Edgar Filing: IMMUNOGEN INC

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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, 2018

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

For the transition period from to

Commission file number 0-17999

ImmunoGen, Inc.

Massachusetts		04-2726691
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

830 Winter Street, Waltham, MA 02451

(Address of principal executive offices, including zip code)

(781) 895-0600

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12-b2 of the Exchange Act.

Large accelerated filer ☐		Accelerated filer ☒

Non-accelerated filer ☐		Smaller reporting company ☐ Emerging growth company ☐

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

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Shares of common stock, par value $.01 per share: 149,090,770 shares outstanding as of October 29, 2018.

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IMMUNOGEN, INC.

FORM 10-Q

FOR THE QUARTER ENDED SEPTEMBER 30, 2018

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Item		Page Number
	Part I
	Financial Information
1.	Financial Statements (Unaudited)	2

1a.	Consolidated Balance Sheets as of September 30, 2018 and December 31, 2017	2

1b.	Consolidated Statements of Operations and Comprehensive Loss for the three and nine months ended September 30, 2018 and 2017	3

1c.	Consolidated Statements of Shareholder’s Equity (Deficit) for the nine months ended September 30, 2018	4

1d.	Consolidated Statements of Cash Flows for the nine months ended September 30, 2018 and 2017	5

1e.	Notes to Consolidated Financial Statements	6

2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	31

3.	Quantitative and Qualitative Disclosures about Market Risk	43

4.	Controls and Procedures	43

	Part II
	Other Information
1A.	Risk Factors	44

5.	Other Information	44

6.	Exhibits	44

	Signatures	45

Forward looking statements

This report includes forward‑looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to analyses and other information which are based on forecasts of future results and estimates of amounts that are not yet determinable. These statements also relate to our future prospects, developments and business strategies. These forward‑looking statements are identified by their use of terms and phrases, such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “predict,” “project,” “will” and other similar terms and phrases, including references to assumptions. These statements are contained in the “Business,” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” sections, as well as other sections of this report.

These forward‑looking statements involve known and unknown risks, uncertainties and other factors that may cause actual results to be materially different from those contemplated by our forward‑looking statements. These known and unknown risks, uncertainties and other factors are described in detail in the “Risk Factors” section and in other sections of this report and our Annual Report on Form 10-K for the year ended December 31, 2017. We disclaim any intention or obligation to update or revise any forward‑looking statements, whether as a result of new information, future events, or otherwise.

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ITEM 1. Financial Statements

IMMUNOGEN, INC.

CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

In thousands, except per share amounts


	September 30,		December 31,
	2018		2017
ASSETS
Cash and cash equivalents	$	303,205	$	267,107
Accounts receivable		2,115		2,649
Unbilled revenue		521		2,580
Contract asset		500		—
Non-cash royalty receivable		8,115		—
Inventory		1,938		1,038
Prepaid and other current assets		6,320		2,967
Total current assets		322,714		276,341
Property and equipment, net of accumulated depreciation		13,209		14,538
Other assets		3,941		3,797
Total assets	$	339,864	$	294,676
LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT)
Accounts payable	$	10,352	$	8,562
Accrued compensation		10,316		11,473
Other accrued liabilities		24,117		15,767
Current portion of deferred lease incentive		832		784
Current portion of liability related to the sale of future royalties, net of deferred financing costs of $759 and $772, respectively		23,040		17,779
Current portion of deferred revenue		1,713		1,405
Total current liabilities		70,370		55,770
Deferred lease incentive, net of current portion		4,854		5,129
Deferred revenue, net of current portion		80,592		93,752
Convertible 4.5% senior notes, net of deferred financing costs of $40 and $50, respectively		2,060		2,050
Liability related to the sale of future royalties, net of current portion and deferred financing costs of $1,739 and $2,373, respectively		130,907		151,634
Other long-term liabilities		4,193		4,236
Total liabilities		292,976		312,571
Commitments and contingencies (Note I)
Shareholders’ deficit:
Preferred stock, $.01 par value; authorized 5,000 shares; no shares issued and outstanding		—		—
Common stock, $0.01 par value; authorized 200,000 shares; issued and outstanding 149,049 and 132,526 shares as of September 30, 2018 and December 31, 2017, respectively		1,490		1,325
Additional paid-in capital		1,186,934		1,009,362
Accumulated deficit		(1,141,536)		(1,028,582)
Total shareholders’ equity (deficit)		46,888		(17,895)
Total liabilities and shareholders’ equity (deficit)	$	339,864	$	294,676

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

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IMMUNOGEN, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(UNAUDITED)

In thousands, except per share amounts


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2018		2017		2018		2017

Revenues:
License and milestone fees	$	672	$	79	$	13,533	$	49,889
Non-cash royalty revenue related to the sale of future royalties		8,441		6,503		22,873		20,555
Research and development support		388		650		1,159		3,030
Clinical materials revenue		1,427		1,248		2,465		2,525
Total revenues		10,928		8,480		40,030		75,999
Operating Expenses:
Research and development		47,243		31,689		130,775		99,896
General and administrative		8,347		7,908		26,994		24,863
Restructuring charge		870		—		3,287		386
Total operating expenses		56,460		39,597		161,056		125,145
Loss from operations		(45,532)		(31,117)		(121,026)		(49,146)
Investment income, net		1,369		293		2,845		551
Non-cash interest expense on liability related to the sale of future royalties and convertible senior notes		(2,546)		(3,385)		(8,203)		(10,461)
Interest expense on convertible senior notes		(23)		(762)		(70)		(3,012)
Non-cash debt conversion expense		—		(22,191)		—		(22,191)
Other (expense) income, net		(75)		480		(590)		1,365
Net loss	$	(46,807)	$	(56,682)	$	(127,044)	$	(82,894)
Basic and diluted net loss per common share	$	(0.32)	$	(0.61)	$	(0.92)	$	(0.93)
Basic and diluted weighted average common shares outstanding		147,220		93,001		137,472		89,133
Total comprehensive loss	$	(46,807)	$	(56,682)	$	(127,044)	$	(82,894)

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

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IMMUNOGEN, INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (DEFICIT)

(UNAUDITED)

In thousands


				Additional				Total
	Common Stock			Paid-In		Accumulated		Shareholders’
	Shares	Amount		Capital		Deficit		Equity (Deficit)
Balance at December 31, 2016	87,301	$	873	$	778,847	$	(932,570)	$	(152,850)
Net loss	—		—		—		(96,012)		(96,012)
Stock options exercised	191		1		649		—		650
Issuance of common stock	16,675		167		101,496		—		101,663
Restricted stock award - net of forfeitures	2,146		21		(21)		—		—
Conversion of debt	26,160		262		117,067		—		117,329
Stock option and restricted stock compensation expense	—		—		11,119		—		11,119
Directors' deferred share units converted	53		1		(1)		—		—
Directors’ deferred share unit compensation	—		—		206		—		206
Balance at December 31, 2017	132,526	$	1,325	$	1,009,362	$	(1,028,582)	$	(17,895)
Transition adjustment for ASC 606	—		—		—		14,090		14,090
Net loss	—		—		—		(127,044)		(127,044)
Stock options exercised	595		6		2,937		—		2,943
Issuance of common stock	15,755		158		162,354		—		162,512
Stock option and restricted stock compensation expense	—		—		12,024		—		12,024
Directors' deferred share units converted	173		1		(1)		—		—
Directors’ deferred share unit compensation	—		—		258		—		258
Balance at September 30, 2018	149,049	$	1,490	$	1,186,934	$	(1,141,536)	$	46,888

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IMMUNOGEN, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

In thousands, except per share amounts


	Nine Months Ended
	September 30,
	2018		2017

Cash flows from operating activities:
Net loss	$	(127,044)	$	(82,894)
Adjustments to reconcile net loss to net cash used for operating activities:
Non-cash royalty revenue related to sale of future royalties		(22,873)		(20,555)
Non-cash interest expense on liability related to sale of future royalties and convertible senior notes		8,203		10,461
Non-cash debt conversion expense		—		22,191
Depreciation and amortization		6,192		4,307
(Gain) loss on sale/disposal of fixed assets and impairment charges		(30)		180
Stock and deferred share unit compensation		12,282		8,458
Deferred rent		(62)		71
Change in operating assets and liabilities:
Accounts receivable		534		(495)
Unbilled revenue		2,059		4,178
Inventory		(900)		(51)
Contract asset		(500)		—
Prepaid and other current assets		(3,353)		641
Other assets		(144)		(93)
Accounts payable		1,420		(993)
Accrued compensation		(1,157)		1,579
Other accrued liabilities		7,898		2,781
Deferred revenue		(7,662)		87,288
Net cash (used) provided by operating activities		(125,137)		37,054
Cash flows from investing activities:
Purchases of property and equipment		(4,220)		(847)
Net cash used for investing activities		(4,220)		(847)
Cash flows from financing activities:
Proceeds from stock options exercised		2,943		363
Proceeds from common stock issuance, net of $395 of transaction costs		162,512		—
Fees for debt conversion		—		(1,683)
Net cash provided (used) for financing activities		165,455		(1,320)
Net change in cash and cash equivalents		36,098		34,887
Cash and cash equivalents, beginning of period		267,107		159,964
Cash and cash equivalents, end of period	$	303,205	$	194,851

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

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IMMUNOGEN, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2018

A.Nature of Business and Plan of Operations

ImmunoGen, Inc. (the Company) was incorporated in Massachusetts in 1981 and is focused on the development of antibody‑drug conjugates, or ADC, therapeutics. The Company has generally incurred operating losses and negative cash flows from operations since inception, incurred a net loss of $127.0 million during the nine months ended September 30, 2018, and has an accumulated deficit of approximately $1.1 billion as of September 30, 2018. The Company has primarily funded these losses through payments received from its collaborations and equity and convertible debt financings. To date, the Company has no product revenue and management expects operating losses to continue for the foreseeable future.

At September 30, 2018, the Company had $303.2 million of cash and cash equivalents on hand. The Company anticipates that its current capital resources will enable it to meet its operational expenses and capital expenditures for more than twelve months after the date these financial statements are issued. The Company may raise additional funds through equity or debt financings or generate revenues from collaborators through a combination of upfront license payments, milestone payments, royalty payments, research funding, and clinical material reimbursements. There can be no assurance that the Company will be able to obtain additional debt or equity financing or generate revenues from collaborators on terms acceptable to the Company or at all. The failure of the Company to obtain sufficient funds on acceptable terms when needed could have a material adverse effect on the Company’s business, results of operations, and financial condition and require the Company to defer or limit some or all of its research, development, and/or clinical projects.

The Company is subject to risks common to companies in the biotechnology industry including, but not limited to, the development by its competitors of new technological innovations, dependence on key personnel, protection of proprietary technology, manufacturing and marketing limitations, complexities associated with managing collaboration arrangements, third‑party reimbursements, and compliance with governmental regulations.

B.Summary of Significant Accounting Policies

Basis of Presentation

The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, ImmunoGen Securities Corp., ImmunoGen Europe Limited, ImmunoGen (Bermuda) Ltd., ImmunoGen BioPharma (Ireland) Limited, and Hurricane, LLC. All intercompany transactions and balances have been eliminated. The consolidated financial statements include all of the adjustments, consisting only of normal recurring adjustments, which management considers necessary for a fair presentation of the Company’s financial position in accordance with accounting principles generally accepted in the U.S. for interim financial information. The December 31, 2017 condensed consolidated balance sheet data presented for comparative purposes was derived from the Company’s audited financial statements, but certain information and footnote disclosures normally included in the Company’s annual financial statements have been condensed or omitted. The preparation of interim financial statements requires the use of management’s estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the interim financial statements and the reported amounts of revenues and expenditures during the reported periods. The results of the interim periods are not necessarily indicative of the results for the entire year. Accordingly, the interim financial statements should be read in conjunction with the audited financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.

Subsequent Events

The Company has evaluated all events or transactions that occurred after September 30, 2018, up through the date the Company issued these financial statements. In October 2018, Lilly informed the Company that it was terminating its three current development and commercialization licenses, two of which were pre-clinical stage programs

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and one for which the clinical program had been cancelled. The Company did not have any other material recognizable or unrecognizable subsequent events during this period.

Adoption of ASC Topic 606, Revenue from Contracts with Customers

The Company adopted Accounting Standards Codification Topic or ASC, 606 – Revenue from Contracts with Customers, (ASC 606) on January 1, 2018, using the modified retrospective method for all contracts not completed as of the date of adoption. The reported results for 2018 reflect the application of ASC 606 guidance, while the reported results for 2017 were prepared under the guidance of ASC 605, Revenue Recognition (ASC 605), which is also referred to herein as "legacy GAAP" or the "previous guidance." For discussion on the Company’s revenue recognition policy under ASC 605, please refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.

Financial Statement Impact of Adopting ASC 606

The cumulative effect of applying the new guidance to all contracts with customers that were not completed as of December 31, 2017, was recorded as an adjustment to accumulated deficit as of the adoption date. As a result of applying the modified retrospective method to adopt the new revenue guidance, the following adjustments were made to accounts on the condensed consolidated balance sheet as of January 1, 2018:

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IMMUNOGEN, INC.

ADJUSTED CONSOLIDATED BALANCE SHEET

(UNAUDITED)

In thousands, except per share amounts


			Adjustments		Balance at
	December 31,		Due to		January 1,
	2017		ASC 606		2018
ASSETS
Cash and cash equivalents	$	267,107	$	—	$	267,107
Accounts receivable		2,649		—		2,649
Unbilled revenue		2,580		—		2,580
Non-cash royalty receivable		—		8,900		8,900
Inventory		1,038		—		1,038
Prepaid and other current assets		2,967		—		2,967
Total current assets		276,341		8,900		285,241
Property and equipment, net of accumulated depreciation		14,538		—		14,538
Other assets		3,797		—		3,797
Total assets	$	294,676	$	8,900	$	303,576
LIABILITIES AND SHAREHOLDERS’ DEFICIT
Accounts payable	$	8,562	$	—	$	8,562
Accrued compensation		11,473		—		11,473
Other accrued liabilities		15,767		—		15,767
Current portion of deferred lease incentive		784		—		784
Current portion of liability related to the sale of future royalties, net		17,779		—		17,779
Current portion of deferred revenue		1,405		41		1,446
Total current liabilities		55,770		41		55,811
Deferred lease incentive, net of current portion		5,129		—		5,129
Deferred revenue, net of current portion		93,752		(5,231)		88,521
Convertible 4.5% senior notes, net		2,050		—		2,050
Liability related to the sale of future royalties, net		151,634		—		151,634
Other long-term liabilities		4,236		—		4,236
Total liabilities		312,571		(5,190)		307,381
Shareholders’ deficit:
Preferred stock		—		—		—
Common stock		1,325		—		1,325
Additional paid-in capital		1,009,362		—		1,009,362
Accumulated deficit		(1,028,582)		14,090		(1,014,492)
Total shareholders’ deficit		(17,895)		14,090		(3,805)
Total liabilities and shareholders’ deficit	$	294,676	$	8,900	$	303,576

Under the previous guidance, the Company deferred revenue pertaining to the transfer of certain exclusive commercialization and development licenses. Under ASC 606, the Company recognizes revenues from non-refundable, up-front fees allocated to the license when the license is transferred to the customer and the customer is able to use and benefit from the license.

Under the previous guidance, milestones that were considered substantive because the Company contributed significant effort to the achievement of such milestones were recognized as revenue upon achievement of the milestone. Under ASC 606, if the achievement of a milestone is considered a direct result of the Company’s efforts to satisfy a performance obligation or transfer a distinct good or service, the associated milestone value is allocated to that distinct good or service. If a milestone is not specifically related to the Company’s effort to satisfy a performance obligation or transfer a distinct good or service, the amount is allocated to all performance obligations using the relative standalone selling price method.

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Under ASC 606, the Company also evaluates the milestone to determine whether the milestone is probable of being achieved and estimates the amount to be included in the transaction price. If it is probable that a significant revenue reversal would not occur, the associated milestone value is included in the transaction price to be allocated, otherwise, such amounts are constrained and excluded from the transaction price. The Company determined it was probable that a future $5.0 million milestone for Takeda enrolling a patient in a Phase I trial as of the date of adoption would occur and, accordingly, recorded a reduction to accumulated deficit of $4.6 million related to this previously delivered license as approximately $400,000 was allocated to undelivered rights to future technological improvements. The $5.0 million contract asset recorded for the probable milestone was netted against contract liabilities related to the specific contract.

Prior to the adoption of ASC 606, the Company recognized royalty revenue when it could reliably estimate such amounts and collectability was reasonably assured. As such, the Company generally recognized revenue for sales royalties in the quarter the amounts were reported to the Company by its licensees, or one quarter following the quarter in which sales by the Company’s licensees occurred. Under ASC 606, if the license is deemed to be the predominant item to which the royalties relate, the Company will recognize revenue at the later of (i) when the related sales occur, or (ii) when the performance obligation to which some or all of the royalty has been allocated has been satisfied (or partially satisfied). As a result of recognizing royalties for sales in the fourth quarter of fiscal year 2017, the Company recognized a reduction to accumulated deficit of $8.9 million.

The net impact of these changes resulted in a $14.1 million reduction to accumulated deficit, a $5.2 million reduction to deferred revenue and an $8.9 million increase in non-cash royalty receivable.

The adoption of ASC 606 resulted in the acceleration of revenue through December 31, 2017, which in turn reduced the related net deferred tax asset by $3.9 million. As the Company fully reserves its net deferred tax assets, the impact was offset by the valuation allowance.

Impact of ASC 606 Revenue Guidance on Financial Statement Line Items

The following tables compare the reported condensed consolidated balance sheet and statement of operations, as of and for the three and nine months ended September 30, 2018, to the pro-forma amounts had the previous guidance been in effect:

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IMMUNOGEN, INC.

PRO FORMA CONSOLIDATED BALANCE SHEET

(UNAUDITED)

In thousands, except per share amounts


	As of September 30, 2018
			Pro forma as if the
			previous accounting
	As reported		was in effect
ASSETS
Cash and cash equivalents	$	303,205	$	303,205
Accounts receivable		2,115		2,115
Unbilled revenue		521		521
Contract asset		500		—
Non-cash royalty receivable		8,115		—
Inventory		1,938		1,938
Prepaid and other current assets		6,320		6,320
Total current assets		322,714		314,099
Property and equipment, net of accumulated depreciation		13,209		13,209
Other assets		3,941		3,941
Total assets	$	339,864	$	331,249
LIABILITIES AND SHAREHOLDERS’ DEFICIT
Accounts payable	$	10,352	$	10,352
Accrued compensation		10,316		10,316
Other accrued liabilities		24,117		24,117
Current portion of deferred lease incentive		832		832
Current portion of liability related to the sale of future royalties, net		23,040		23,040
Current portion of deferred revenue		1,713		1,455
Total current liabilities		70,370		70,112
Deferred lease incentive, net of current portion		4,854		4,854
Deferred revenue, net of current portion		80,592		83,834
Convertible 4.5% senior notes, net		2,060		2,060
Liability related to the sale of future royalties, net		130,907		130,907
Other long-term liabilities		4,193		4,193
Total liabilities		292,976		295,960
Shareholders’ deficit:
Preferred stock		—		—
Common stock		1,490		1,490
Additional paid-in capital		1,186,934		1,186,934
Accumulated deficit		(1,141,536)		(1,153,135)
Total shareholders’ deficit		46,888		35,289
Total liabilities and shareholders’ deficit	$	339,864	$	331,249

As a result of adoption of ASC 606, a receivable is recorded for royalties earned during the current quarter rather than one quarter in arrears under the previous guidance. Deferred revenue increased under ASC 606 due to a greater amount of the transaction prices being allocated to the future technological improvement rights under ASC 606.

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IMMUNOGEN, INC.

PRO FORMA CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(UNAUDITED)

In thousands, except per share amounts


	Three Months Ended				Nine months ended
	September 30, 2018				September 30, 2018
			Pro forma as if the				Pro forma as if the
			previous accounting				previous accounting
	As reported		was in effect		As reported		was in effect
Revenues:
License and milestone fees	$	672	$	80	$	13,533	$	15,239
Non-cash royalty revenue related to the sale of future royalties		8,441		7,562		22,873		23,658
Research and development support		388		388		1,159		1,159
Clinical materials revenue		1,427		1,427		2,465		2,465
Total revenues		10,928		9,457		40,030		42,521
Operating Expenses:
Research and development		47,243		47,243		130,775		130,775
General and administrative		8,347		8,347		26,994		26,994
Restructuring charge		870		870		3,287		3,287
Total operating expenses		56,460		56,460		161,056		161,056
Loss from operations		(45,532)		(47,003)		(121,026)		(118,535)
Investment income, net		1,369		1,369		2,845		2,845
Non-cash interest expense on liability related to the sale of future royalties and convertible senior notes		(2,546)		(2,546)		(8,203)		(8,203)
Interest expense on convertible senior notes		(23)		(23)		(70)		(70)
Other (expense) income, net		(75)		(75)		(590)		(590)
Net loss	$	(46,807)	$	(48,278)	$	(127,044)	$	(124,553)
Basic and diluted net loss per common share	$	(0.32)	$	(0.33)	$	(0.92)	$	(0.91)

Under the previous guidance, non-cash royalty revenue would have been lower than the amount recorded for the three months ended September 30, 2018, however, higher non-cash royalty revenue would have been recorded for the nine months ended September 30, 2018 due to higher tiered royalties for Kadcyla® in the fourth quarter of 2017 (because under the previous guidance, the Company recorded the royalties one quarter in arrears as previously described). License and milestone fee revenue for the three months ended September 30, 2018 would have been lower due to a $500,000 development milestone recorded due to its probability of occurring in accordance with the new guidance. During the nine months ended September 30, 2018, under the previous guidance, a $5.0 million milestone would have been included as license and milestone fee revenue, however, due to its probability of occurring at the time of transition to ASC 606, it was recognized as part of the transition adjustment. Partially offsetting this change, less license and milestone fee revenue would have been recognized under the previous guidance related to a partner foregoing its remaining rights under a right-to-test agreement upon expiration in March 2018. A greater amount of the transaction price was allocated to the expired material rights under ASC 606 than under the previous guidance.

The adoption of ASC 606 had no aggregate impact on the Company’s cash flows from operations. The aforementioned impact resulted in offsetting shifts in cash flows through net losses and working capital accounts.

Revenue Recognition

The Company enters into licensing and development agreements with collaborators for the development of

ADC therapeutics. The terms of these agreements contain multiple performance obligations which may include (i) licenses, or options to obtain licenses, to the Company’s ADC technology, (ii) rights to future technological improvements, (iii) research activities to be performed on behalf of the collaborative partner, (iv) delivery of cytotoxic agents, and (v) the manufacture of preclinical or clinical materials for the collaborative partner. Payments to the Company under these agreements may include upfront fees, option fees, exercise fees, payments for research activities,

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payments for the manufacture of preclinical or clinical materials, payments based upon the achievement of certain milestones, and royalties on product sales. Revenue is recognized when a customer obtains control of promised goods or services, in an amount that reflects the consideration which the entity expects to receive in exchange for those goods or services. In determining the appropriate amount of revenue to be recognized as it fulfills its obligations under the agreements, the Company performs the following steps: (i) identification of the promised goods or services in the contract; (ii) determination of whether the promised goods or services are performance obligations including whether they are distinct in the context of the contract; (iii) measurement of the transaction price, including the constraint on variable consideration; (iv) allocation of the transaction price to the performance obligations; and (v) recognition of revenue when or as the Company satisfies each performance obligation.

The Company only applies the five-step model to contracts when it is probable that the Company will collect the consideration to which it is entitled in exchange for the goods or services it transfers to the customer. At contract inception, once the contract is determined to be within the scope of ASC 606, the Company assesses the goods or services promised within each contract and determines those that are performance obligations, and assesses whether each promised good or service is distinct. The Company then recognizes as revenue the amount of the transaction price that is allocated to the respective performance obligation when or as the performance obligation is satisfied.

As part of the accounting for the arrangement, the Company must develop assumptions that require judgment to determine the stand-alone selling price for each performance obligation identified in the contract, which is discussed in further detail below.

At September 30, 2018, the Company had the following material types of agreements with the parties identified below:

Development and commercialization licenses, which provide the party with the right to use the Company’s ADC technology and/or certain other intellectual property to develop and commercialize anticancer compounds to a specified antigen target:

Amgen (one exclusive single-target license which has been sublicensed to Oxford BioTherapeutics Ltd.)

Bayer (one exclusive single-target license)

Biotest (one exclusive single-target license)

CytomX (one exclusive single-target license)

Fusion Pharmaceuticals (one exclusive single-target license)

Lilly (three exclusive single-target licenses – terminated in October 2018)

Novartis (five exclusive single-target licenses)

Roche, through its Genentech unit (five exclusive single-target licenses)

Sanofi (five fully-paid, exclusive single-target licenses)

Takeda, through its wholly owned subsidiary, Millennium Pharmaceuticals, Inc. (one exclusive single-target license)

Debiopharm (one exclusive single-compound license)

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Collaboration and option agreement for a defined period of time to secure development and commercialization licenses to develop and commercialize specified anticancer compounds on established terms:

Jazz Pharmaceuticals

Collaboration and license agreement to co-develop and co-commercialize a specified anticancer compound on established terms:

MacroGenics

There are no performance, cancellation, termination or refund provisions in any of the arrangements that contain material financial consequences to the Company.

Development and Commercialization Licenses

The obligations under a development and commercialization license agreement generally include the license to the Company’s ADC technology with respect to a specified antigen target, and may also include obligations related to rights to future technological improvements, research activities to be performed on behalf of the collaborative partner and the manufacture of preclinical or clinical materials for the collaborative partner.

Generally, development and commercialization licenses contain non‑refundable terms for payments and, depending on the terms of the agreement, provide that the Company will (i) at the collaborator’s request, provide research services at negotiated prices which are generally consistent with what other third parties would charge, (ii) at the collaborator’s request, manufacture and provide preclinical and clinical materials or deliver cytotoxic agents at negotiated prices which are generally consistent with what other third parties would charge, (iii) earn payments upon the achievement of certain milestones, and (iv) earn royalty payments, generally until the later of the last applicable patent expiration or 10 to 12 years after product launch. In the case of Kadcyla, however, the minimum royalty term is 10 years and the maximum royalty term is 12 years on a country‑by‑country basis, regardless of patent protection. Royalty rates may vary over the royalty term depending on the Company’s intellectual property rights and/or the presence of comparable competing products. In the case of Sanofi, its licenses are fully-paid and no further milestones or royalties will be received. In the case of Debiopharm, no royalties will be received. The Company may provide technical assistance and share any technology improvements with its collaborators during the term of the collaboration agreements. The Company does not directly control when or whether any collaborator will request research or manufacturing services, achieve milestones or become liable for royalty payments.

In determining the performance obligations, management evaluates whether the license is distinct, and has significant standalone functionality, from the undelivered elements to the collaborative partner based on the consideration of the relevant facts and circumstances for each arrangement. Factors considered in this determination include the research capabilities of the partner and the availability of ADC technology research expertise in the general marketplace and whether technological improvements are required for the continued functionality of the license. If the license to the Company’s intellectual property is determined to be distinct from the other performance obligations identified in the arrangement, the Company recognizes revenues from non-refundable, up-front fees allocated to the license when the license is transferred to the customer and the customer is able to use and benefit from the license. The Company estimates the stand-alone selling prices of the license and all other performance obligations based on market conditions, similar arrangements entered into by third parties, and entity‑specific factors such as the terms of the Company’s previous collaborative agreements, recent preclinical and clinical testing results of therapeutic products that use the Company’s ADC technology, the Company’s pricing practices and pricing objectives, the likelihood that technological improvements will be made, and, if made, will be used by the Company’s collaborators and the nature of the research services to be performed on behalf of its collaborators and market rates for similar services.

The Company recognizes revenue related to research services as the services are performed. The Company performs research activities, including developing antibody specific conjugation processes, on behalf of its collaborators and potential collaborators during the early evaluation and preclinical testing stages of drug development. The Company

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also develops conjugation processes for materials for later stage testing and commercialization for certain collaborators. The Company is compensated at negotiated rates and may receive milestone payments for developing these processes which are also recorded as a component of research and development support revenue. The Company may also produce research material for potential collaborators under material transfer agreements. The Company records amounts received for research materials produced or services performed as a component of research and development support revenue.

The Company may also provide cytotoxic agents to its collaborators or produce preclinical and clinical materials (drug substance) at negotiated prices which are generally consistent with what other third parties would charge. The Company recognizes revenue on cytotoxic agents and on preclinical and clinical materials when the materials have passed all quality testing required for collaborator acceptance and control has transferred to the collaborator. The majority of the Company’s costs to produce these preclinical and clinical materials are fixed and then allocated to each batch based on the number of batches produced during the period. Therefore, the Company’s costs to produce these materials are significantly affected by the number of batches produced during the period. The volume of preclinical and clinical materials the Company produces is directly related to the scale and scope of preclinical activities and the number of clinical trials the Company and its collaborators are preparing for or currently have underway, the speed of enrollment in those trials, the dosage schedule of each clinical trial and the time period such trials last. Accordingly, the volume of preclinical and clinical materials produced, and therefore the Company’s per‑batch costs to manufacture these preclinical and clinical materials, may vary significantly from period to period, which impacts the margins recognized on such product sales. The Company will no longer be producing preclinical and clinical materials for its collaborators after 2018.

The Company recognizes revenue related to the rights to future technological improvements over the estimated term of the applicable license.

The Company’s development and commercialization license agreements have milestone payments which for reporting purposes are aggregated into three categories: (i) development milestones, (ii) regulatory milestones, and (iii) sales milestones. Development milestones are typically payable when a product candidate initiates or advances into different clinical trial phases. Regulatory milestones are typically payable upon submission for marketing approval with the U.S. Food and Drug Administration, or FDA, or other countries’ regulatory authorities or on receipt of actual marketing approvals for the compound or for additional indications. Sales milestones are typically payable when annual sales reach certain levels.

At the inception of each arrangement that includes developmental and regulatory milestone payments, the Company evaluates whether the achievement of each milestone specifically relates to the Company’s efforts to satisfy a performance obligation or transfer a distinct good or service within a performance obligation. If the achievement of a milestone is considered a direct result of the Company’s efforts to satisfy a performance obligation or transfer a distinct good or service and the receipt of the payment is based upon the achievement of the milestone, the associated milestone value is allocated to that distinct good or service. If the milestone payment is not specifically related to the Company’s effort to satisfy a performance obligation or transfer a distinct good or service, the amount is allocated to all performance obligations using the relative standalone selling price method. In addition, the Company evaluates the milestone to determine whether the milestone is considered probable of being reached and estimates the amount to be included in the transaction price using the most likely amount method. If it is probable that a significant revenue reversal would not occur, the associated milestone value is included in the transaction price to be allocated; otherwise, such amounts are considered constrained and excluded from the transaction price. At the end of each subsequent reporting period, the Company re-evaluates the probability of achievement of such development or regulatory milestones and any related constraint, and if necessary, adjusts its estimate of the transaction price. Any such adjustments to the transaction price are allocated to the performance obligations on the same basis as at contract inception. Amounts allocated to a satisfied performance obligation shall be recognized as revenue, or as a reduction of revenue, in the period in which the transaction price changes.

For development and commercialization license agreements that include sales-based royalties, including milestone payments based on the level of sales, and the license is deemed to be the predominant item to which the royalties relate, the Company will recognize revenue at the later of (i) when the related sales occur, or (ii) when the performance obligation to which some or all of the royalty has been allocated has been satisfied (or partially satisfied) in accordance with the royalty recognition constraint. Under the Company’s development and commercialization license

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agreements, except for the Sanofi and Debiopharm licenses, the Company receives royalty payments based upon its licensees’ net sales of covered products. Generally, under the development and commercialization agreements, the Company receives royalty reports and payments from its licensees approximately one quarter in arrears. The Company estimates the amount of royalty revenue to be recognized based on historical and forecasted sales and/or sales information from its licensees if available.

Collaboration and Option Agreements/Right-to-Test Agreements

The Company’s right-to-test agreements provide collaborators the right to test the Company’s ADC technology for a defined period of time through a research, or right‑to‑test, license. Under both right-to-test agreements and collaboration and option agreements, collaborators may (a) take options, for a defined period of time, to specified targets and (b) upon exercise of those options, secure or “take” licenses to develop and commercialize products for the specified targets on established terms. Under these agreements, fees may be due to the Company (i) at the inception of the arrangement (referred to as “upfront” fees or payments), (ii) upon the opt-in to acquire a development and commercialization license(s) (referred to as exercise fees or payments earned, if any, when the development and commercialization license is “taken”), (iii) at the collaborator’s request, after providing research services at negotiated prices which are generally consistent with what other third parties would charge, or (iv) some combination of all of these fees.

The accounting for collaboration and option agreements and right-to-test agreements is dependent on the nature of the options granted to the collaborative partner. Options are considered distinct performance obligations if they provide a collaborator with a material right. Factors that are considered in evaluating whether options convey a material right include the overall objective of the arrangement, the benefit the collaborator might obtain from the agreement without exercising the options, the cost to exercise the options relative to the fair value of the licenses, and the additional financial commitments or economic penalties imposed on the collaborator as a result of exercising the options. As of September 30, 2018, all right-to-test agreements have expired.

If the Company concludes that an option provides the customer a material right, and therefore is a separate performance obligation, the Company then determines the estimated selling prices of the option and all other units of accounting based on an option pricing model using the following inputs: a) estimated fair value of each program, b) the amount the partner would pay to exercise the option to obtain the license and c) probability of exercise.

Upfront payments on development and commercialization licenses may be recognized upon delivery of the license if facts and circumstances dictate that the license has stand-alone functionality and is distinct from the undelivered elements.

The Company does not control when or if any collaborator will exercise its options for development and commercialization licenses. As a result, the Company cannot predict when or if it will recognize revenues in connection with any of the foregoing.

In determining whether a collaboration and option agreement is within the scope of ASC 808, Collaborative Arrangements, management evaluates the level of involvement of both companies in the development and commercialization of the products to determine if both parties are active participants and if both parties are exposed to risks and rewards dependent on the commercial success of the licensed products. If the agreement is determined to be within the scope of ASC 808, the Company will segregate the research and development activities and the related cost sharing arrangement. Payments made by the Company for such activities will be recorded as research and development expense and reimbursements received from its partner will be recognized as an offset to research and development expense.

Transaction Price Allocated to Future Performance Obligations

Remaining performance obligations represent the transaction price of contracts for which work has not been performed (or has been partially performed) and includes unexercised contract options that are considered material rights. As of September 30, 2018, the aggregate amount of the transaction price allocated to remaining performance obligations comprising deferred revenue was $82.3 million. The Company expects to recognize revenue on

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approximately 2%, 2% and 96% of the remaining performance obligations over the next 12 months, 13 to 60 months, and 61 to 120 months, respectively, however it does not control when or if any collaborator will exercise its options for, or terminate existing development and commercialization licenses.

Contract Balances from Contracts with Customers

The following table presents changes in the Company’s contract assets and contract liabilities during the nine months ended September 30, 2018 (in thousands):