, that would have been established for the purpose of facilitating off-balance sheet arrangements (as that term is defined in Item 303(a)(4)(ii) of Regulation S-K) or other contractually narrow or limited purposes. As such, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in those types of relationships. We enter into guarantees in the ordinary course of business related to the guarantee of our own performance.

New Accounting Pronouncements

For a discussion of new accounting pronouncements see Note 2, Summary of Significant Accounting Policies, of the condensed consolidated and combined financial statements appearing elsewhere in this Quarterly Report on Form 10-Q.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

We are a smaller reporting company as defined by Rule 12b-2 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and are not required to provide the information required under this item.

Item 4. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act refers to controls and procedures that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. Because there are inherent limitations in all control systems, a control system, no matter how well conceived and operated, can provide only reasonable, as opposed to absolute, assurance that the objectives of the control system are met. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were effective, at the reasonable assurance level, as of the end of the period covered by this report. However, our management does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent all errors and all fraud.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the period covered by this Quarterly Report on Form 10-Q which have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II

Item 1. Legal Proceedings

From time to time we may become involved in legal proceedings or be subject to claims arising in the ordinary course of our business. We are not presently subject to any pending or threatened litigation that we believe, if determined adversely to us, would individually, or taken together, reasonably be expected to have a material adverse effect on our business or financial results.

Item 1A. Risk Factors

You should carefully review and consider the information regarding certain factors which could materially affect our business, financial condition or future results set forth under the heading “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019.

There have been no material changes to the risk factors described therein, except the following new risk factor:

A pandemic, epidemic or outbreak of infectious disease, such as COVID-19, has the potential to disrupt our business, including our clinical development activities, and its effect on our business is difficult to precisely judge at this time.

A novel strain of coronavirus (COVID-19) has reached pandemic levels. We are conducting multiple clinical development activities at various locations. Many nations, including the United States, have implemented stay-at-home orders to contain the coronavirus outbreak which, along with other related mitigation measures, may limit our ability to access patients and physicians at certain local clinical centers that are participating in these development activities. To a limited extent this has delayed or disrupted and may be expected to further delay or disrupt our clinical development activities. The extent to which this hinders procurement of resources, raw materials or components necessary for research studies or preclinical or clinical development is not fully predictable. New information is expected to emerge about the severity of the coronavirus and the actions to contain the coronavirus or treat its effects. To a limited extent we have experienced and may further experience other delays and disruptions, such as limitations on access to capital and to our personnel, resources and facilities or the temporary closure of our suppliers and suspension of services, which may materially and adversely affect our development timelines, results of operations and our financial condition.

See the “Risk Factors” section in Item 1A of our annual report on Form 10-K for the fiscal year ended December 31, 2019, and elsewhere in this Quarterly Report on Form 10-Q for a further description of these and other factors. We caution you that the risks, uncertainties and other factors referenced above may not contain all of the risks, uncertainties and other factors that are important to you. In addition, we cannot assure you that we will realize the results, benefits or developments that we expect or anticipate or, even if substantially realized, that they will result in the consequences or affect us or our business in the way expected.

Item 6. Exhibits

See the Exhibit Index on the following page of this Quarterly Report on Form 10-Q.

EXHIBIT INDEX

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Date: May 4, 2020