Orchard Therapeutics plc - Quarter Report: 2020 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

For the quarterly period ended March 31, 2020

OR

For the transition period from                       to                    

Commission File Number: 001-38722

ORCHARD THERAPEUTICS PLC

(Exact Name of Registrant as Specified in its Charter)

Registrant’s telephone number, including area code: +44 (0) 203 808-8286

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, 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 ☒ 

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.     Yes  ☒    No  ☐

As of May 4, 2020, the registrant had 97,263,817 ordinary shares, nominal value £0.10 per share, outstanding.

Table of Contents

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains express or implied forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, that involve substantial risks and uncertainties. In some cases, forward-looking statements may be identified by the words “may,” “might,” “will,” “could,” “would,” “should,” “expect,” “intend,” “plan,” “objective,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “continue,” “ongoing,” or the negative of these terms, or other comparable terminology intended to identify statements about the future. These statements involve known and unknown risks, uncertainties and other important factors that may cause our actual results, levels of activity, performance or achievements to be materially different from the information expressed or implied by these forward-looking statements. The forward-looking statements and opinions contained in this Quarterly Report on Form 10-Q are based upon information available to our management as of the date of this Quarterly Report on Form 10-Q, and while we believe such information forms a reasonable basis for such statements, such information may be limited or incomplete, and our statements should not be read to indicate that we have conducted an exhaustive inquiry into, or review of, all potentially available relevant information. Forward-looking statements contained in this Quarterly Report on Form 10-Q include, but are not limited to, statements about:

You should refer to the section titled “Item 1A. Risk Factors” for a discussion of important factors that may cause our actual results to differ materially from those expressed or implied by our forward-looking statements. As a result of these factors, we cannot be assured that the forward-looking statements in this Quarterly Report on Form 10-Q will prove to be accurate. Furthermore, if our forward-looking statements prove to be inaccurate, the inaccuracy may be material. In light of the significant uncertainties in these forward-looking statements, these statements should not be regarded as a representation or warranty by us or any other person that we will achieve our objectives and plans in any specified time frame, or at all. We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.

You should read this Quarterly Report on Form 10-Q and the documents that we reference in this Quarterly Report on Form 10-Q and have filed as exhibits to this Quarterly Report on Form 10-Q completely and with the understanding that our actual future results may be materially different from what we expect. We qualify all of our forward-looking statements by these cautionary statements.

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PART I—FINANCIAL INFORMATION

Item 1. Financial Statements.

ORCHARD THERAPEUTICS PLC

Condensed Consolidated Balance Sheets

(In thousands, except per share amounts)

(unaudited)

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

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ORCHARD THERAPEUTICS PLC

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

ORCHARD THERAPEUTICS PLC

Condensed Consolidated Statements of Cash Flows

(In thousands)

(unaudited)

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

3

ORCHARD THERAPEUTICS PLC

Condensed Consolidated Statements of Convertible Preferred Shares and Shareholders’ (Deficit) 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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ORCHARD THERAPEUTICS PLC

Notes to the Condensed Consolidated Financial Statements

(unaudited)

1. Nature of the Business

Orchard Therapeutics plc (the “Company”) is a global gene therapy leader dedicated to transforming the lives of people affected by rare diseases through the development of innovative, potentially curative gene therapies. The Company’s ex vivo autologous gene therapy approach utilizes genetically modified blood stem cells and seeks to correct the underlying cause of disease in a single administration. The Company’s gene therapy product candidate pipelines span multiple therapeutic areas where the disease burden on children, families and caregivers is immense and current treatment options are limited or do not exist.

The Company is a public limited company incorporated pursuant to the laws of England and Wales. The Company has American Depositary Shares (ADSs) registered with the U.S. Securities and Exchange Commission (the “SEC”) and has been listed on the Nasdaq Global Select Market since October 31, 2018. The Company’s ADSs each represent one ordinary share of the Company.

The Company is subject to risks and uncertainties common to development-stage companies in the biotechnology industry. There can be no assurance that the Company’s research and development will be successfully initiated or completed, that adequate protection for the Company’s technology will be obtained, that any products developed will obtain necessary government regulatory approval or that any products, if approved, will be commercially viable. The Company operates in an environment of rapid scientific and technological innovation and substantial competition from pharmaceutical and biotechnology companies. In addition, the Company is dependent upon the services of its employees, consultants and service providers. Even if the Company’s product development efforts are successful in gaining regulatory approval, it is uncertain when, if ever, the Company will realize significant revenue from product sales.

The Company is subject to risks associated with the COVID-19 pandemic. In an effort to halt the outbreak of COVID-19, a number of countries, including the United States, United Kingdom and Italy where the Company operates, have placed significant restrictions on travel. Limitations on travel and other social distancing measures have had an effect on the Company’s preclinical and clinical activities and regulatory timelines. Commercial activity associated with the Company’s EMA-approved gene therapy for ADA-SCID, Strimvelis®, has been postponed by the treatment site and scheduled patients are continuing to receive enzyme replacement therapy until treatment with Strimvelis can occur. Any prolonged material disruptions to the Company’s employees, suppliers, contract manufacturers, vendors, patients, government sponsored funding programs or the Company’s marketable securities could impact operating results and could lead to impairments; however, there has been no material impairments to date. The capital markets have experienced significant volatility as a result of the pandemic and the Company’s ability to access the capital markets in the future could be impacted if disruptions in the capital markets continue.

Through March 31, 2020, the Company funded its operations primarily with proceeds from the sale of convertible preferred shares and ADSs in the Company’s initial public offering (“IPO”) and a subsequent follow-on offering, as well as with certain grant and reimbursement payments and a drawdown on its credit facility, described in note 6 below. The Company has incurred recurring losses since its inception. As of March 31, 2020, the Company had an accumulated deficit of $504.2 million. The Company expects to continue to generate operating losses for the foreseeable future. The Company expects that its cash, cash equivalents, and marketable securities on hand as of March 31, 2020 of $263.9 million, will be sufficient to fund its operations and capital expenditure requirements through at least the next twelve months. 

The Company will seek additional funding through private or public equity financings, debt financings, collaborations, strategic alliances and marketing, distribution or licensing arrangements, or any combination thereof. The Company may not be able to obtain financing on acceptable terms, or at all, and the Company may not be able to enter into collaborations or other arrangements. The terms of any financing may adversely affect the holdings or the rights of the Company’s shareholders and ADS holders. The future viability of the Company is dependent on its ability to raise additional capital to finance its operations. If the Company is unable to obtain funding, the Company will be forced to delay, reduce or eliminate some or all of its research and development programs, product portfolio expansion or commercialization efforts, which could adversely affect its business prospects, or the Company may be unable to continue operations. Although management continues to pursue these plans, there is no assurance that the Company will be successful in obtaining sufficient funding on terms acceptable to the Company to fund continuing operations, if at all.

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2. Basis of Presentation and Summary of Significant Accounting Policies

Basis of presentation

The condensed consolidated interim financial statements of the Company are unaudited and have been prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) for interim financial reporting and in accordance with Regulation S-X, Rule 10-01. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. Any reference in these notes to applicable guidance is meant to refer to the authoritative U.S. GAAP as found in the Accounting Standards Codification (“ASC”), and Accounting Standards Update (“ASU”), of the Financial Accounting Standards Board (“FASB”). All intercompany accounts and transactions between the Company and its subsidiaries have been eliminated upon consolidation.

The accompanying unaudited condensed consolidated interim financial statements should be read in conjunction with the audited consolidated financial statements and accompanying notes included in the Company’s Annual Report on Form 10-K filed with the SEC on February 27, 2020 (the “Annual Report”).  The condensed consolidated balance sheet as of December 31, 2019 was derived from audited consolidated financial statements included in the Company’s Annual Report but does not include all disclosures required by U.S. GAAP. 

Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted from these interim financial statements.  However, these interim financial statements include all adjustments, consisting only of normal recurring adjustments, which are, in the opinion of the Company’s management, necessary to fairly state the results of the interim period.  The interim results are not necessarily indicative of results to be expected for the full year.

The change in other receivables reported in the condensed consolidated statement of cash flows for the three months ended March 31, 2019 previously included in changes in trade and other receivables has been presented in changes in prepaid expenses, current assets and other assets to conform with current period presentation. The change in the Company’s research and development tax credit receivable in the condensed consolidated statement of cash flows for the three months ended March 31, 2019 previously included in changes in research and development tax credit receivable, prepaids, and other assets has been presented as a separate line item within operating cash flows to conform to current period presentation.

Use of estimates

The preparation of condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenue and expenses during the reporting periods. Significant estimates and assumptions reflected in these condensed consolidated financial statements include, but are not limited to, the accrual for research and development expenses, the research and development tax credit receivable, the Strimvelis loss provision, share-based compensation, operating lease assets and liabilities, and income taxes. The full extent to which the COVID-19 pandemic will directly or indirectly impact the Company’s business, results of operations and financial condition, including sales, expenses, reserves and allowances, manufacturing, clinical trials, research and development costs and employee-related costs, will depend on future developments that are highly uncertain, including as a result of new information that may emerge concerning COVID-19 and the actions taken to contain it or treat COVID-19, as well as the economic impact on local, regional, national and international customers and markets. The Company has made estimates of the impact of COVID-19 within the Company’s financial statements and there may be changes to those estimates in future periods. As of the date of issuance of these unaudited condensed consolidated financial statements, the Company is not aware of any specific event or circumstance that would require the Company to update estimates, judgments or revise the carrying value of any assets or liabilities. Actual results may differ from these estimates.

Foreign currency translation

The reporting currency of the Company is the U.S. dollar. The Company has determined the functional currency of the parent company, Orchard Therapeutics plc, is the U.S. dollar because it predominantly raises finances and expends cash in U.S. dollars. The functional currency of the Company’s subsidiary operations is the applicable local currency. Transactions in foreign currencies are translated into the functional currency of the subsidiary in which they occur at the foreign exchange rate in effect on the date of the transaction.  Monetary assets and liabilities denominated in foreign currencies at the balance sheet date are translated into the functional currency of the relevant subsidiary at the foreign exchange rate in effect on the balance sheet date. Non-monetary assets and liabilities denominated in foreign currencies that differ from the functional currency are translated into the functional currency at the exchange rates prevailing at the date of the transaction. The Company recorded realized and unrealized foreign currency transaction losses of $6.8 million and $3.5 million for the three months ended March 31, 2020 and 2019, respectively, which is included in other income (expense) in the condensed consolidated statements of operations and comprehensive loss.

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The results of operations for subsidiaries, the functional currency of which is not the U.S. dollar, are translated at an average rate for the period in which this rate approximates to the foreign exchange rates ruling at the dates of the transactions and the balance sheets of these subsidiaries are translated at foreign exchange rates prevailing at the balance sheet date. Exchange differences arising from this translation of foreign operations are reported as an item of other comprehensive loss.

Cash and cash equivalents

The Company considers all highly liquid investments purchased with original maturities of 90 days or less at acquisition to be cash equivalents.

Marketable debt securities

Marketable securities consist of investments with original maturities greater than ninety days. The Company has classified its investments with maturities beyond one year as short term, based on their highly liquid nature and because such marketable securities represent the investment of cash that is available for current operations. The Company considers its investment portfolio of investments as available-for-sale. Accordingly, these investments are recorded at fair value, which is based on quoted market prices or other observable inputs. Unrealized gains and losses are recorded as a component of other comprehensive income (loss). Realized gains and losses are determined on a specific identification basis and are included in other income (loss). Amortization and accretion of discounts and premiums is also recorded in other income (loss).

When the fair value is below the amortized cost of the asset an estimate of expected credit losses is made, and is limited to the amount by which fair value is less than amortized cost. The credit-related impairment amount is recognized in net income; the remaining impairment amount and unrealized gains are reported as a component of accumulated other comprehensive income (loss) in shareholders’ equity. Credit losses are recognized through the use of an allowance for credit losses account and subsequent improvements in expected credit losses are recognized as a reversal of the allowance account. If the Company has the intent to sell the security or it is more likely than not that the Company will be required to sell the security prior to recovery of its amortized cost basis the allowance for credit loss is written off and the excess of the amortized cost basis of the asset over its fair value is recorded in net income.

United Kingdom Research and development tax credit

As a company that carries out extensive research and development activities, the Company seeks to benefit from two U.K. research and development tax relief programs, the Small and Medium-sized Enterprises research and development tax credit (“SME”) program and the Research and Development Expenditure (“RDEC”) program. Qualifying expenditures largely comprise employment costs for research staff, consumables and certain internal overhead costs incurred as part of research projects for which the Company does not receive income.

Based on criteria established by U.K. HM Revenue and Customs (“HMRC”), management of the Company expects a proportion of expenditures being incurred in relation to its pipeline research, clinical trials management and manufacturing development activities to be eligible for research and development tax credits for the 2020 fiscal year. The Company has qualified under the more favorable SME regime for the year ended December 31, 2019 and expects to qualify under the SME regime for the year ending December 31, 2020.

The RDEC and SME credits are not dependent on the Company generating future taxable income or on the ongoing tax status or tax position of the Company. The Company has assessed its research and development activities and expenditures to determine which activities and expenditures are likely to be eligible under the research and development incentive program described above. At each period end, the Company estimates the reimbursement available to the Company based on available information at the time.

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The Company recognizes credits from the research and development incentives when the relevant expenditure has been incurred and there is reasonable assurance that the reimbursement will be received. Such credits are accounted for as reductions in research and development expense. The following table below outlines the changes to the research and development tax credit receivable, including amounts recognized as an offset to research and development expense during the period, for the periods ended March 31, 2020 and 2019 (in thousands):

As of March 31, 2020, the Company’s tax incentive receivable from the U.K. government was $30.2 million, of which $14.0 million was classified as current and $16.2 million was classified as long-term. As of December 31, 2019, the Company’s tax incentive receivable from the U.K. government was $28.6 million, of which $14.9 million was classified as current, and $13.7 million was classified as noncurrent.

Restricted cash and construction deposits

Cash and cash equivalents that are restricted as to withdrawal or use under the terms of certain contractual agreements are recorded as restricted cash on the Company’s condensed consolidated balance sheet. The Company has an outstanding letter of credit for $3.0 million associated with a lease, and is required to hold this amount in a standalone bank account, as of March 31, 2020 and December 31, 2019. The Company is also contractually required to maintain cash collateral accounts associated with corporate credit cards and other leases in the amount of $1.3 million at March 31, 2020, and December 31, 2019.

The Company includes the restricted cash balance in cash and cash equivalents when reconciling beginning-of-period and end-of-period total amounts shown on the condensed consolidated statements of cash flows The following table provides a reconciliation of cash, cash equivalents, and restricted cash reported in the condensed consolidated balance sheet that sum to the total of the amounts reported in the unaudited condensed consolidated statement of cash flows:

The Company also has a deposit of $10.0 million in an escrow account associated with the construction of the Company’s leased facility in Fremont, California, which subsequent to March 31, 2020, the Company has ceased construction and build-out of and intends to consider its options relating to the lease, including subleasing the facility. Subject to the terms of the lease and reduction provisions, this amount may be decreased to nil over time upon qualifying construction expenditure. The deposit is classified in other current assets on the consolidated balance sheet.

Research and development costs

Research and development costs are expensed as incurred. Research and development expenses consist of costs incurred in performing research and development activities, including salaries, share-based compensation and benefits, facilities costs, depreciation, third-party license fees, certain milestone payments, and external costs of outside vendors engaged to conduct preclinical and clinical development activities and clinical trials, as well as costs to develop a manufacturing process, perform analytical testing and manufacture clinical trial materials. Non-refundable prepayments for goods or services that will be used or rendered for future research and development activities are recorded as prepaid expenses. Such amounts are recognized as an expense as the goods are delivered or the related services are performed, or until it is no longer expected that the goods will be delivered, or the services rendered. In addition, funding from research grants is recognized as an offset to research and development expense on the basis of costs incurred on the research program. Royalties to third parties associated with our research grants will be accrued when they become probable.

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Research agreement costs and accruals

The Company has entered into various research and development contracts. These agreements are cancelable, and related costs are recorded as research and development expenses as incurred. When billing terms under these contracts do not coincide with the timing of when the work is performed, the Company is required to make estimates of outstanding obligations as of period end to those third parties.  Any accrual estimates are based on a number of factors, including the Company’s knowledge of the progress towards completion of the research and development activities, invoicing to date under the contracts, communication from the research institution or other companies of any actual costs incurred during the period that have not yet been invoiced, and the costs included in the contracts. Significant judgments and estimates may be made in determining the accrued balances at the end of any reporting period. Actual results could differ from the estimates made by the Company. The historical accrual estimates made by the Company have not been materially different from the actual costs.

Share-based compensation

The Company measures share-based awards granted to employees and directors based on the fair value of the shares and options on the date of the grant and recognizes compensation expense for those awards over the requisite service period, which is the vesting period of the respective award. Forfeitures are accounted for as they occur.

Comprehensive loss

Comprehensive loss includes net loss as well as other changes in shareholders’ equity (deficit) that result from transactions and economic events other than those with shareholders. The components of accumulated other comprehensive income (loss) are detailed as follows (in thousands):

Leases

The Company determines if an arrangement is a lease at contract inception. Operating lease assets represent a right to use an underlying asset for the lease term and operating lease liabilities represent an obligation to make lease payments arising from the lease. Operating lease liabilities with a term greater than one year and their corresponding right-of-use assets are recognized on the balance sheet at the commencement date of the lease based on the present value of lease payments over the expected lease term. Certain adjustments to the right-of-use asset may be required for items such as initial direct costs paid or incentives received. The Company made an accounting policy election to not record a right-of-use asset or lease liability for leases with a term of one year or less. To date, the Company has not identified any material short-term leases, either individually or in the aggregate.

As the Company’s leases do not provide an implicit rate, the Company utilized the appropriate incremental borrowing rate, which is the rate incurred to borrow on a collateralized basis over a similar term an amount equal to the lease payments in a similar economic environment. The Company estimated the incremental borrowing rate based on the Company’s currently outstanding credit facility as inputs to the analysis to calculate a spread, adjusted for factors that reflect the profile of secured borrowing over the expected term of the lease.

The components of a lease should be split into three categories: lease components (e.g., land, building, etc.), non-lease components (e.g., common area maintenance, utilities, performance of manufacturing services, purchase of inventory, etc.), and non-components (e.g., property taxes, insurance, etc.). Then the fixed contract consideration (including any related to non-components) must be allocated based on fair values to the lease components and non-lease components. Although separation of lease and non-lease components is required, certain practical expedients are available to entities. Entities electing the practical expedient would not separate lease and non-lease components. Rather, they would account for each lease component and the related non-lease component together as a single component. The Company has elected not to apply the practical expedient and with respect to its lease of manufacturing space at a contract manufacturing organization, the Company has instead allocated the consideration between the lease and non-lease components of the contract. The Company calculated the fair value of the lease component using financial information readily available as part of its master services arrangement. The remainder of the consideration was allocated to the non-lease components.

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Strimvelis loss provision

As part of the GSK transaction (as defined in Note 8), the Company is required to maintain commercial availability of Strimvelis in the European Union until such time that an alternative gene therapy is available (see Note 8). Strimvelis is not currently expected to generate sufficient cash flows to overcome the costs of maintaining the product and certain regulatory commitments; therefore, the Company initially recorded a liability associated with the loss contract of $18.4 million in 2018. The Company recognizes the amortization of the loss provision on a diminishing balance basis based on the actual net loss incurred associated with Strimvelis and the expected future net losses to be generated until such time as Strimvelis is no longer commercially available. The amortization of the provision is recorded as a credit to research and development expense. The Company has made an estimate of the expected future losses associated with Strimvelis and will adjust this estimate as facts and circumstances change regarding the commercial availability and costs of maintaining and selling Strimvelis. The Company does not update the accrued loss provision for any subsequent adjustment of the future losses, however, the timing of recognizing the amortization of what was originally recorded is adjusted for the updated future losses. The following table below outlines the changes to the Strimvelis loss provision for the periods ended March 31, 2020 and 2019 (in thousands):

Of the balance as of March 31, 2020 noted in the table above, $1.9 million is classified as current, and $2.8 million is classified as non-current.

Net income (loss) per share

Basic net income (loss) per share attributable to ordinary shareholders is computed by dividing the net income (loss) attributable to ordinary shareholders by the weighted average number of ordinary shares outstanding for the period. Diluted net income (loss) attributable to ordinary shareholders is computed by adjusting net income (loss) attributable to ordinary shareholders based on the potential impact of dilutive securities. Diluted net income (loss) per share attributable to ordinary shareholders is computed by dividing the diluted net income (loss) attributable to ordinary shareholders by the weighted average number of ordinary shares outstanding for the period, including potential dilutive ordinary shares. For purpose of this calculation, outstanding options and unvested restricted shares are considered potential dilutive ordinary shares. Since the Company was in a loss position for all periods presented, basic net loss per share is the same as diluted net loss per share for all periods as the inclusion of all shares convertible into ordinary shares outstanding would have been anti-dilutive.

The following securities, presented based on amounts outstanding at each period end, are considered to be ordinary share equivalents, but were not included in the computation of diluted net loss per ordinary share because to do so would have been anti-dilutive:

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Recent Accounting Pronouncements

Recently adopted accounting pronouncements

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (“ASU 2016-02”), which sets out the principles for the recognition, measurement, presentation and disclosure of leases for both parties to a contract (i.e., lessees and lessors). ASU 2016-02 supersedes the lease guidance under FASB ASC Topic 840, Leases, resulting in the creation of FASB ASC Topic 842, Leases (“ASC 842”). As we are no longer an emerging growth company as of December 31, 2019, ASC 842 became effective for us in 2019, as of January 1, 2019. During the nine months ended September 30, 2019, while we were still an emerging growth company, we applied ASC 840 to our leases. Our previously reported consolidated cash flow statement for the three months ended March 31, 2019 has been recast to reflect adoption of ASC 842 effective January 1, 2019. The following table summarizes the impact of the adoption to the Company’s operating cash flows in our previously issued condensed consolidated statement of cash flows. There was no impact to the condensed consolidated statement of comprehensive loss for the three months ended March 31, 2019 as a result of the adoption of ASC 842. The table also includes other presentation adjustments within operating cash flows made to conform to current period presentation (in thousands):

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”), which requires entities to record expected credit losses for certain financial instruments, including trade receivables, as an allowance that reflects the entity's current estimate of credit losses expected to be incurred. For available-for-sale debt securities in unrealized loss positions, the new standard requires allowances to be recorded instead of reducing the amortized cost of the investment. The new standard became effective for us on January 1, 2020. This guidance did not have a significant impact on our consolidated financial statements and related disclosures. The Company has a U.K. research and development tax credit receivable that is subject to this guidance; however, there has been no allowance recorded for this receivable.

3. Fair Value Measurements and Marketable Debt Securities

The following tables present information about the Company’s financial assets that have been measured at fair value as of March 31, 2020 and indicate the fair value of the hierarchy of the valuation inputs utilized to determine such fair value. In general, fair values determined by Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities. Fair value determined by Level 2 inputs utilize observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted market prices in markets that are not active or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the related assets or liabilities. Fair values determined by Level 3 inputs are unobservable data points for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability. During the three months ended March 31, 2020, there were no transfers between Level 1 and Level 2 financial assets.

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The following table summarizes the Company’s cash equivalents and marketable debt securities as of March 31, 2020, in thousands:

The following table summarizes the Company’s cash equivalents and marketable debt securities as of December 31, 2019, in thousands:

The carrying amount reflected in the condensed consolidated balance sheets for research and development tax incentive receivable, trade receivables, accounts payable, and accrued expenses approximate fair value due to their short-term maturities. The carrying value of the Company’s outstanding notes payable approximates fair value (a Level 2 fair value measurement), reflecting interest rates currently available to the Company.

Marketable Debt Securities

The following table summarizes the Company’s marketable debt securities as of March 31, 2020, in thousands:

The following table summarizes the Company’s marketable securities as of December 31, 2019, in thousands:

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The following table summarizes the Company’s available-for-sale debt securities by contractual maturity, as of March 31, 2020 and December 31, 2019, in thousands:

4. Property and Equipment, Net

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

Depreciation expense was $0.5 million and $0.4 million for the three months ended March 31, 2020 and 2019, respectively.

5. Accrued Expenses and Other Liabilities

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

6. Notes Payable

In May 2019, as amended in April 2020, the Company entered into a senior term facilities agreement (the “Credit Facility”) with MidCap Financial (Ireland) Limited (“MidCap Financial”), as agent, and additional lenders from time to time (together with MidCap Financial, the “Lenders”), to borrow up to $75.0 million in term loans. To date, the Company has borrowed $25.0 million under an initial term loan. The remaining $50.0 million under the Credit Facility may be drawn down in the form of a second and third term loan, the second term loan being a $25.0 million term loan available no earlier than July 1, 2020 and no later than March 31, 2021 upon submission of certain regulatory filings and evidence of the Company having $100 million in cash and cash equivalent investments; and the third term loan being a $25.0 million term loan available no earlier than July 1, 2020 and no later than September 30, 2021 upon certain regulatory approvals and evidence of the Company having $125 million in cash and cash equivalent investments.

Each term loan under the Credit Facility bears interest at an annual rate equal to 6% plus LIBOR. The Company is required to make interest-only payments on the term loan for all payment dates prior to 24 months following the date of the Credit Facility, unless the third tranche is drawn, in which case for all payment dates prior to 36 months following the date of the Credit Facility. The term loans

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under the Credit Facility will begin amortizing on either the 24-month or the 36-month anniversary of the Credit Facility (as applicable), with equal monthly payments of principal plus interest to be made by the Borrower to the Lenders in consecutive monthly installments until the Loan Maturity Date. In addition, a final payment of 4.5% is due on the Loan Maturity Date. The Company accrues the final payment amount of $1.1 million associated with the first term loan, to outstanding debt by charges to interest expense using the effective-interest method from the date of issuance through the maturity date.

The Credit Facility includes affirmative and negative covenants. The affirmative covenants include, among others, covenants requiring the Company to maintain their legal existence and governmental approvals, deliver certain financial reports, maintain insurance coverage, maintain property, pay taxes, satisfy certain requirements regarding accounts and comply with laws and regulations. The negative covenants include, among others, restrictions on the Company transferring collateral, incurring additional indebtedness, engaging in mergers or acquisitions, paying dividends or making other distributions, making investments, creating liens, amending material agreements and organizational documents, selling assets, changing the nature of the business and undergoing a change in control, in some cases subject to certain exceptions. The Company is also subject to an ongoing minimum cash financial covenant in which the Company must maintain unrestricted cash in an amount not less than $20.0 million following the utilization of the second term loan and not less than $35.0 million following the utilization of the third term loan.

As of March 31, 2020, and December 31, 2019, notes payable consist of the following (in thousands):

As of March 31, 2020, the estimated future principal payments due are as follows (in thousands):

During the three months ended March 31, 2020 and 2019, the Company recognized $0.6 million and nil of interest expense, respectively, related to the initial term loan. The effective annual interest rate as of March 31, 2020 on the outstanding debt under the term loan was approximately 9.8%.

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7. Share-Based Compensation

The Company maintains three equity compensation plans; the Orchard Therapeutics Limited Employee Share Option Plan with Non-Employee Sub-Plan and U.S. Sub-Plan (the “2016 Plan”), the Orchard Therapeutics plc 2018 Share Option and Incentive Plan (the “2018 Plan”), and the 2018 Employee Share Purchase Plan (the “ESPP”). The board of directors has determined not to make any further awards under the 2016 plan following the Company’s IPO. As of March 31, 2020, 1,862,298 shares remained available for issuance under the 2018 Plan, and 1,580,887 shares remained available for issuance under the ESPP.

Share option activity

The following table summarizes option activity under the plans for three months ended March 31, 2020:

The weighted-average grant date fair value of share options granted during the three months ended March 31, 2020 was $8.54 per share.

Restricted Share Units

The Company has issued performance-based restricted share units (“RSUs”) to certain executives and members of its senior management, with vesting linked to the achievement of three specific regulatory and research and development milestones and one market condition based upon the volume weighted-average price (“VWAP”) of the Company’s ADSs for a certain period. Upon achievement of any of the aforementioned milestones, one third of the RSU’s will vest, and the award will become fully vested upon achievement of three of the four performance conditions.  

The maximum aggregate total fair value of the outstanding performance-based RSUs is $6.3 million. The fair value associated with the shares that could vest based on the market-based condition is being recognized as expense over an average derived service period of 1.3 years. The fair value associated with the performance-based conditions will be recognized when achievement of the milestones becomes probable, if at all. The Company determined that, as of March 31, 2020, none of the regulatory and research and development milestones were deemed probable.

The following table summarizes award activity for the three months ended March 31, 2020:

The amount of compensation cost recognized for the three months ended March 31, 2020 and 2019 for the market condition associated with the performance-based RSUs was $0.3 million and nil, respectively.

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Share-based compensation expense

Share-based compensation expense recorded as research and development and general and administrative expenses is as follows (in thousands):

During the three months ended March 31, 2020, the Company recognized $2.7 million of share-based compensation expense to selling, general and administrative expense related to the modification of share option awards associated with the separation of the Company’s former Chief Executive Officer.

As of March 31, 2020, total unrecognized compensation cost related to unvested share option grants was approximately $67.8 million. This amount is expected to be recognized over a weighted average period of approximately 3.0 years. As of March 31, 2020, the total unrecognized compensation cost related to performance-based RSUs is a maximum of $4.8 million, dependent upon achievement of the aforementioned milestones.

8. License Agreements

GSK asset purchase and license agreement

In April 2018, the Company completed an asset purchase and license agreement (the “GSK Agreement”) with subsidiaries of GSK to acquire a portfolio of autologous ex vivo gene therapy assets and licenses, for rare diseases and option rights on three additional programs in preclinical development from Telethon Foundation and San Raffaele Hospital (“Telethon-OSR”). The portfolio of programs and options acquired consisted of two late-stage clinical gene therapy programs in ongoing registrational trials for MLD and WAS, one earlier stage clinical gene therapy program for TDT, Stimvelis, and option rights exercisable upon completion of clinical proof of concept studies for three additional earlier-stage development programs, which option rights have all subsequently lapsed. The Company accounted for the GSK Agreement as an asset acquisition, since the asset purchase and licensing arrangement did not meet the definition of a business pursuant to ASC 805, Business Combinations, resulting in total consideration of $ 133.6 million, which was recorded in the second quarter of 2018.

The Company is required to use commercially reasonable efforts to obtain a Priority Review Voucher (“PRV”) from the United States Food and Drug Administration for each of the programs for MLD, WAS and TDT, the first of which GSK retained beneficial ownership over. GSK also has an option to acquire, at a price pursuant to an agreed upon formula, any PRV granted to the Company thereafter for MLD, WAS and TDT. If GSK does not exercise this option to purchase any PRV, the Company may sell the PRV to a third party and must share any proceeds in excess of a specified sale price equally with GSK. As part of the GSK Agreement the Company is also required to use its best endeavors to make Strimvelis commercially available in the European Union until such time as an alternative gene therapy, such as the Company’s OTL-101 product candidate, is commercially available for patients in Italy, and at all times at the San Raffaele Hospital in Milan, provided that a minimum number of patients continue to be treated at this site.

The Company will pay GSK non-refundable royalties and milestone payments in relation to the gene therapy programs acquired and the Company-developed product candidate, OTL-101. The Company will pay a flat mid-single digit percentage royalty on the combined annual net sales of ADA-SCID products, which includes Strimvelis and OTL-101. The Company will also pay tiered royalty rates at a percentage beginning in the mid-teens up to twenty percent for the MLD and WAS products, upon marketing approval, calculated as percentages of aggregate cumulative net sales of the MLD and WAS products, respectively. The Company will pay a tiered royalty at a percentage from the high single-digits to low double-digit for the TDT product, upon marketing approval, calculated as percentages of aggregate annual net sales of the TDT product. These royalties owed to GSK are in addition to any royalties owed to other third parties under various license agreements for the GSK programs. In aggregate, the Company may pay up to £90.0 million in milestone payments upon achievement of certain sales milestones applicable to GSK. The Company’s royalty obligations with respect to MLD and WAS may be deferred for a certain period in the interest of prioritizing available capital to develop each product. The Company’s royalty obligations are subject to reduction on a product-by-product basis in the event of market control by biosimilars and will expire in April 2048. Other than Strimvelis, these royalty and milestone payments were not determined to be probable and estimable at the date of the acquisition and are not included as part of consideration.

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Telethon-OSR research and development collaboration and license agreements

In connection with the Company’s entering into the GSK Agreement in April 2018, the Company also acquired and assumed agreements with Telethon Foundation and San Raffaele Hospital, together referred to as Telethon-OSR, for the research, development and commercialization of autologous ex vivo gene therapies for ADA-SCID, WAS, MLD and TDT.

As consideration for the licenses, the Company will be required to make payments to Telethon-OSR upon achievement of certain product development milestones, up to an aggregate of approximately €31.0 million. Additionally, the Company will be required to pay to Telethon-OSR a tiered mid-single to low-double digit royalty percentage on annual sales of licensed products covered by patent rights on a country-by-country basis, as well as a low double-digit percentage of sublicense income received from any certain third-party sublicenses of the collaboration programs.

In May 2019, the Company entered into a license agreement with Telethon-OSR, under which Telethon-OSR granted to the Company an exclusive worldwide license for the research, development, manufacture and commercialization of Telethon-OSR’s ex vivo autologous HSC lentiviral based gene therapy for the treatment of mucopolysaccharidosis type I (“MPS-I”), including the Hurler variant. Under the terms of the agreement, Telethon-OSR received €15.0 million in upfront and milestone payments from the Company upon entering into the agreement, resulting in $17.2 million in in-process research and development expense. The Company is also required to make milestone payments contingent upon certain development, regulatory and commercial milestones are achieved. Additionally, the Company will be required to pay Telethon a tiered mid-single to low-double digit royalty percentage on annual net sales of licensed products.

Oxford BioMedica license, development and supply agreement

In November 2016, and amended in June 2017, May 2018, July 2018, September 2018, May 2019 and April 2020, the Company entered into an arrangement with Oxford BioMedica plc whereby Oxford BioMedica granted an exclusive intellectual property license to the Company for the purposes of research, development, and commercialization of collaboration products, and whereby Oxford BioMedica will provide process development services (“Oxford BioMedica Development Agreement”). As part of the consideration to rights and licenses granted under the Oxford BioMedica Development Agreement, the Company issued 588,220 ordinary shares to Oxford BioMedica. The Company is also obligated to make certain development milestone payments in the form of issuance of additional ordinary shares if the milestones are achieved. In November 2017, the first milestone was achieved, and the Company was committed to issue another 150,826 ordinary shares, and issued these shares in 2018. In September 2018, the second and fourth milestones were achieved, and the Company issued 150,826 ordinary shares. No milestones were met during the three months ended March 31, 2020.  In April 2020, the fifth milestone was deemed to have been met upon execution of the amended agreement in April 2020, and the Company issued another 75,413 ordinary shares to Oxford BioMedica. The expense associated with the milestone achieved in April 2020 will be recorded in the second quarter of 2020 as of the April 2020 amendment date. The Company may also pay low single-digit percentage royalties on net sales of collaborated product generated under the Oxford BioMedica Agreement.

9. Income Taxes

Deferred tax assets and deferred tax liabilities are determined based on temporary differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. A valuation allowance is recorded against deferred tax assets if it is more likely than not that some portion or all of the deferred tax assets will not be realized.

The Company does not recognize a tax benefit for uncertain tax positions unless it is more likely than not that the position will be sustained upon examination by tax authorities, including resolution of any related appeals or litigation processes, based on the technical merits of the position. The tax benefit that is recorded for these positions is measured at the largest amount of cumulative benefit that has greater than a 50 percent likelihood of being realized upon ultimate settlement. Deferred tax assets that do not meet these recognition criteria are not recorded and the Company recognizes a liability for uncertain tax positions that may result in tax payments. If such unrecognized tax benefits were realized and not subject to valuation allowances, the entire amount would impact the tax provision. The Company has not recorded any amounts for unrecognized tax positions as of March 31, 2020 or December 31, 2019.

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In response to the COVID-19 pandemic, the Coronavirus Aid, Relief and Economic Security Act (CARES Act) was signed into law in March 2020. The CARES Act lifts certain deduction limitations originally imposed by the Tax Cuts and Jobs Act of 2017 (2017 Tax Act). The CARES Act provides that corporate taxpayers may carryback net operating losses (NOLs) originating during 2018 through 2020 for up to five years to recover taxes paid in prior years, eliminates the 80% of taxable income limitations by allowing corporate entities to fully utilize NOL carryforwards to offset taxable income in 2018, 2019 or 2020. Taxpayers may generally deduct interest up to the sum of 50% of adjusted taxable income plus business interest income (30% limit under the 2017 Tax Act) for tax years beginning January 1, 2019 and 2020. The CARES Act allows taxpayers with alternative minimum tax credits to claim a refund in 2020 for the entire amount of the credits instead of recovering the credits through refunds over a period of years, as originally enacted by the 2017 Tax Act. In addition, the CARES Act raises the corporate charitable deduction limit to 25% of taxable income and makes qualified improvement property generally eligible for 15-year cost-recovery and 100% bonus depreciation. The enactment of the CARES Act did not result in any material adjustments to the Company’s income tax provision for the three months ended March 31, 2020, or to the Company’s net deferred tax assets as of March 31, 2020.

The Company recorded income tax benefit of $0.3 million and expense of $0.6 million for the three months ended March 31, 2020 and 2019, respectively. The benefit for income taxes consists of current and deferred tax, which relates primarily to the Company’s subsidiary operations in Europe and the U.S.  

10. Commitments and Contingencies

The Company is not a party to any material litigation and does not have contingency reserves established for any litigation liabilities.

11. Employee Benefit Plans

The Company makes contributions to private defined contribution employee benefit plans on behalf of its employees. The Company provides employee contributions of up to six percent of each employee’s annual salary based on the jurisdiction the employees are located. The Company paid $0.6 million and $0.4 million in matching contributions for the three months ended March 31, 2020 and 2019, respectively.

12. Related Party Transactions

GSK

In April 2018, the Company completed the GSK Agreement with subsidiaries of GSK to acquire a portfolio of autologous ex vivo gene therapy assets and licenses, for rare diseases and option rights on three additional programs in preclinical development from Telethon-OSR (See Note 8).

As of March 31, 2020, and December 31, 2019, the Company had inventory purchase liability in accrued research and development expenses of $3.1 million and $3.3 million, respectively. During the three months ended March 31, 2019, the Company made $0.4 million in payments to settle accounts payable due to GSK. During the three months ended March 31, 2020 and 2019 there were no sales of Strimvelis and the Company incurred no royalties due to GSK.

13. Subsequent Events

On May 4, 2020, the Company committed to a new strategic plan and restructuring intended to enable the Company to advance its corporate strategy while reducing overall operating expenses, including ceasing construction and build-out of its Fremont, California manufacturing facility, closing its office in Menlo Park, California, reducing its workforce by approximately 25% across the Company, eliminating a number of future positions expected to be recruited in 2020 and 2021, reducing its investment in the future development of OTL-101 for ADA-SCID and OTL-300 for TDT, and other cost-saving measures (collectively, the “Restructuring”). The workforce reduction will take place primarily during the second and third quarters of 2020.

The Company estimates that it will incur aggregate charges of approximately $2.1 million in the second and third quarters of 2020 as a result of the Restructuring, consisting of one-time cash expenditures for severance and employee termination-related costs. The Company will accelerate the depreciation on certain property and equipment in the Menlo Park, California office, which lease will expire at the end of 2020, to reflect its intended remaining useful life. The Company intends to consider its options relating to the Fremont, California manufacturing facility lease, including subleasing the facility.  

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

The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this Quarterly Report. Some of the information contained in this discussion and analysis and set forth elsewhere in this Quarterly Report, including information with respect to our plans and strategy for our business, includes forward-looking statements that involve risks and uncertainties. You should review the section titled “Risk Factors” in Part II—Item 1A of this Quarterly Report for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.

Business Overview

Orchard Therapeutics is a global gene therapy leader dedicated to transforming the lives of people affected by rare diseases through the development of innovative, potentially curative gene therapies. Our ex vivo autologous gene therapy approach harnesses the power of genetically modified blood stem cells and seeks to correct the underlying cause of disease in a single administration. We have one of the deepest and most advanced gene therapy product candidate pipelines in the industry spanning multiple therapeutic areas where the disease burden on children, families and caregivers is immense and current treatment options are limited or do not exist. We recently announced a new strategic plan and restructuring intended to enable us to advance our corporate strategy while reducing overall operating expenses, including reducing our investment in the future development of OTL-101 for ADA-SCID and OTL-300 for TDT, among other measures.

Since our inception in 2015, we have devoted substantially all of our resources to conducting research and development of our product candidates, in-licensing and acquiring rights to our product candidates, business planning, raising capital and providing general and administrative support for our operations. To date, we have financed our operations primarily with proceeds from the sale of equity securities, including ADSs and convertible preferred shares. Through March 31, 2020, we had received net proceeds of $335.1 million from sales of ADSs in our initial public offering and follow-on public offering, $283.4 million from sales of our convertible preferred shares, and $24.5 million from our senior term facilities agreement (the “Credit Facility”) with MidCap Financial (Ireland) Limited (“MidCap Financial”).

We have incurred significant operating losses since our inception. With the exception of our commercial product Strimvelis^®, which was acquired in April 2018, we will not generate revenue from product sales unless and until we successfully complete clinical development and obtain regulatory approval for our product candidates. Our net losses were $50.6 million and $30.7 million for the quarters ended March 31, 2020 and 2019, respectively. As of March 31, 2020, and December 31, 2019, we had an accumulated deficit of $504.2 million and $453.7 million, respectively. As of March 31, 2020, we had cash, cash equivalents, marketable securities and restricted cash of $268.1 million, excluding amounts held in escrow deposits. Our losses have resulted primarily from costs incurred in connection with research and development activities and general and administrative costs associated with our operations. We expect to continue to incur significant expenses and increasing operating losses for the foreseeable future.

As a result, we will need substantial additional funding to support our continuing operations and pursue our growth strategy. Until such time as we can generate significant revenue from product sales, if ever, we expect to finance our operations through a combination of equity offerings, debt financings, collaborations, government contracts or other strategic transactions. We may be unable to raise additional funds or enter into such other agreements or arrangements when needed on favorable terms, or at all.

Recent Developments

Business update regarding COVID-19

The current COVID-19 pandemic has presented substantial public health and economic challenges around the world and is affecting our employees, patients, communities and business operations, as well as the U.S. and global economies and financial markets.  The impact of this pandemic has been and will likely continue to be extensive in many aspects of society and will likely continue to result in significant disruptions to the global economy, as well as businesses and capital markets around the world.

In an effort to halt the outbreak of COVID-19, a number of countries, including the United States, United Kingdom and Italy, have placed significant restrictions on travel. In the U.S. and U.K, our office-based employees have been working from home since early March 2020. Limitations on travel and other social distancing measures may have an effect on our preclinical and clinical activities and regulatory timelines. While our clinical sites are still treating patients in studies for OTL-201, OTL-103 and OTL-200 (for the treatment of mucopolysaccharidosis type IIIA (MPS-IIIA), Wiskott-Aldrich syndrome (WAS) and metachromatic leukodystrophy (MLD), respectively), these centers are devoting significant resources to patients with COVID-19, which could limit their ability to enroll additional patients in ongoing clinical studies. While we believe we have enrolled and treated enough patients to support regulatory filings for OTL-200 in the U.S. and EU, COVID-19-related impacts are likely to shift the enrollment timeline for our OTL-201 trial for the treatment of MPS-IIIA by at least three months.

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Travel and stay-at-home orders could adversely affect our contract manufacturers and third-party logistics providers. To date, our third-party contract development and manufacturing organization (CDMO) partners have continued to operate at or near normal levels. While we currently do not anticipate any interruptions, it is possible that the COVID-19 pandemic and response efforts may have an impact in the future on our and/or our third-party suppliers and CDMO partners’ ability to manufacture our products in development. The treatment site for Strimvelis^®, our European Medicines Agency-approved gene therapy for the treatment of ADA-SCID, postponed scheduling and treating any non-urgent patients with the therapy, however, expects to resume such treatments in June 2020. We have reviewed the collectability and valuation of our assets through the date of financial statement issuance and did not identify any significant recoverability concerns or impairments. Any prolonged material disruptions to our employees, suppliers, CDMOs, vendors, or patients could impact our operating results and could lead to impairments; however, there have been no material impairments to date. The capital markets have experienced significant volatility as a result of the pandemic and our ability to access the capital markets could be impacted if disruptions in the capital markets continue.  

For additional information on the various risks posed by the COVID-19 pandemic, please read Item 1A. Risk Factors included in this report.

Strategic plan and restructuring

In May 2020 we announced a new strategic plan and restructuring intended to enable us to advance our corporate strategy while reducing overall operating expenses, which includes decisions to:

We currently expect that the net effect of our new strategic plan and restructuring will result in approximately $125.0 million in cost savings in 2020 and 2021, but there can be no assurance that we will achieve all of these cost savings

Components of our results of operations

Revenue

We do not expect to generate any significant revenue from the sale of products, with the exception of Strimvelis, in the near future. Our product candidate, OTL-200, for the treatment of MLD is currently under review with the European Medicines Agency (EMA) and we expect a regulatory decision on approval in 2020. If OTL-200 is approved by the EMA and we are able to identify patients and secure reimbursement for our treatment, we will begin to generate revenue from the sale of OTL-200 in Europe. If our development efforts for other product candidates that we may develop in the future are successful and result in regulatory approval, or collaboration or license agreements with third parties, we may generate revenue in the future from a combination of product sales or payments from collaboration or license agreements.

During the quarter ended March 31, 2020 and 2019, we recognized no revenue from sales of Strimvelis. Strimvelis is currently distributed exclusively at the San Raffaele Hospital in Milan, Italy. We expect that product sales of Strimvelis will fluctuate quarter over quarter, in particular as we continue to promote the product and increase market access. As a result of the COVID-19 global pandemic, the San Raffaele Hospital postponed scheduling and treating non-urgent patients with Strimvelis, which may impact the

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timing of future Strimvelis revenues. Net product sales of nil for the quarter ended March 31, 2020 may not be representative of our sales for any future period.

Cost of product sales

Cost of sales consists of costs to manufacture, including raw materials, distribute and administer Strimvelis and royalty payments due to third parties that are tied to sales.

Operating expenses

Research and development expenses

Research and development expenses consist primarily of costs incurred for our research activities, including our discovery efforts and the development of our product candidates, and include:

We expense research and development cost as incurred. We recognize external development costs based on an evaluation of the progress to completion of specific tasks using information provided to us by our service providers. Payments for these activities are based on the terms of the individual agreements, which may differ from the pattern of costs incurred, and are reflected in our financial statements as a prepaid expense or accrued research and development expenses. United Kingdom research and development tax credits are recorded as an offset to research and development expense. Amortization of the Strimvelis loss provision is also recorded as an offset to research and development expense (See Note 2 of our condensed consolidated financial statements).

Our direct external research and development expenses are tracked on a program-by-program basis and consist of costs, such as fees paid to consultants, contractors and contract manufacturing organizations in connection with our preclinical and clinical development activities. License fees and other costs incurred after a product candidate has been designated and that are directly related to the product candidate are included in direct research and development expenses for that program. License fees and other costs incurred prior to designating a product candidate for development are included in unallocated costs. We do not allocate employee costs, costs associated with our discovery efforts, laboratory supplies, and facilities, including depreciation or other indirect costs, to specific product development programs because these costs are deployed across multiple product development programs and, as such, are not separately classified.

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Research and development activities are central to our business model. Product candidates in later stages of clinical development generally have higher development costs than those in earlier stages of clinical development, primarily due to the increased size and duration of later-stage clinical trials or the manufacturing requirements to conduct those clinical trials. We expect that our research and development expenses will remain consistent for the near term as we continue to: (i) expedite the clinical development and seek to obtain marketing approval for our lead product candidates, including OTL-200 for MLD and OTL-103 for WAS; (ii) initiate additional clinical trials for our product candidates, which may include OTL-102 for X-CGD, OTL-201 for MPS-IIIA, and OTL-203 for MPS-I; (iii) reduce our investment in and development expenses for OTL-101 for ADA-SCID and OTL-300 for TDT and reallocate those financial resources to other programs; (iv) seek to improve the efficiency and scalability of our outsourced manufacturing processes and supply chain; (v) build process development and analytical capabilities in the near term, and potential manufacturing capabilities in the longer term; and (vi) continue to discover and develop additional product candidates. For example, we recently announced that we intend to accelerate our research and development efforts for projects in less rare indications, including two new research programs in genetic subsets of frontotemporal dementia (FTD) and Crohn’s disease. We also expect to incur additional expenses related to milestone, royalty payments and maintenance fees payable to third parties with whom we have entered into license agreements to acquire the rights related to our product candidates.

The successful development of our product candidates and commercialization of Strimvelis and our product candidates, if approved, is highly uncertain. This is due to the numerous risks and uncertainties associated with product development and commercialization, including the following:

A change in the outcome of any of these variables with respect to the development of a product candidate could mean a significant change in the costs and timing associated with the development of that product candidate. For example, if the FDA, EMA or another regulatory authority were to require us to conduct clinical trials beyond those that we anticipate will be required for the completion of clinical development of a product candidate, or if we experience significant trial delays due to patient enrollment or other reasons, we would be required to expend significant additional financial resources and time on the completion of clinical development and we may never succeed in obtaining regulatory approval for any of our product candidates.

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Selling, general and administrative expenses

Selling, general and administrative expenses consist primarily of salaries and other related costs, including share-based compensation, for personnel in our executive, finance, commercial, corporate and business development, and administrative functions. Selling, general and administrative expenses also include professional fees for legal, patent, accounting, auditing, tax and consulting services, travel expenses and facility-related expenses, which include direct depreciation costs and allocated expenses for rent and maintenance of facilities and other operating costs.

We expect that our selling, general and administrative expenses will increase in the future as we increase our selling, general and administrative headcount to support our continued research and development and potential commercialization of our portfolio of product candidates. In addition, we are expanding our organization into multiple countries in Europe to support the potential commercialization of OTL-200 for MLD, which is currently under regulatory review by the EMA. We also expect to incur increased expenses associated with compliance with our obligations as a public company, including costs of accounting, audit, legal, regulatory and tax compliance services, director and officer insurance costs and investor and public relations costs.

In the first quarter of 2020, we recorded a $3.4 million charge to selling, general, and administrative expenses associated with the separation of our former Chief Executive Officer. Of this charge, there was $0.7 million associated with cash benefits, and $2.7 million associated with the modification of share options. We expect that we will incur additional future charges of approximately $2.1 million in the second and third quarters of 2020 as a result of headcount reductions we expect to make in connection with our new strategic initiatives and related restructuring.

Other income (expense), net

Interest income

Interest income consists of income earned on our cash and cash equivalents and marketable securities.

Interest expense

Interest expense consists of interest associated with our Credit Facility with MidCap Financial, which we entered into in May 2019. The Credit Facility bears a variable interest rate at a rate of 6.0% above LIBOR, plus a final payment equal to 4.5% of the principal borrowed under the Credit Facility. In fiscal year 2020, we will have a full year of interest expense, as compared to 7 months in 2019.

Other income (expense)

Other income (expense), net consists primarily of realized and unrealized foreign currency transaction gains and losses.

Results of operations

Comparison of the three months ended March 31, 2020 and 2019

The following table summarizes our results of operations for the three months ended March 31, 2020 and 2019:

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Research and development expenses

The table below summarizes our research and development expenses by therapeutic area:

Direct research and development expenses for neurometabolic programs increased by $2.5 million. Direct expenses associated with OTL-200 increased by $1.5 million compared to the first quarter of 2019. This was primarily due to an increase of $0.5 million in manufacturing costs, and $0.7 million in clinical trial costs. Direct expenses for OTL-201 increased by $0.5 million compared to the first quarter of 2019, which was primarily attributable to increases in clinical costs. Direct expenses for OTL-202 declined slightly by $0.1 million as compared to the first quarter of 2019. In addition, we incurred an increase in spending of $0.7 million on our OTL-203 for MPS-I, which we licensed from Telethon-OSR in May 2019.

Direct research and development expenses for primary immune deficiency-related programs declined by $3.8 million. Direct expenses associated with OTL-101 declined by $3.0 million. This was due to a $1.5 million decrease in manufacturing and process development costs with third-party contract manufacturers compared to the first quarter of 2019, a $1.0 million decline in clinical trial and contract research costs, and a $0.5 million decline in technical consulting costs related to the program. We expect that OTL-101 costs will continue to decline compared to the prior year as we reduce our investment and development in the program. Direct expenses for OTL-103 declined by $0.6 million, primarily due to a $0.4 decline in manufacturing costs and a $0.2 million decline in clinical costs. Direct expenses for Strimvelis were down $0.1 million as compared to the first quarter of 2019, as we continued to collect data and perform follow-up on patients treated with Strimvelis.

Direct research and development expenses for blood disorder-related programs declined by $0.6 million in the first quarter of 2020 due to lower expenses for OTL-300 compared to the first quarter of 2019. The decline in costs is due to a $0.1 million decline in manufacturing costs, and a $0.4 million decline in clinical costs. We expect that OTL-300 costs will continue to decline compared to the prior year as we reduce our investment and development in the program. The increase in costs associated with other research and preclinical programs relates to costs associated with having additional early-stage programs in our pipeline in 2020 compared to 2019. We expect these costs to continue to increase as part of our new strategic growth plan to focus on less rare indications, including our two new research programs in genetic subsets of FTD and Crohn’s disease.

Unallocated research and development costs and offsets to research and development expenses increased by $8.6 million due to an increase in personnel related costs of $3.4 million and share-based compensation of $1.8 million. The personnel and share-based compensation increases are attributable to an increased headcount year-over-year. Further, other research and development costs such as lab supplies and consumables, external manufacturing and process development, and other unallocated platform-related costs not attributable to a specific developmental program increased by $1.8 million in the first quarter of 2020 compared to the first quarter of 2019. This increase was due to $0.4 million increase in occupancy and information technology costs, as well as $1.3 million in unallocated manufacturing and clinical costs. The increases noted above were offset by $3.4 million as a result of the benefits of the U.K. research and development tax credit that is recorded as an offset to research and development expense. Tax credit benefits declined by $1.8 million in the first quarter of 2020 compared to the first quarter of 2019, as we have maximized the tax credit available for some programs. Amortization of the Strimvelis loss provision, which is also accounted for as an offset to research and development expense remained flat in the first quarter of 2020 as compared to the first quarter of 2019, as we recorded no sales of Strimvelis in either period, and expenses remained flat in the two periods.

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Selling, general and administrative expenses

The table below summarizes our selling, general and administrative expenses by functional area: