UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10‑Q

☒QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2017

OR

☐TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 001-38129

Mersana Therapeutics, Inc.

(Exact name of registrant as specified in its charter)

 

840 Memorial Drive Cambridge, MA 02139

(Address of principal executive offices)

(Zip Code)

(617) 498‑0020

(Registrant’s telephone number, including area code)

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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post 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. (Check one):

 

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  ☒.

There were 22,753,404 shares of Common Stock ($0.0001 par value per share) outstanding as of November 8, 2017.

 

 

 

Unless otherwise stated, all references to “us,” “our,” “Mersana,” “Mersana Therapeutics,” “we,” the “Company” and similar designations in this Quarterly Report on Form 10-Q refer to Mersana Therapeutics, Inc.  and its consolidated subsidiary, Mersana Securities Corp.

FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward‑looking statements. Forward‑looking statements are neither historical facts nor assurances of future performance. Instead, they are based on our current beliefs, expectations and assumptions regarding the future of our business, future plans and strategies, our clinical results and other future conditions. The words “anticipate,” “believe,” “estimate,” “expect,” “goal,” “intend,” “may,” “seek,” “plan,” “predict,” “project,” “target,” “potential,” “will,” “would,” “possible,” “could,” “should,” “continue,” “contemplate” or the negative of these terms or other similar expressions are intended to identify forward‑looking statements, although not all forward‑looking statements contain these identifying words.

These forward‑looking statements include, among other things, statements about:

We may not actually achieve the plans, intentions or expectations disclosed in our forward‑looking statements, and you should not place undue reliance on our forward‑looking statements. Actual results or events could differ materially from the plans, intentions and expectations disclosed in the forward‑looking statements we make. We have included important factors in the cautionary statements included in this Quarterly Report on Form 10-Q, particularly in the “Risk factors” section, that we believe could cause actual results or events to differ materially from the forward‑looking statements that we make. Our forward‑looking statements do not reflect the potential impact of any future acquisitions, mergers, dispositions, joint ventures or investments we may make.

The forward‑looking statements contained herein represent our views as of the date of this Quarterly Report on Form 10-Q. We anticipate that subsequent events and developments will cause our views to change. However, although we may elect to update these forward‑looking statements at some point in the future, we have no current intention of doing so except to the extent required by applicable law. You should, therefore, not rely on these forward‑looking statements as representing our views as of any date subsequent to the date of this Quarterly Report on Form 10-Q.

TABLE OF CONTENTS

 

 

PART I – FINANCIAL INFORMATION

Item 1.    Financial Statements

Mersana Therapeutics, Inc.

Condensed Consolidated Balance Sheets

(unaudited)

(in thousands, except share and per share data)

 

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

Mersana Therapeutics, Inc.

Condensed Consolidated Statements of Operations and Comprehensive Loss

(unaudited)

(in thousands, except share and per share data)

 

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

 

Mersana Therapeutics, Inc.

Condensed Consolidated Statements of Cash Flows

(unaudited)

(in thousands)

 

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

 

 

Mersana Therapeutics, Inc.

Notes to condensed consolidated financial statements

(unaudited)

(in thousands, except share and per share data)

1. Nature of business and basis of presentation

Mersana Therapeutics, Inc. (the Company) is a clinical stage company located in Cambridge, Massachusetts. The Company is advancing a proprietary pipeline of targeted oncology therapeutics leveraging its Dolaflexin® antibody drug conjugate (ADC) platform. Mersana's first product candidate, XMT-1522, designed to address a much broader population of patients with HER2-expressing tumors than served by currently approved HER2 therapies, is currently in a Phase 1 dose escalation study. The Company’s second product candidate, XMT-1536, is an ADC targeting NaPi2b, an antigen broadly expressed in certain types of cancer. In October 2017, the Company received FDA clearance of the XMT-1536 IND and we expect to begin dosing patients in early 2018. The Company also has partnerships utilizing the Dolaflexin platform with multiple strategic partners.

The Company is subject to risks common to companies in the biotechnology industry, including but not limited to, risks of failure of preclinical studies and clinical trials, the need to obtain marketing approval for any drug product candidate that it may identify and develop, the need to successfully commercialize and gain market acceptance of its product candidates, dependence on key personnel, protection of proprietary technology, compliance with government regulations, development of technological innovations by competitors, reliance on third party manufacturers and ability to transition from pilot-scale production to large-scale manufacturing of products.

On July 3, 2017, the Company completed an initial public offering (IPO), in which the Company issued and sold 5,000,000 shares of its common stock at a public offering price of $15.00 per share, for aggregate gross proceeds of $75,000. The Company received $67,420 in net proceeds after deducting $7,580 of underwriting discounts and commissions and offering costs. On August 2, 2017, the Company issued and sold 51,977 shares of common stock at $15.00 per share for gross proceeds of $780 upon the partial exercise of the underwriters’ overallotment option. The Company received net proceeds of $725 after deducting $55 in underwriting discounts and commissions.

Upon the closing of the IPO, all of the outstanding shares of convertible preferred stock automatically converted into 16,154,671 shares of common stock. Subsequent to the closing of the IPO, there were no shares of preferred stock outstanding. In connection with the IPO, the Company amended and restated its certificate of incorporation to change the authorized capital stock to 175,000,000 shares designated as common stock and 25,000,000 shares designated as preferred stock, all with a par value of $0.0001 per share.

In connection with preparing for its IPO, the Company effected a 1-for-4.5 reverse stock split of the Company’s common stock. The reverse stock split became effective on June 15, 2017. The par value and authorized shares of common stock and convertible preferred stock were not adjusted as a result of the reverse stock split. All share and per share amounts in the financial statements and notes thereto have been retroactively adjusted for all periods presented to give effect to this reverse stock split, including reclassifying an amount equal to the reduction in par value of common stock to additional paid-in capital. The financial statements have also been retroactively adjusted to reflect adjustments to the conversion ratio for each series of convertible preferred stock effected in connection with the reverse stock split.

The Company has incurred net losses since inception. The Company’s net loss was $24,740 for the nine months ended September 30, 2017 and $13,700 for the year ended December 31, 2016. The Company expects to continue to incur operating losses for at least the next several years.  As of September 30, 2017, the Company had an accumulated deficit of $83,911. The future success of the Company is dependent on its ability to identify and develop its product candidates, and ultimately upon its ability to attain profitable operations. The Company has devoted substantially all of its financial resources and efforts to research and development and general and administrative expense to support such research and development. The Company’s net losses may fluctuate significantly from quarter to quarter and year to year. Net losses and negative cash flows have had, and will continue to have, an adverse effect on the Company’s stockholders' deficit and working capital. The Company believes that its existing cash, cash equivalents and marketable securities as of September 30, 2017, will enable it to fund its operating plan through at least mid-2019, which the Company expects will allow it to achieve initial clinical data readouts for its two lead development programs.

The Company’s unaudited interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (U.S. GAAP) and the rules and regulations of the Securities and Exchange Commission (SEC). Any reference in these notes to applicable guidance is meant to refer to the authoritative United States generally accepted accounting principles as found in the Accounting Standards Codification (ASC) and Accounting Standards Updates (ASU) of the Financial Accounting Standards Board (FASB). Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted from this report, as is permitted by such rules and regulations.  Accordingly, these financial statements should be read in conjunction with the audited financial statements as of and for the year ended December 31, 2016 and notes thereto, included in the Company’s final prospectus for the IPO filed with the Securities and Exchange Commission pursuant to Rule 424(b)(4) on June 29, 2017 (the Prospectus). 

The unaudited interim consolidated financial statements have been prepared on the same basis as the audited financial statements. In the opinion of the Company’s management, the accompanying unaudited interim condensed consolidated financial statements contain all adjustments which are necessary to present fairly the Company’s financial position as of September 30, 2017, the results of its operations for the three and nine months ended September 30, 2017 and 2016 and cash flows for the nine months ended September 30, 2017 and 2016. Such adjustments are of a normal and recurring nature. The results for the three and nine months ended September 30, 2017 are not necessarily indicative of the results for the year ending December 31, 2017, or for any future period.

2. Summary of significant accounting policies

Principles of consolidation

The accompanying condensed consolidated financial statements include those of the Company and its subsidiary, Mersana Securities Corp., which was established in December 2016. All intercompany balances and transactions have been eliminated.

Use of estimates

The preparation of the Company's consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, equity, revenue, expenses and related disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenue and expenses during the reporting period. On an ongoing basis, the Company's management evaluates its estimates, which include, but are not limited to management's judgments with respect to the separate units of accounting and best estimate of selling price of those units of accounting within its revenue arrangements, accrued expenses, valuation of stock-based awards and income taxes. Actual results could differ from those estimates.

The Company utilized significant estimates and assumptions in determining the fair value of its common stock prior to the Company’s IPO. The Company has utilized various valuation methodologies in accordance with the framework of the American Institute of Certified Public Accountants Technical Practice Aid, Valuation of Privately‑Held Company Equity Securities Issued as Compensation, the Practice Aid, to estimate the fair value of its common stock. Each valuation methodology includes estimates and assumptions that require the Company’s judgment. These estimates and assumptions include a number of objective and subjective factors, including external market conditions, the prices at which the Company sold shares of preferred stock, the superior rights and preferences of securities senior to the Company’s common stock at the time of, and the likelihood of, achieving a liquidity event, such as an initial public offering or sale. Significant changes to the key assumptions used in the valuations could result in different fair values of common stock at each valuation date.

Segment information

Operating segments are defined as components of an enterprise about which separate discrete information is available for evaluation by the chief operating decision-maker in deciding how to allocate resources and assess performance. The Company and the Company's chief operating decision-maker, the Company's chief executive officer, view the Company's operations and manage its business as a single operating segment, which is the business of discovering and developing ADC’s.

Research and development

The Company expenses all costs incurred in performing research and development activities. Research and development expenses include salaries and benefits, materials and supplies, preclinical expenses, manufacturing expenses, stock-based compensation expense, depreciation of equipment, contract services and other outside expenses. Costs of certain development activities, such as manufacturing, are recognized based on an evaluation of the progress to completion of specific tasks. Payments for these activities are based on the terms of the individual arrangements, which may differ from the pattern of costs incurred, and are reflected in the financial statements as prepaid or accrued research and development costs. Nonrefundable advance payments for goods or services to be received in the future for use in research and development activities are deferred and capitalized. The capitalized amounts are expensed as the related goods are delivered or the services are performed. Costs associated with collaboration agreements are included in research and development expense.

Revenue recognition

The Company recognizes revenue from collaboration arrangements in accordance with FASB ASC Topic 605, Revenue Recognition (ASC 605). Accordingly, revenue is recognized when all of the following criteria are met:

Amounts received prior to satisfying the revenue recognition criteria are recorded as deferred revenue in the consolidated balance sheets. Amounts expected to be recognized as revenue within the 12 months following the balance sheet date are classified as current liabilities. Amounts not expected to be recognized as revenue within the 12 months following the balance sheet date are classified as deferred revenue, net of current portion.

Multiple element arrangements

The Company analyzes its strategic partnerships that include multiple element arrangements based on the guidance in FASB ASC Topic 605-25, Revenue Recognition—Multiple Element Arrangements, or ASC 605-25.

Pursuant to the guidance in ASC 605-25, the Company evaluates multiple element arrangements to determine i) the deliverables included in the arrangement and ii) whether the individual deliverables represent separate units of accounting or whether they must be accounted for as a combined unit of accounting. This evaluation requires subjective determinations and requires management to make judgments about the individual deliverables and whether such deliverables are separable from the other aspects of the contractual relationship. Deliverables are considered separate units of accounting provided that: (i) the delivered item(s) has value to the customer on a standalone basis and (ii) if the arrangement includes a general right of return relative to the delivered item(s), delivery or performance of the undelivered item(s) is considered probable and substantially in the Company's control. In assessing whether an item has standalone value, the Company considers factors such as the research, manufacturing and commercialization capabilities of the collaboration partner and the availability of the associated expertise in the general marketplace. In addition, the Company considers whether the collaboration partner can use the deliverable(s) for their intended purpose without the receipt of the remaining element(s), whether the value of the deliverable is dependent on the undelivered item(s) and whether there are other vendors that can provide the undelivered element(s).

Options are considered substantive if, at the inception of the arrangement, the Company is at risk as to whether the collaboration partner will choose to exercise the option. Factors that the Company considers in evaluating whether an option is substantive include the cost to exercise the option, the overall objective of the arrangement, the benefit the collaborator might obtain from the arrangement without exercising the option and the likelihood the option will be exercised. When an option is considered substantive, the Company does not consider the option or item underlying the option to be a deliverable at the inception of the arrangement and the associated option fees are not included in the allocable consideration, assuming the option is not priced at a significant and incremental discount. Conversely, when an

option is not considered substantive, the Company would consider the option including other deliverables contingent upon the exercise of the option, to be a deliverable at the inception of the arrangement and a corresponding amount would be included in the allocable arrangement consideration. Notwithstanding whether the option is considered substantive or non-substantive, if the price of the option includes a significant incremental discount, the discount would be included as a deliverable at the inception of the arrangement.

Allocation of arrangement consideration

Arrangement consideration that is fixed or determinable is allocated among the separate units of accounting using the relative selling price method. Then, the applicable revenue recognition criteria in ASC 605-25 are applied to each of the separate units of accounting in determining the appropriate period and pattern of recognition. The Company determines the selling price of a unit of accounting following the hierarchy of evidence prescribed by ASC 605-25. Accordingly, the Company determines the estimated selling price for units of accounting within each arrangement using vendor-specific objective evidence (VSOE) of selling price, if available, third-party evidence (TPE) of selling price if VSOE is not available, or best estimate of selling price (BESP) if neither VSOE nor TPE is available. The Company typically uses BESP to estimate the selling price, since it generally does not have VSOE or TPE of selling price for its units of accounting. Determining the BESP for a unit of accounting requires significant judgment. In developing the BESP for a unit of accounting, the Company considers applicable market conditions and relevant entity-specific factors, including factors that were contemplated in negotiating the agreement with the customer and estimated costs. The Company validates the BESP for units of accounting by evaluating whether changes in the key assumptions used to determine the BESP will have a significant effect on the allocation of arrangement consideration between multiple units of accounting.

Pattern of recognition

The Company recognizes arrangement consideration allocated to each unit of accounting when all of the revenue recognition criteria in ASC 605 are satisfied for that particular unit of accounting. Deliverables under collaboration agreements generally consist of licenses and research and development services. License revenue is recognized when the license is delivered when it is determined to have standalone value from the undelivered elements of the arrangement. If the license does not have standalone value, the amounts allocated to the license will be combined with the related undelivered items as a single unit of accounting. The revenue recognition of a combined unit of accounting typically follows the pattern of revenue of the last delivered item in the combined accounting unit.

The Company recognizes the amounts associated with research and development services and other service related deliverables over the associated period of performance. If there is no discernable pattern of performance or objectively measurable performance measures do not exist, then the Company recognizes revenue under the arrangement on a straight-line basis over the period the Company is expected to complete its performance obligations. Conversely, if the pattern of performance in which the service is provided to the customer can be determined and objectively measurable performance exists, then the Company recognizes revenue under the arrangement using the proportional performance method.

The Company recognizes revenue associated with license options upon exercise of the option, if the underlying license has standalone value from the other deliverables to be provided subsequent to delivery of the license. If the license does not have standalone value, the amounts allocated to the license option will be combined with the related undelivered items as a single unit of accounting.

Revenue recognized is limited to the lesser of the cumulative amount of payments received or the cumulative revenue earned determined using the straight-line method or proportional performance, as applicable, as of the period end date.

Recognition of milestones and royalties

At the inception of each arrangement that includes milestone payments, the Company evaluates whether each milestone is substantive and at-risk. This evaluation includes an assessment of whether (a) the consideration is commensurate with either (1) the entity's performance to achieve the milestone, or (2) the enhancement of the value of the delivered item(s) as a result of a specific outcome resulting at least in part from the entity's performance to achieve the milestone, (b) the consideration relates solely to past performance, and (c) the consideration is reasonable relative to all of the deliverables and payment terms within the arrangement. The Company evaluates factors such as the scientific, regulatory, commercial, and other risks that must be overcome to achieve the respective milestone, the level of effort and investment

required to achieve the respective milestone, and whether the milestone consideration is reasonable relative to all deliverables and payment terms in the arrangement in making this assessment. On the milestone achievement date, assuming all other revenue recognition criteria are met and the milestone is deemed substantive and at-risk, the Company recognizes the payment as collaboration revenue. For milestones that are not deemed substantive and at-risk, where payment is reasonably assured, the Company recognizes the milestone payment over the remaining service period.

The Company will recognize royalty revenue, if any, in the period of sale of the related product(s), based on the underlying contract terms, provided that the reported sales are reliably measurable and the Company has no remaining performance obligations, assuming all other revenue recognition criteria are met.

Collaborative arrangements

The Company records the elements of its collaboration agreements that represent joint operating activities in accordance with ASC Topic 808, Collaborative Arrangements (ASC 808). Accordingly, the elements of the collaboration agreements that represent activities in which both parties are active participants and to which both parties are exposed to the significant risks and rewards that are dependent on the commercial success of the activities, are recorded as collaborative arrangements. The Company considers the guidance in ASC Topic 605-45, Revenue Recognition—Principal Agent Considerations (ASC 605-45) in determining the appropriate treatment for the transactions between the Company and its collaborative partner and the transactions between the Company and third parties. Generally, the classification of transactions under the collaborative arrangements is determined based on the nature and contractual terms of the arrangement along with the nature of the operations of the participants. To the extent revenue is generated from a collaboration, the Company will recognize its share of the net sales on a gross basis if it is deemed to be the principal in the transactions with customers, or on a net basis if it is instead deemed to be the agent in the transactions with customers, consistent with the guidance in ASC 605-45.

Fair value measurements

Fair value is defined as the price that would be received upon sale of an asset or paid to transfer a liability between market participants at measurement dates. ASC Topic 820 Fair Value Measurement (ASC 820), establishes a three-level valuation hierarchy for instruments measured at fair value. The hierarchy is based on the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels are defined as follows:

Level 1—Inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.

Level 2—Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

Level 3—Inputs to the valuation methodology are unobservable and significant to the fair value measurement.

Cash and cash equivalents

The Company considers all highly liquid investments with an original maturity, or a remaining maturity at the time of purchase, of three months or less to be cash equivalents. The Company invests excess cash primarily in money market funds, commercial paper and government agency securities, which are highly liquid and have strong credit ratings. These investments are subject to minimal credit and market risks. Cash and cash equivalents are stated at cost, which approximates market value.

Marketable securities

Short-term marketable securities consist of investments with maturities greater than three months and less than one year from the balance sheet date. Long-term marketable securities consist of investments with maturities greater than one year that are not expected to be used to fund current operations. The Company classifies all of its marketable securities as available-for-sale. Accordingly, these investments are recorded at fair value. Amortization and accretion of discounts and premiums are recorded as interest income within other income. Unrealized gains and losses on available-for-sale securities are included in other comprehensive loss as a component of stockholders’ equity (deficit) until realized.

Restricted cash

Restricted cash of $371 is recorded in other non-current assets as of September 30, 2017 and December 31, 2016 and includes amounts held as security deposits for a standby letter of credit related to a facility lease and a corporate credit card program.

Accounting for stock-based compensation

The Company accounts for its stock-based compensation in accordance with ASC Topic 718 Compensation—Stock Compensation (ASC 718). ASC 718 requires all stock-based payments to employees and directors to be recognized as expense in the statements of operations based on their grant date fair values. Expense related to stock awards to non-employees is required to be recognized in the statement of operations based on the awards' vesting date fair values. The Company estimates the fair value of options granted using the Black-Scholes option pricing model.

The Black-Scholes option pricing model requires inputs based on certain subjective assumptions, including (a) the expected stock price volatility, (b) the calculation of expected term of the award, (c) the risk-free interest rate and (d) expected dividends. Due to the lack of a public market for the Company's common stock prior to completion of the IPO and a lack of company-specific historical and implied volatility data, the Company has based its estimate of expected volatility on the historical volatility of a group of similar companies that are publicly traded. The historical volatility is calculated based on a period of time commensurate with the expected term assumption. The computation of expected volatility is based on the historical volatility of a representative group of companies with similar characteristics to the Company, including stage of product development and life science industry focus. The Company uses the simplified method as prescribed by the SEC Staff Accounting Bulletin No. 107, Share-Based Payment, to calculate the expected term for options granted to employees as it does not have sufficient historical exercise data to provide a reasonable basis upon which to estimate the expected term. For options granted to non-employees, the Company utilizes the contractual term of the arrangement as the basis for the expected term assumption. The risk-free interest rate is based on a treasury instrument whose term is consistent with the expected term of the stock options. The expected dividend yield is assumed to be zero as the Company has never paid dividends and has no current plans to do so.

There were significant judgments and estimates inherent in the determination of the fair value of our common stock prior to the closing of the IPO. These estimates and assumptions include a number of objective and subjective factors, including external market conditions, the prices at which the Company sold shares of preferred stock, the superior rights and preferences of securities senior to its common stock at the time of, and the likelihood of, achieving a liquidity event, such as an IPO or sale.

Through December 31, 2016, the Company was required to estimate forfeitures at the time of grant, and revise those estimates in subsequent periods if actual forfeitures differ from its estimates. The Company used historical data to estimate post-vesting forfeitures and recorded stock-based compensation expense only for those awards that were expected to vest. To the extent that actual forfeitures differ from estimates, the difference was recorded as a cumulative adjustment in the period the estimates were revised. Stock-based compensation expense recognized in the financial statements is based on awards that were ultimately expected to vest. The fair value of stock-based payments was recognized as expense, net of estimated forfeitures, over the requisite service period which is generally the vesting period.

In the first quarter of 2017, the Company made an accounting policy election to recognize forfeitures as they occur upon adoption of guidance per ASU No. 2016-09. The adoption of this ASU did not have a material impact on the Company's financial statements. In reporting periods prior to 2017, the Company estimated forfeitures at the time of grant and revised in subsequent periods as necessary if actual forfeitures differed from estimates.

Net loss per share

Basic net loss per common share is calculated by dividing the net loss attributable to common stockholders by the weighted-average number of common shares outstanding during the period, without consideration for potentially dilutive securities. Diluted net loss per share is computed by dividing the net loss attributable to common stockholders by the weighted-average number of common shares and potentially dilutive securities outstanding for the period determined using the treasury stock and if-converted methods.

For purposes of the diluted net loss per share calculation, convertible preferred stock, warrants to purchase common stock and options to purchase common stock are considered to be potentially dilutive securities, but are excluded from the calculation of diluted net loss per share because their effect would be anti-dilutive and therefore, basic and diluted net loss per share were the same for all periods presented.

The following table sets forth the outstanding potentially dilutive securities that have been excluded from the calculation of diluted net loss per share because to include them would be anti-dilutive (in common stock equivalent shares):

 

Recently issued accounting pronouncements

In May 2014, the Financial Accounting Standards Board (FASB) issued a new standard, ASU No. 2014-09, Revenue from Contracts with Customers (ASU No. 2014-09), as amended, which will supersede nearly all existing revenue recognition guidance. Under ASU No. 2014-09, an entity is required to recognize revenue upon transfer of promised goods or services to customers in an amount that reflects the expected consideration received in exchange for those goods or services. ASU No. 2014-09 defines a five-step process in order to achieve this core principle, which may require the use of judgment and estimates, and also requires expanded qualitative and quantitative disclosures relating to the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers, including significant judgments and estimates used.

The FASB has issued several amendments to the new standard, including clarification on accounting for licenses of intellectual property and identifying performance obligations. The amendments include ASU No. 2016-08, Revenue from Contracts with Customers (Topic 606)—Principal versus Agent Considerations, which was issued in March 2016, and clarifies the implementation guidance for principal versus agent considerations in ASU No. 2014-09, and ASU No. 2016-10, Revenue from Contracts with Customers (Topic 606)—Identifying Performance Obligations and Licensing, which was issued in April 2016, and amends the guidance in ASU No. 2014-09 related to identifying performance obligations and accounting for licenses of intellectual property.

The new standard permits adoption either by using (i) a full retrospective approach for all periods presented in the period of adoption or (ii) a modified retrospective approach with the cumulative effect of initially applying the new standard recognized at the date of initial application and providing certain additional disclosures. The new standard is effective for annual reporting periods beginning after December 15, 2017. The Company plans to adopt the new standard effective January 1, 2018 using the modified retrospective approach.

The Company is in process of implementing its overall adoption plan and evaluating the impact of the new standard on its accounting policies. The Company has assigned internal resources and engaged third-party service providers to assist in the implementation. While the Company continues to assess the standard, it is expected that it may have a material impact on the revenue recognition for the Company's current arrangements with Takeda Pharmaceutical Company Limited (Takeda) and Merck KGaA.

In February 2016, the FASB issued ASU No. 2016-02, Leases (ASU No. 2016-02), which will replace the existing guidance in ASC 840, Leases. The updated standard aims to increase transparency and comparability among organizations by requiring lessees to recognize lease assets and lease liabilities on the balance sheet and requiring disclosure of key information about leasing arrangements. This amendment is effective for the Company in the fiscal year beginning after December 15, 2019, but early adoption is permissible. The Company is currently evaluating the potential impact that ASU No. 2016-02 may have on its financial position and results of operations.

In March 2016, the FASB issued ASU No. 2016-09, Compensation—Stock Compensation (ASU No. 2016-09), which amends ASC Topic 718, Compensation—Stock Compensation. The new standard identifies areas for simplification

involving several aspects of accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, an option to recognize gross stock compensation expense with actual forfeitures recognized as they occur, as well as certain classifications on the consolidated statements of cash flows. The amendments are effective for annual reporting periods (including interim reporting periods within those years) beginning after December 15, 2016. The Company adopted this ASU effective January 1, 2017. The adoption of this ASU did not have a material impact on the Company's financial statements. Upon adoption of ASU No. 2016-09, the Company accounts for forfeitures as they occur.

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments. The new standard clarifies certain aspects of the statement of cash flows, including the classification of contingent consideration payments made after a business combination and several other clarifications not currently applicable to the Company. The new standard also clarifies that an entity should determine each separately identifiable source or use within the cash receipts and cash payments on the basis of the nature of the underlying cash flows. In situations in which cash receipts and payments have aspects of more than one class of cash flows and cannot be separated by source or use, the appropriate classification should depend on the activity that is likely to be the predominant source or use of cash flows for the item. The new standard will be effective for the Company on January 1, 2018. The adoption of this standard is not expected to have a material impact on the Company’s consolidated statement of cash flows upon adoption.

In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows: Restricted Cash (ASU 2016-18). The amendments in this update require that amounts generally described as restricted cash and restricted cash equivalents be included within cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. ASU 2016-18 will be effective January 1, 2018, with early adoption permitted. The Company expects the adoption to impact its consolidated statement of cash flows as, upon adoption, it will include the Company’s restricted cash balance in the cash and cash equivalents reconciliation of operating, investing and financing activities.

 

 

3.     Collaboration agreements

Takeda strategic research and development partnership

In March 2014, the Company entered into a Research Collaboration and Commercial License Agreement with Takeda through its wholly owned subsidiary, Millennium Pharmaceuticals, Inc. (the 2014 Agreement). The 2014 Agreement was amended in January 2015 (the 2015 Amended Agreement) and amended and restated in January 2016 (the 2016 Restated Agreement). The agreements provide Takeda with the right to develop ADCs directed to a total of seven exclusive targets over a specified period of time. Takeda will be responsible for the product development and marketing of any products resulting from this collaboration.

The 2014 Agreement was structured to allow Takeda the right to evaluate two targets upon payment of a per target technology access fee with the right to receive a development and commercialization license upon the exercise of an option with an additional payment to the Company. The 2014 Agreement also provided a limited replacement right for a target. The 2015 Amended Agreement granted Takeda the right to develop two additional targets and also gave Takeda an additional limited replacement right. The 2016 Restated Agreement provided Takeda with the right to develop three additional targets.

Under the terms of the 2014 Agreement, the Company was eligible to receive a nonrefundable technology access fee of $500 per target, payable upon designation of the target, and an option exercise fee of $1,300 per target to receive a development and commercialization license. The Company received an upfront payment of $1,150 representing the $500 technology access fee for the first designated target and a $650 nonrefundable payment creditable against the $1,300 option exercise payment for the development and commercialization license for the first designated target. In 2014, the Company also received the remaining $650 option exercise fee for the first designated target and the $500 technology access fee for the second designated target.

In connection with the 2015 Amended Agreement, the Company received a nonrefundable payment of $9,000 for the right to develop two additional targets. Takeda is required to pay $500 in order to utilize the second limited replacement

right. Under the terms of the 2016 Restated Agreement, the Company received a nonrefundable payment of $13,500 for the right to develop three additional targets, bringing the total to seven.

For all targets under the 2015 Amended Agreement and the 2016 Restated Agreement, the Company grants a research, development and commercialization license upon the designation of a target, including targets initially covered by the 2015 Amended Agreement.

Through September 30, 2017 Takeda has designated four targets and received development and commercialization licenses for the first, third and fourth designated targets. In order to receive a development and commercialization license for the second designated target, Takeda must exercise its option and make a payment of $1,300. Takeda still has three targets and the limited replacement rights for two targets available.

Under the terms of the agreements, the Company and Takeda develop research plans to evaluate Takeda's antibodies as ADCs incorporating the Company's technology. The Company receives reimbursement for its efforts under the research plans. The goal of the research plans is to provide Takeda with sufficient information to formally nominate a development candidate and begin Investigational New Drug Application, or IND, enabling studies or cease development on the designated target.

If products are successfully developed and commercialized, the Company is entitled to receive aggregate milestones of up to $1,063,300 for all seven designated targets consisting of $107,800 in development milestones, $325,000 in regulatory milestones, and $630,500 in commercial milestones. The total milestones payable on each of the first and second designated targets are $136,000 and the total milestones payable on each of the third, fourth, fifth, sixth and seventh designated target are $158,300. There are four individual development milestones per target, which are payable upon either the initiation of a GLP toxicology study or the filing of an IND application (depending upon the designated target), and the initiation of Phase 1 through Phase 3 clinical trials. There are six or eight individual regulatory milestones per target, depending on the target. These are payable upon regulatory submissions, regulatory approvals and pricing approvals, as applicable, for the U.S., European Union and Japanese markets and regulatory approvals for both a second and third indication. There are six individual commercial milestones, which are payable upon the first commercial sale in each of the U.S., European Union and Japanese markets and upon the attainment of three separate defined thresholds for annual net sales. The next potential milestone payment the Company will be eligible to receive is either a development milestone of $500 related to a GLP toxicology study or a development milestone of $750 related to the filing of an IND, depending upon the designated target. The Company is also entitled to receive royalties on product sales, if any, during the applicable royalty term. Royalties payable on the first and second designated targets are in the mid single digits and royalties payable on the third, fourth, fifth, sixth and seventh designated target are in the mid to high single digits.

In connection with the 2016 Restated Agreement, the Company may elect to exercise an option to co-develop and co-commercialize one product incorporating either Takeda's third, fourth, fifth, sixth or seventh target in the United States for a payment of $15,000. If the Company elects to exercise the option to co-develop and co-commercialize a product, the Company will share in 50% of the profits related to United States. The Company will be responsible for 50% of costs incurred specifically for the United States and 30% of global development costs. Any costs incurred specifically for a foreign country will be borne 100% by Takeda. If the Company elects to co-develop and co-commercialize a product, certain regulatory milestones and royalties related to the United States for that target would not be paid by Takeda.

Unless earlier terminated, the 2016 Restated Agreement will expire upon the expiration of the last royalty term for a product under the agreement, after which time, Takeda will have a perpetual, royalty-free license. Except with respect to the target antigen of a product for which the Company exercised its option to co-develop and co-commercialize in the United States, Takeda may terminate the 2016 Restated Agreement in its entirety or with respect to any target for convenience upon 45 days' prior written notice. Each party may terminate the 2016 Restated Agreement in its entirety upon bankruptcy or similar proceedings of the other party or upon an uncured material breach of the agreement by the other party. However, if such breach only relates to one target, the agreement may only be terminated with respect to such target.

Takeda XMT-1522 strategic partnership

In January 2016, the Company entered into a Development Collaboration and Commercial license Agreement with Takeda through its wholly owned subsidiary, Millennium Pharmaceuticals, Inc. for the development and

commercialization of XMT-1522 (the XMT-1522 Agreement). Under the XMT-1522 Agreement, Takeda was granted the exclusive right to commercialize XMT-1522 outside of the United States and Canada. Under the XMT-1522 Agreement, the Company is responsible for conducting certain Phase 1 development activities for XMT-1522, including the ongoing Phase 1 clinical study, at its own expense. Takeda has the option to conduct Phase 1 development activities at its own expense within its territory. The parties will collaborate on the further development of XMT-1522 in accordance with a global development plan (Post-Phase 1 Development). The parties will share equally all clinical stage manufacturing costs and any Post-Phase 1 Development costs incurred in the performance of activities for the purpose of obtaining regulatory approval in either the United States or Canada and in certain major markets in the rest of the world. Each party will be responsible for all Post-Phase 1 Development costs incurred in the performance of activities solely for the purpose of obtaining regulatory approval in such party's territory. Each party may conduct independent development of XMT-1522, subject to certain restrictions.

The Company received an upfront payment of $26,500 upon execution of the XMT-1522 Agreement. In addition, the Company was entitled to a milestone payment of $20,000 upon achievement of the IND Clearance Date. The Company achieved the IND Clearance Date in October 2016. Accordingly, the right to credit a portion of the upfront payment lapsed and the Company received the $20,000 milestone payment in October 2016.

In addition to the milestone payment upon achievement of the IND Clearance Date, the Company is entitled to receive future development, regulatory and commercial milestones of up to $288,000 consisting of $87,000 of development milestones, $128,000 of regulatory milestones and $73,000 of commercial milestones, as well as royalties in the low to mid teens on net sales of XMT-1522 in Takeda's territory during the applicable royalty term. There are development milestones payable upon the achievement of nine separate events: the initiation of Phase 2 clinical trials and Phase 3 clinical trials for four separate specified patient populations and the initiation of a Phase 3 clinical trial for one additional unspecified patient population. There are 14 regulatory milestones, which are payable upon regulatory submissions, regulatory approvals and pricing approvals, as applicable, for the U.S., European Union and Japanese markets for up to four separate patient populations and multiple label indications. In addition, a regulatory milestone is payable upon the receipt of regulatory and pricing approval in two specified markets other than the United States, the European Union or Japan. There are three individual commercial milestones, which are payable upon the attainment of certain thresholds for annual net sales. The next potential milestone the Company will be eligible to receive is a development milestone of $12,000 related to the initiation of a Phase 2 clinical trial.

Under the XMT-1522 Agreement, Takeda committed to make equity investments in the Company of up to $20,000 in the aggregate in either a qualified private financing or in connection with the Company's IPO at the same price paid by the investors in the qualified private financing or the price per share in the IPO. Takeda invested approximately $10,000 in the Company's Series C-1 financing in June 2016 and invested the remaining $10,000 in the Company's IPO.

The XMT-1522 Agreement expires upon the expiration of the royalty term for XMT-1522, after which time, Takeda will have a perpetual, royalty-free license. However, Takeda may terminate the XMT-1522 Agreement in its entirety for convenience upon 30 days' prior written notice at any time up to the initiation of the first Phase 2 clinical study of XMT-1522 or upon 90 days' prior written notice following the initiation of the first Phase 2 clinical study of XMT-1522. Each party may terminate the XMT-1522 Agreement in its entirety upon bankruptcy or similar proceedings of the other party and in its entirety or on a country-by-country basis upon an uncured material breach of the agreement by the other party. Following termination, XMT-1522 will revert to the Company for further development and commercialization.

Accounting analysis

In accordance with ASC 605-25, the Company identified the deliverables under the 2014 Agreement. The deliverables were determined to be (i) research license for the first designated target, (ii) exclusive development and commercialization license for the first designated target, (iii) research and development services under the research plan associated with the first designated target, (iv) replacement right for a designated target, (v) rights to future technological improvements, and (vi) providing joint research committee services. The Company determined that the option to obtain an exclusive development and commercialization license for the first designated target was not a substantive option for accounting purposes, primarily because Takeda had made an upfront nonrefundable payment of 50% of the option exercise fee. As a result, the exclusive development and commercialization license was considered a deliverable at the inception of the arrangement. In addition, the total option exercise fee of $1,300 related to the first designated target was included in the allocable consideration. Similarly, the Company concluded the option to replace a designated target was not a substantive option as there were no additional payments required in connection with the first replacement option.

Conversely, the Company concluded that Takeda's ability to designate a second designated target was a substantive option as the designation of an additional target was at Takeda's option and was not required to pursue the development of the first designated target. The Company has determined that the research license for the first designated target and the research and development services under the research plan associated with the first designated target should be combined into one unit of accounting (the research license and related service) as the research license does not have standalone value from the research services as the research services are required for Takeda to obtain the benefit of the research license. The Company has concluded the research license and related services have standalone value from the other units of accounting. The exclusive commercial license, replacement right for a designated target, rights to future technological improvements and joint research committee services are not required for Takeda to realize the value of the initial research license and related services.

Under the terms of the 2014 Agreement, the total arrangement consideration of $4,500 (which comprises the $500 upfront technology access payment, expected fees of $2,700 for the research services and $1,300 for the option exercise fee for the first designated target) was allocated to the units of accounting based on management's BESP. The Company determined the BESP for the research license and related research services based on the estimated selling price of a research license and an estimate of the overall effort to perform the research services and an estimated market rate for research services. In developing the BESP for the exclusive development and commercialization license, the replacement rights for a designated target and the future technological improvements, the Company considered other comparable transactions, the selling price for a research license and the probability that the future technology will be developed and utilized. The BESP for the joint research committee services was developed using an estimate of the time and costs incurred to participate in the committees. The Company applied the relative selling price allocation using these BESP, which resulted in the consideration being allocated as follows: $2,790 to the research license and related service for the first designated target, $1,125 related to the commercial license on the first designated target, $450 to the replacement right for a designated target, $45 to rights to future technological improvements and $90 to joint research committee services. In addition, Takeda paid $500 in 2014 for the technology access fee and research license associated with the second designated target.

In connection with the 2015 Amended Agreement, the Company reassessed the units of accounting from the 2014 Agreement and identified incremental deliverables, resulting in the following units of accounting at the time of the 2015 Amended Agreement (i) exclusive license to the first designated target and related research services, (ii) research license to the second designated target and related research services, (iii) research license to the third designated target and related services, (iv) research license to the fourth designated target and related services, (v) replacement right to the first or second designated target, (vi) discount on the option for an exclusive development and commercialization license for the second designated target, (vii) option for exclusive development and commercialization license for the third designated target, (viii) option for an exclusive development and commercialization license for the fourth designated target, (ix) rights to future technological improvements and (x) joint research committee services. The Company concluded that the option for the exclusive development and commercialization license for the second designated target includes a significant incremental discount as the option exercise fee was at a discount to the then-current estimated selling price of an exclusive development and commercialization license for a designated target. The Company concluded the options to obtain exclusive development and commercialization licenses for the third and fourth designated targets were not substantive options as there were no additional payments required to exercise those options. Consistent with the assessment of the units of accounting under the 2014 Agreement, the research licenses (and the exclusive commercial license as it relates to the first designated target) have been combined with the related research services under the related research plan as the license does not have standalone value from the related research services. Upon execution of the 2015 Amended Agreement the total arrangement consideration of $16,697 (which comprises the $9,000 upfront payment, expected fees of $5,776 for the research services and $1,921 of remaining deferred revenue related to the initial 2014 Agreement) was allocated to the units of accounting based on management's BESP, which were developed using consistent methodologies to the 2014 Agreement, as follows: $4,308 to the exclusive development and commercialization license to the first designated target and related research services, $1,611 to each of the research licenses and related research services for the second, third and fourth designated targets, $388 to the replacement right on the first or second designated target, $524 to the discount on the exclusive license to the second designated target, $3,105 to each of the exclusive development and commercialization licenses on the third and fourth designated targets, $262 to rights to future technological improvements and $174 to joint research committee services.

The Company has concluded that the 2016 Restated Agreement and the XMT-1522 Agreement should be accounted for as one arrangement due in part because the agreements are with the same party and were negotiated and executed contemporaneously. The Company reassessed the accounting units from the 2015 Amended Agreement and identified

the additional deliverables and units of accounting. As such, the Company identified the units of accounting: (i) exclusive development and commercialization license to the first designated target and related research services, (ii) research license to the second designated target and related research services, (iii) discount on the exclusive development and commercialization license to the second designated target, (iv) exclusive development and commercialization license to the third designated target and related research services, (v) exclusive development and commercialization license to the fourth designated target and related research services, (vi) exclusive development and commercialization license to the fifth designated target and related research services, (vii) exclusive development and commercialization license to the sixth designated target and related research services, (viii) exclusive development and commercialization license to the seventh designated target and related research services, (ix) first replacement right for a designated target, (x) discount on the second replacement right to a designated target, (xi) rights to future technological improvements, (xii) joint research committee services, (xiii) XMT-1522 license and related services, and (xiv) joint research committee services for XMT-1522.

Consistent with the assessment under the prior Takeda agreements, the Company has concluded that the license does not have standalone value from the research services and has accounted for each exclusive license and the related research services as a combined unit of accounting.

 In addition, in assessing the additional accounting units under the XMT-1522 Agreement, the Company concluded that the license to the Company's intellectual property and the related obligations to perform services, including Phase 1 development and transfer certain materials and know how related to the Company's manufacturing processes should be a combined unit of accounting. The license to the Company's intellectual property does not have standalone value from the services that the Company is obligated to perform. Takeda would not have the ability to realize the value of the license without the Company performing the related services.

The Company has concluded that the Post-Phase 1 Development activities under the XMT-1522 Agreement represent joint operating activities in which both parties are active participants and of which both parties are exposed to significant risks and rewards that are dependent on the commercial success of the activities. Accordingly, the Company is accounting for the Post-Phase 1 Development activities in accordance with ASC No. 808, Collaborative Arrangements (ASC 808) and they are not considered revenue elements under ASC 605-25. For the three months ended September 30, 2017 and 2016 and the nine months ended September 30, 2017 and 2016, the Company was billed approximately $924, $196, $1,719 and $353, respectively, from Takeda representing the Company's share of Post-Phase 1 Development costs incurred by Takeda. These amounts have been reflected as research and development costs in the consolidated statement of operations for the three months ended September 30, 2017 and 2016 and the nine months ended September 30, 2017 and 2016. The Company did not perform any Post-Phase 1 Development activities or incur any associated costs during the three months ended September 30, 2017 and 2016 or the nine months ended September 30, 2017 and 2016.

The total allocable arrangement consideration for the 2016 Restated Agreement and the XMT-1522 Agreement was $50,089 comprised of the following: (i) nonrefundable upfront payment—$13,500, (ii) expected fees for the remaining research services—$9,515, (iii) remaining deferred revenue from the 2015 Amended Agreement—$7,498, (iv) non-creditable portion of the XMT-1522 upfront fee—$13,250, and (v) expected reimbursement for related services—$6,326. In the third quarter 2017, based on an assessment of the total costs to complete research services, the Company revised its estimate for (i) the expected fees for the remaining research services under the 2016 Restated Agreement to $4,160 and (ii) the expected reimbursement for the related services under the XMT-1522 Agreement to $7,740.  The revised total allocable arrangement consideration for the 2016 Restated Agreement and the XMT-1522 Agreement is $46,148.

Additionally, the Company has received approximately $800 in additional license consideration and research plan extension fees through September 30, 2017 which has been included in total allocable arrangement consideration.

The Company excluded from the initial allocable consideration $13,250 of the upfront fee under the XMT-1522 Agreement as it was contingent on the Company achieving IND Clearance before January 30, 2017. Upon achievement of the IND Clearance, which occurred in October 2016, the contingent consideration was included in the allocable consideration and the Company recognized the cumulative revenue that would have been recognized if the contingent consideration was included in allocable consideration at the inception of the agreements.

The allocable arrangement consideration was allocated to the units of accounting based on the relative estimated selling prices of each unit of accounting. The Company utilized BESP for each accounting unit which was developed on a basis similar to the prior Takeda agreements. The BESP for units of accounting which include a license and research services, was developed using the estimated selling price of the license and an estimate of the overall effort to perform the research service and an estimated market rate for research services. The BESP for the discounts on exclusive license, replacement rights (or discounts thereon) and rights to future technological improvements were developed based on the estimated selling prices of a license, as well as considering the probability that additional technology would be made available or the probability the counterpart would utilize the technology or exercise the option. The BESP for the joint research committee services was developed using an estimate of the time and costs incurred to participate in the committees.

The total allocable consideration, as revised in the third quarter 2017 and including contingent fees received after achieving IND Clearance in October 2016,  was allocated to each unit of accounting as follows (i) exclusive development and commercialization license to the first designated target and related research services—$4,502, (ii) research license to the second designated target and related research services—$1,362, (iii) discount on the exclusive development and commercialization license to the second designated target—$553, (iv) exclusive development and commercialization license to the third designated target and related research services—$4,546, (v) exclusive development and commercialization license to the fourth designated target and related research services—$4,975, (vi) exclusive development and commercialization license to the fifth designated target and related research services—$4,975, (vii) exclusive development and commercialization license to the sixth designated target and related research services—$4,975, (viii) exclusive development and commercialization license to the seventh designated target and related research services—$4,975, (ix) first replacement right for a designated target—$3,685, (x) discount on the second replacement right to a designated target—$3,276, (xi) rights to future technological improvements—$1,843, (xii) joint research committee services—$157, (xiii) XMT-1522 license and related services—$39,901, and (xiv) XMT-1522 joint research committee services—$472.

The Company will recognize revenue related to the combined units of accounting which include research licenses or an exclusive development and commercialization license (if the license option is exercised during the research term) and the related research services, over the estimated period of the research and development services using a proportional performance model. Revenue related to discounts on options will be recognized when the option is exercised, unless there are additional research services that the Company is required to perform related to the designated target or at the time the option right lapses. Revenue related to the replacement rights will be recognized over the research term of the replacement target once the replacement right is exercised or at the time the right lapses unused. Revenue related to future technological improvements and joint research committee services will be recognized ratably over the performance period, which is expected to be ten years and six years, respectively. The Company will reassess the estimated remaining term at each subsequent reporting period.

The Company has evaluated all of the development, regulatory and commercial milestones that may be received in connection with the Takeda agreements. In evaluating if a milestone is substantive, the Company assesses whether: (i) the consideration is commensurate with either the Company's performance to achieve the milestone or the enhancement of the value of the delivered item(s) as a result of a specific outcome resulting from the Company's performance to achieve the milestone, (ii) the consideration relates solely to past performance, and (iii) the consideration is reasonable relative to all of the deliverables and payment terms within the arrangement. With the exception of the $20,000 milestone payment due upon achievement of IND Clearance under the XMT-1522 Agreement, all development and regulatory milestones are considered substantive on the basis of the contingent nature of the milestone, specifically reviewing factors such as the scientific, clinical, regulatory, commercial and other risks that must be overcome to achieve the milestone as well as the level of effort and investment required. Accordingly, such amounts will be recognized as revenue in full in the period in which the associated milestone is achieved, assuming all other revenue recognition criteria have been met. The $20,000 milestone payment was not considered a substantive milestone as the payment was not considered commensurate with the Company's performance to achieve IND Clearance nor was the payment solely for past performance. The $20,000 milestone payment was in substance part of the overall consideration for the license and development services the Company is required to perform under the XMT-1522 Agreement. Upon achievement of the IND Clearance, which occurred in October 2016, the contingent consideration was included in the allocable consideration and the Company recognized the cumulative revenue that would have been recognized if the contingent consideration as included in allocable consideration at the inception of the agreement. All commercial milestones will be accounted for in the same manner as royalties and recorded as revenue upon achievement of the milestone, assuming all other revenue recognition criteria are met.

The Company will recognize royalty revenue in the period of sale of the related product(s), based on the underlying contract terms, provided that the reported sales are reliably measurable and the Company has no remaining performance obligations, assuming all other revenue recognition criteria are met.

For the three months ended September 30, 2017 and 2016 and the nine months ended September 30, 2017 and 2016, the Company recorded total revenue of $5,768, $2,422, $12,052 and $10,456, respectively, related to its efforts under the 2016 Restated Agreement and the XMT-1522 Agreement. Included in accounts receivable as of September 30, 2017 and December 31, 2016 was $484 and $542, respectively, related to the Takeda agreements. During the quarter ended September 30, 2017, the Company revised its estimates of the total costs to complete the research services under the Takeda agreements, which changed the total consideration to be received under the agreements and the amount of revenue recognized in the three months and nine months ended September 30, 2017. Approximately $4,028 of the Company’s revenue from the Takeda agreements for the three months and nine months ended September 30, 2017 is a result of the Company’s change in estimates. The change in estimates decreased net loss by $4,028 for the three months ended September 30, 2017, or $0.18 per common share.

As of September 30, 2017 and December 31, 2016, the Company had $43,578 and $52,066, respectively, of deferred revenue related to the Takeda agreements that will be recognized over the remaining performance period, of which amounts approximately $11,263 and $16,536, respectively, are classified as short-term.

Merck KGaA

In June 2014, the Company entered into a Collaboration and Commercial License Agreement with Merck KGaA. Upon the execution of the agreement, Merck KGaA paid the Company a nonrefundable technology access fee of $12,000 for the right to develop ADCs directed to six exclusive targets over a specified period of time. No additional fees are due when a target is designated and the commercial license to the target is granted. Merck KGaA will be responsible for the product development and marketing of any products resulting from this collaboration.

Under the terms of the agreement, the Company and Merck KGaA develop research plans to evaluate Merck KGaA's antibodies as ADCs incorporating the Company's technology. The Company receives reimbursement for its efforts under the research plans. The goal of the research plans is to provide Merck KGaA with sufficient information to formally nominate a development candidate and begin IND-enabling studies or cease development on the designated target.

In addition to the payments received for research and development activities performed on behalf of Merck KGaA, the Company is also eligible to receive up to a total of $780,000 in future milestones related to all targets under the agreement, plus low to mid single digit royalties on the commercial sales of any resulting products during the applicable royalty term. The total milestones are categorized as follows: development milestones—$84,000; regulatory milestones—$264,000; and sales milestones—$432,000. There are six individual development milestones per target, payable upon the completion of various activities from the delivery of ADCs meeting defined specifications, through the dosing in a Phase 3 clinical trial. There are five regulatory milestones, which are payable upon regulatory approvals for a first indication in each of the U.S., European Union and Japanese markets and regulatory approvals for both a second and a third indication in the United States. There are three individual commercial milestones, which are payable upon the attainment of certain defined thresholds for annual net sales. Through December 31, 2016, the Company received and recognized as revenue $2,000 related to development milestones under the agreement. During the three months ended September 30, 2017, the Company received and recognized as revenue $500 related to a development milestone under the agreement. At the time of the execution of the agreement, there was significant uncertainty as to whether the milestones would be achieved. In consideration of this, as well as the Company's expected involvement in the research, these milestones were deemed to be substantive. The next potential milestone payment the Company will be eligible to receive will be a development milestone of $500 for the delivery of ADCs meeting product specification for the next designated targets or Merck KGaA's designation of a preclinical development candidate for any target. Revenue will be recognized upon achievement of the milestone. The Company and Merck KGaA may also enter into a future supply agreement to provide clinical study material should Merck KGaA pursue clinical development of any candidates nominated under the agreement. Through September 30, 2017, Merck KGaA has designated six targets, all of which are still covered by research plans.

Unless earlier terminated, the agreement will expire upon the expiration of the last royalty term for a product under the agreement, after which time, Merck KGaA will have a perpetual, royalty-free license, or if Merck KGaA does not designate any ADC product candidates produced by the Company under the agreement as preclinical development

candidates, upon the expiration of the last to expire research program. Merck KGaA may terminate the agreement in its entirety or with respect to any target for convenience upon 60 days' prior written notice. Each party may terminate the Merck KGaA Agreement in its entirety upon bankruptcy or similar proceedings of the other party or upon an uncured material breach of the agreement by the other party. However, if such breach only relates to one target, the agreement may only be terminated with respect to such target.

In accordance with ASC 605-25, the Company identified all of the deliverables at the inception of the agreement. The deliverables were determined to be (a) commercial licenses for six designated targets, (b) research and development services for each research plan associated with a designated target, (c) rights to future technological improvements and (d) participation of project team leaders and providing joint research committee services. The commercial licenses and associated research services for each target were combined into a single unit of accounting as the research licenses do not have stand alone value without the research services.

The Company determined the BESP for the commercial license and related research services based on the estimated selling price of a commercial license and an estimate of the overall effort to perform the research services and an estimated market rate for research services. In developing the BESP for the future technological improvements, the Company considered other comparable transactions, and the probability that the future technology will be developed and utilized. The BESP for the joint research committee services was developed using an estimate of the time and costs incurred to participate in the committees. The Company applied the relative selling price allocation using these BESPs.

The total arrangement consideration of $23,025 (which comprises the $12,000 upfront payment and expected fees of $11,025 for the research services) was allocated to the units of accounting based on management's best estimate of selling price as follows: $3,723 for each of the license and corresponding research and development services units of account; $437 for rights to future technological improvements; and $248 for joint research committee services. In the third quarter 2017, based on an assessment of the total costs to complete research services, the Company revised its estimate for the expected fees for the research services to $7,875 which changed the total arrangement consideration to $19,875. The Company allocated the revised arrangement consideration to the units of accounting based on management’s best estimate of selling price as follows: $6,428 for the first and second targets (combined); $3,214 for each of the other license and corresponding research and development services units of account; $376 for rights to future technological improvements; and $214 for joint research committee services.

The Company is recognizing revenue related to the commercial license and research and development services unit of accounting over the estimated period of the research and development services using a proportional performance model based on projected Company efforts. The estimated term is 36 months from the time the target is designated until Merck KGaA makes a decision whether to nominate a preclinical development candidate or cease development efforts with respect to the designated target. Revenue related to future technological improvements and joint research committee services will be recognized ratably over the performance period, which is expected to be ten years and six years, respectively. The Company is continuing to reassess the estimated remaining term at each subsequent reporting period.

During the three months ended September 30, 2017 and 2016 and the nine months ended September 30, 2017 and 2016, the Company recorded revenue of $499, $777, $2,107 and $2,656, respectively, related to its efforts under the collaboration agreement. Included in accounts receivable as of September 30, 2017 and December 31, 2016, respectively, was $51 and $509 related to the Merck KGaA Agreement.

As of September 30, 2017 and December 31, 2016 the Company had recorded $7,335 and $8,236 respectively, in deferred revenue related to the Merck KGaA agreement that will be recognized over the remaining performance period, of which amounts approximately $5,213 and $6,195, respectively, are classified as short-term.

Other Revenue

In 2016, the Company entered into an agreement to provide limited services for Asana BioSciences, an existing partner, for $250. For the three months ended September 30, 2017 and 2016 and the nine months ended September 30, 2017 and 2016, the Company recorded revenue of $0, $63, $125 and $63, respectively, related to these services.

4. Fair value measurements

The following table presents information about the Company's assets and liabilities regularly measured and carried at a fair value and indicates the level within fair value hierarchy of the valuation techniques utilized to determine such value as of September 30, 2017 and December 31, 2016:

 

 

There were no changes in valuation techniques or transfers between fair value measurement levels during the nine months ended September 30, 2017 and 2016. As of September 30, 2017 and December 31, 2016, cash and cash equivalents were comprised of cash and money market funds.

5. Marketable securities

The following table summarizes marketable securities held at September 30, 2017. There were no marketable securities as of December 31, 2016.

 

As of September 30, 2017, the Company held 17 securities that were in an unrealized loss position. The aggregate fair value of securities held by the Company in an unrealized loss position for less than 12 months at September 30, 2017 was $53,934 and there were no securities held by the Company in an unrealized loss position for more than 12 months. As of September 30, 2017, the Company did not intend to sell, and would not be more likely than not required to sell, the securities in an unrealized loss position before recovery of their amortized cost basis. Furthermore, the Company has determined that there was no material change in the credit risk of these securities. As a result, the Company determined it did not hold any securities with any other-than-temporary impairment as of September 30, 2017.

There were no realized gains or losses on available-for-sale securities during the three and nine month periods ended September 30, 2017 and 2016.

 

 

 

6. Accrued expenses

Accrued expenses consist of the following:

 

 

7. Convertible preferred stock

Prior to January 1, 2016, the Company issued 25,085,153 shares of Series A-1 convertible preferred stock (Series A-1 Preferred Stock) at a purchase price of $1.0763 per share resulting in net proceeds of $26,336.

In February 2015 and June 2016, the Company issued 9,410,551 and 23,526,368 shares of Series B-1 convertible preferred stock (Series B-1 Preferred Stock) at a purchase price of $1.0763 per share resulting in net proceeds of $35,232.

In June 2016 the Company issued 14,674,062 shares of Series C-1 convertible preferred stock (Series C-1 Preferred Stock) at a purchase price of $2.25568 resulting in net proceeds of $32,882.

In connection with the closing of the Company’s IPO in July 2017, all outstanding convertible preferred stock was converted into 16,154,671 shares of common stock.

8. Stockholders’ equity (deficit)

Common stock

The holders of the common stock are entitled to one vote for each share held. Common stockholders are not entitled to receive dividends, unless declared by the Board of Directors.

At September 30, 2017, there were 3,335,205 shares of common stock reserved for the conversion of outstanding stock options and warrants.  At December 31, 2016 there were 19,186,147 shares of common stock reserved for the conversion of outstanding Series A-1, Series B-1 and Series C-1 Preferred Stock and for the exercise of outstanding stock options and warrants (in common stock equivalent shares).

 

Warrants

In connection with a 2013 Series A-1 Preferred Stock issuance, the Company granted to certain investors warrants to purchase 129,491 shares of common stock. The warrants have a $0.05 per share exercise price and a contractual life of 10 years. The fair value of these warrants was recorded as a component of equity at the time of issuance.

 

9. Stock options

Stock option plans

As of June 30, 2017, there were 3,141,625 options outstanding under the Company’s 2007 Stock Incentive Plan.  The 2007 Plan expired in June 2017 and there will be no future grants under this plan.

In June 2017 the Company’s shareholders approved the 2017 Stock Incentive Plan (the 2017 Plan or the Plan).  Under the 2017 Plan, up to 2,255,000 shares of common stock may be granted to the Company's employees, officers, directors, consultants and advisors in the form of options, restricted stock awards or other stock-based awards. The number of shares of common stock issuable under the Plan will be cumulatively increased annually by 4% of the outstanding shares or such lesser amount specified by the Board of Directors (the Board). The terms of the awards are determined by the Board, subject to the provisions of the Plan. Any cancellations under the 2007 Plan would increase the number of shares that could be granted under the 2017 Plan. As of September 30, 2017 there were 2,160,664 shares available for future issuance under the Plan.

With respect to incentive stock options, the option price per share will equal the fair market value of the common stock on the date of grant, as determined by the Board, and the vesting period is generally four years. Nonqualified stock options will be granted at an exercise price established by the Board at its sole discretion (which has not been less than fair market value on the date of grant) and the vesting periods may vary. Options granted under the Plan expire no later than 10 years from the date of grant. The Board may accelerate vesting or extend the expiration of granted options in the case of a merger, consolidation, dissolution, or liquidation of the Company.

A summary of the activity under the Plans is as follows:

 

The weighted-average grant date fair value of options granted during the nine months ended September 30, 2017 and 2016, was $5.27 and $2.19 per share, respectively.

Cash received from the exercise of stock options was $431 and $81 for the nine months ended September 30, 2017 and 2016, respectively.

Stock-based compensation

The Company uses the provisions of ASC 718, Stock Compensation, to account for stock-based awards.

The measurement date for employee awards is generally the date of grant. Stock-based compensation expense is recognized over the requisite service period, which is generally the vesting period, using the straight-line method.

For the three months ended September 30, 2017 and 2016 and the nine months ended September 30, 2017 and 2016, the Company recorded stock-based compensation expense of $373, $196, $990 and $436, respectively. The Company has an aggregate of $4,705 of unrecognized stock compensation cost as of September 30, 2017 remaining to be amortized over

the weighted-average period of 3.0 years. The fair value of each option award is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions:

 

Employee Stock Purchase Plan

In connection with the IPO, the Company's board of directors adopted and the Company's stockholders approved the 2017 employee stock purchase plan (the 2017 ESPP), which became effective upon the closing of the Company's IPO in July 2017. The Company has reserved 225,000 shares of common stock for issuance under the 2017 ESPP. The Company has not issued any shares under the 2017 ESPP.

 

 

10. Commitments

Operating leases

The Company leases office space in Cambridge, MA under an operating lease, which is effective through March 2019. The lease also provided the Company with a tenant improvement allowance of up to $356. The Company fully utilized the allowance and recorded the assets acquired with the allowance as leasehold improvements. The Company recorded the tenant improvement allowance as a deferred lease incentive and is amortizing the deferred lease incentive through a reduction of rent expense ratably over the lease term.

In connection with the office lease, the Company has a letter of credit agreement for the benefit of its landlord in the amount of $321 as of each September 30, 2017 and December 31, 2016, respectively, collateralized by a money market account. The Company classified this amount as restricted cash in the accompanying consolidated balance sheets.

For the three months ended September 30, 2017 and 2016 and for the nine months ended September 30, 2017 and 2016, rent expense was $419, $419, $1,256 and $1,256, respectively.

The Company is recording rent expense on a straight-line basis over the term of the lease and has recorded deferred rent in the condensed consolidated balance sheets, accordingly.

License agreements

Through September 30, 2017 the Company has licensed intellectual property from two biotechnology companies. The consideration included upfront payments and a commitment to pay annual license fees, milestone payments, and, upon product commercialization, royalties on revenue generated from the sale of products covered by the licenses. The Company recorded milestone payments of $750 and $2,250 during the three and nine months ended September 30, 2017.

11. Related party transactions

Included in Series C‑1 financing and the Company’s IPO are investments of $10,000 and $10,000 by Takeda, one of the Company’s collaborators.

12. Subsequent events

For the purposes of the unaudited financial statements as of September 30, 2017 and the period then ended, the Company has evaluated subsequent events through November 9, 2017, the date the unaudited interim financial statements were issued. There were no items requiring adjustment or disclosure in the consolidated financial statements.

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

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q and the audited financial information and the notes thereto included in our final prospectus for our initial public offering filed pursuant to Rule 424(b) under the Securities Act of 1933, as amended, or the Securities Act, with the Securities and Exchange Commission, or the SEC on June 29, 2017, or the Prospectus.

Our actual results and timing of certain events may differ materially from the results discussed, projected, anticipated, or indicated in any forward-looking statements. We caution you that forward-looking statements are not guarantees of future performance and that our actual results of operations, financial condition and liquidity, and the development of the industry in which we operate may differ materially from the forward-looking statements contained in this Quarterly Report. In addition, even if our results of operations, financial condition and liquidity, and the development of the industry in which we operate are consistent with the forward-looking statements contained in this Quarterly Report, they may not be predictive of results or developments in future periods. 

The following information and any forward-looking statements should be considered in light of factors discussed elsewhere in the Quarterly Report on Form 10-Q, including those risks identified under Part II, Item 1A. Risk Factors.

We caution readers not to place undue reliance on any forward-looking statements made by us, which speak only as of the date they are made. We disclaim any obligation, except as specifically required by law and the rules of the SEC, to publicly update or revise any such statements to reflect any change in our expectations or in events, conditions or circumstances on which any such statements may be based, or that may affect the likelihood that actual results will differ from those set forth in the forward-looking statements.

Overview

We are a clinical stage biopharmaceutical company focused on developing antibody drug conjugates (ADCs), that offer a clinically meaningful benefit for cancer patients with significant unmet need. We have leveraged 20 years of industry learning in the ADC field to develop proprietary technologies that enable us to design ADCs to have improved efficacy, safety and tolerability relative to existing ADC therapies. Our most advanced platform, Dolaflexin, has been used to generate a pipeline of proprietary ADC product candidates to address patient populations that are not currently amenable to treatment with traditional ADC-based therapies. Our lead product candidate, XMT‑1522, is a HER2‑targeted ADC currently in a Phase 1 dose escalation study in primarily breast cancer patients as well as non‑small cell lung cancer (NSCLC) and gastric cancer, with interim safety results expected around the end of 2017. Upon the completion of dose escalation, we plan to expand clinical development of XMT‑1522 into additional breast cancer, NSCLC, and gastric cancer patient populations, all of which are not addressed by existing HER2 therapies. Our second product candidate, XMT-1536, is an ADC targeting NaPi2b, an antigen broadly expressed in ovarian cancer and NSCLC. In October 2017, the Company received FDA clearance of the XMT-1536 IND and we expect to begin dosing patients in early 2018. Beyond our two lead product candidates, we continue to invest in our earlier stage product candidates and in our ADC technologies. In addition, we have established a strategic partnership with Takeda Pharmaceutical Company Limited, or Takeda, under which they obtained rights to XMT-1522 outside of the United States and Canada. We have also established strategic research and development partnerships with Takeda and Merck KGaA for the development and commercialization of additional ADC product candidates against a limited number of targets selected by our partners based on our Dolaflexin platform. We believe the potential of our ADC technologies, supported by our world-class management team and protected by our robust intellectual property portfolio, will allow us to develop targeted and highly tailored therapies to help cancer patients become cancer survivors.

 On July 3, 2017 we closed our IPO of 5,000,000 shares at a price of $15.00 per share; gross proceeds of $75.0 million.  We received approximately $67.4 million after deducting underwriting discounts and commissions and offering costs of approximately $7.6 million. On August 2, 2017, we issued and sold 51,977 shares of common stock at $15.00 per share for gross proceeds of $0.78 million upon the partial exercise of the underwriters’ overallotment option. We received net proceeds of $0.73 million after deducting $0.05 in underwriting discounts and commissions.

Since inception, our operations have focused on building our platform, identifying potential product candidates, producing drug substance and drug product material for use in preclinical studies, conducting preclinical studies, including Good Laboratory Practice, or GLP, toxicology studies, manufacturing clinical trial material and commencing

clinical trials, establishing and protecting our intellectual property, staffing our company and raising capital. We do not have any products approved for sale and have not generated any revenue from product sales. We have funded our operations primarily through our strategic partnerships, private placements of our convertible preferred stock and our initial public offering.

Since inception, we have incurred significant operating losses. Our net losses were $24.7 million and $15.0 million for the nine months ended September 30, 2017 and 2016, respectively. As of September 30, 2017, we had an accumulated deficit of $83.9 million. We expect to continue to incur significant expenses and operating losses over the next several years. We anticipate that our expenses will increase significantly in connection with our ongoing activities, as we:

Financial operations overview

Revenue

To date, all of our revenue has been generated from strategic partnerships. We have not generated any revenue from product sales, and we do not expect to generate any revenue from product sales for the foreseeable future.

In March 2014, we entered into a collaboration agreement with Takeda for the development and commercialization of ADC product candidates utilizing Fleximer. Under this agreement, as amended, Takeda may select up to seven target antigens and has selected four target antigens to date. Takeda is responsible for generating antibodies against the target antigens and we are responsible for generating Fleximer and our proprietary payloads and conjugating this to the antibody to create the ADC product candidates. Takeda then has the exclusive right to and is responsible for the further development, manufacture and commercialization of these ADC product candidates, except that we have an option to co-develop and co-commercialize one product targeting one of Takeda's third through seventh target antigens and may exercise such option with respect to an applicable product no later than 30 days after initiation of a Phase 2 clinical study for such product or at an earlier time if Takeda intends to grant rights to such product to a third party.

In addition, in January 2016, we entered into a collaboration agreement with Takeda for the development and commercialization of XMT-1522. Under this agreement, Takeda is granted the exclusive right and responsibility to commercialize XMT-1522 outside the United States and Canada.

For the three months ended September 30, 2017 and 2016 and the nine months ended September 30, 2017 and 2016, we recognized revenue of $5.8 million, $2.4 million, $12.1 million and $10.5 million, respectively, related to the Takeda agreements.

In June 2014, we entered into a collaboration agreement with Merck KGaA for the development and commercialization of ADC product candidates utilizing Fleximer for up to six target antigens. Merck KGaA is responsible for generating antibodies against the target antigens and we are responsible for generating Fleximer and our proprietary payloads and conjugating this to the antibody to create the ADC product candidates. Merck KGaA then has the exclusive right to and is responsible for the further development and commercialization of these ADC product candidates.

For the three months ended September 30, 2017 and 2016 and the nine months ended September 30, 2017 and 2016, we recognized revenue of $0.5 million, $0.8 million, $2.1 million and $2.7 million, respectively, related to the Merck KGaA agreement.

For the foreseeable future, we expect substantially all of our revenue to be generated from our collaboration agreements with Takeda and Merck KGaA and any other collaboration agreements we may enter into. Given the schedule of potential milestone payments and the uncertain nature and timing of clinical development, we cannot predict when or whether we will receive further milestone payments or any royalty payments under these collaborations.

For information about our revenue recognition policy, see the notes to condensed consolidated financial statements included in this Quarterly Report on Form 10-Q.

Operating expenses

Research and development expenses

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

Research and development costs are expensed as incurred. Costs of certain activities, such as manufacturing, preclinical studies and clinical trials, are generally recognized based on an evaluation of the progress to completion of specific tasks. Nonrefundable advance payments for goods or services to be received in the future for use in research and development activities are deferred and capitalized. The capitalized amounts are expensed as the related goods are delivered or the services are performed.

We expect research and development costs to increase significantly for the foreseeable future as our product candidate development programs progress. There are numerous factors associated with the successful development and commercialization of any of our product candidates, including future trial design and various regulatory requirements, many of which cannot be determined with accuracy at our current stage of development. Additionally, future commercial and regulatory factors beyond our control may impact our clinical development programs and plans.

A significant portion of our research and development costs have been external costs, which we track on a program-by-program basis following nomination as a product candidate. Our internal research and development costs are primarily personnel-related costs, facility costs, including depreciation and lab consumables. We have not historically tracked all of our internal research and development expenses on a program-by-program basis as they are deployed across multiple projects under development. The following table summarizes our external research and development expenses, by

program following nomination as a development candidate. Pre-development candidate expenses, unallocated costs and internal research and development costs have been stated separately.

 

The successful development of our product candidates is highly uncertain. As such, we cannot reasonably estimate or know the nature, timing and estimated costs of the efforts that will be necessary to complete the remainder of the development of our product candidates. We are also unable to predict when, if ever, material net cash inflows will commence from the development efforts associated with our product candidates. This is due to the numerous risks and uncertainties associated with developing drugs, including the uncertainty of:

A change in the outcome of any of these variables with respect to the development, manufacture or commercialization of any of our product candidates would significantly change the costs, timing and viability associated with the development of that product candidate.

General and administrative expenses

General and administrative expenses consist primarily of salaries and other related costs, including stock-based compensation, for personnel in executive, finance, accounting, business development, legal and human resources functions. Other significant costs include facility costs not otherwise included in research and development expenses, legal fees relating to patent and corporate matters and fees for accounting and consulting services.

We anticipate that our general and administrative expenses will increase in the future to support continued research and development activities. This will likely include increased costs related to the hiring of additional personnel, fees to outside consultants and patent costs, among other expenses. We also anticipate increased expenses associated with being a public company, including costs for audit, legal, regulatory and tax-related services, director and officer insurance premiums and investor relations costs.

Other income

Other income consists primarily of interest income earned on cash equivalents and marketable securities.

Critical accounting policies and estimates

Our management's discussion and analysis of our financial condition and results of operations are based on our financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make judgments and estimates that affect the reported amounts of assets, liabilities, revenues, and expenses and the disclosure of contingent assets and liabilities in our financial statements. We base our estimates on historical experience, known trends and events, and various other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. On an ongoing basis, we evaluate our judgments and estimates in light of changes in circumstances, facts and experience. The effects of material revisions in estimates, if any, will be reflected in the financial statements prospectively from the date of change in estimates.

We believe that our most critical accounting policies are those relating to revenue recognition, accrued research and development expenses and stock-based compensation, discussed in the notes to condensed consolidated financial statements included in this Quarterly Report on Form 10-Q.

Results of Operations

Comparison of the three months ended September 30, 2017 and 2016

The following table summarizes our results of operations for the three months ended September 30, 2017 and 2016:

 

Collaboration Revenue

The increase in collaboration revenue from $3.3 million during the three months ended September 30, 2016 to $6.3 million during the comparable period of 2017 is largely the result of $4.0 million in revenue due to changes in estimates of the costs to complete services under the Takeda agreements. This was offset by a $1.0 million decrease due to a reduction in efforts required to support collaboration activities.

Research and Development Expense

Research and development expense increased by $3.9 million from $7.6 million for the three months ended September 30, 2016 to $11.4 million for the three months ended September 30, 2017. The increase in research and development expense was primarily attributable to the following:

We expect our research and development expenses to increase as we continue our clinical development of XMT‑1522 and XMT-1536 and continue to advance our preclinical product candidate pipeline and invest in improvements in our ADC technologies.

General and Administrative Expense

General and administrative expense increased by $1.3 million from $1.6 million during the three months ended September 30, 2016 to $2.9 million for the three months ended September 30, 2017. The increase in general and administrative expense was primarily attributable to the following:

We expect that our general and administrative expense will increase in future periods as we expand our operations and incur additional costs in connection with being a public company. These increases will likely include legal, auditing and filing fees, additional insurance premiums and general compliance and consulting expenses.

Other Income

Other income was $0.1 million for the three months ended September 30, 2016 compared to $0.4 million for the three months ended September 30, 2017. The change in other income was primarily related to the recognition of interest income during the period ended September 30, 2017 due to higher cash, cash equivalents and marketable securities balances.

Comparison of the nine months ended September 30, 2017 and 2016

The following table summarizes our results of operations for the nine months ended September 30, 2017 and 2016, together with the changes in those items:

 

Collaboration Revenue

The increase in collaboration revenue from $13.2 million during the nine months ended September 30, 2016 to $14.3 million during the comparable period of 2017 is primarily the result of a $4.0 million increase in revenue due to the impact of changes in estimates of the total costs to complete the research services under the Takeda agreements. This increase in revenue was partially offset by a $3.0 million decrease in revenue due to the timing of activities performed under the XMT-1522 agreement.