Item 1A. Risk Factors
Our business is subject to numerous risks. We caution you that the following important factors, among others, could cause our actual results to differ materially from those expressed in forward-looking statements made by us or on our behalf in filings with the SEC and Canadian securities regulators, press releases, communications with investors and oral statements. All statements other than statements relating to historical matters should be considered forward-looking statements. When used in this annual report, the words “believe,” “expect,” “plan,” “anticipate,” “estimate,” “predict,” “may,” “could,” “should,” “intend,” “will,” “target,” “goal” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these words. Any or all of our forward-looking statements in this annual report on Form 10-K and in any other public statements we make may turn out to be wrong. They can be affected by inaccurate assumptions we might make or by known or unknown risks and uncertainties. Many factors mentioned in the discussion below will be important in determining future results. Consequently, no forward-looking statement can be guaranteed. Actual future results may vary materially from those anticipated in forward-looking statements. We explicitly disclaim any obligation to update any forward-looking statements to reflect events or circumstances that arise after the date hereof, unless required by law. You are advised, however, to consult any further disclosure we make in our reports filed with the SEC and Canadian securities regulators.
Risks Related to Our Business
We are in the early stages of our development, there is a limited amount of information about us upon which you can evaluate our Hepatitis B (HBV) candidates and other prospects as well as our delivery technologies.
We have not begun to market or generate revenues from the commercialization of any HBV products and our other delivery technologies. We have only a limited history upon which one can evaluate our business and prospects as our therapeutic products are still at an early stage of development and thus we have limited experience and have not yet demonstrated an ability to successfully overcome many of the risks and uncertainties frequently encountered by companies in new and rapidly evolving fields, particularly in the biopharmaceutical area. For example, to execute our business plan, we will need to successfully:
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execute research and development activities using our HBV technology; and technologies involved in the development of HBV therapeutics;
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build, maintain and protect a strong intellectual property portfolio;
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gain acceptance for the development and commercialization of any product we develop;
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develop and maintain successful strategic relationships; and
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manage our spending and cash requirements as our expenses are expected to increase due to research and preclinical work, clinical trials, regulatory approvals, and commercialization and maintaining our intellectual property portfolio.
If we are unsuccessful in accomplishing these objectives, we may not be able to develop products, raise capital, expand our business or continue our operations. The approach we are taking to discover and develop novel drug products is unproven and may never lead to marketable drug products.
We intend to concentrate our internal research and development efforts in the future primarily on the discovery and development of therapeutics targeting chronic HBV in order to ultimately develop a cure for the disease. Our future success depends in part on the successful development of these therapeutics. Our approach to the treatment of HBV is unproven, and we do not know whether we will be able to develop any drugs of commercial value.
There is no known cure for HBV. Any compounds that we develop may not effectively address HBV persistence. Even if we are able to develop compounds that address one or more of these key factors, targeting these key factors has not been proven to cure HBV. If we cannot develop compounds to achieve our goal of curing HBV internally, we may be unable to acquire additional drug candidates on terms acceptable to us, or at all. Even if we are able to acquire or develop drug candidates that address one of these mechanisms of action in preclinical studies, we may not succeed in demonstrating safety and efficacy of the drug candidate in human clinical trials. If we are unable to identify suitable compounds for preclinical and clinical development, we will not succeed in realizing our goal of a cure for HBV.
We also intend to continue research and development efforts on RNAi technology and products based on RNAi technology as well as capsid inhibitors and other assets. While RNAi technology is based on a naturally occurring process that takes place inside cells, which can suppress the production of specific proteins, and has the potential to generate therapeutic drugs that take advantage of that process, neither we nor any other company has received regulatory approval to market a therapeutic product based on RNAi technology. The scientific discoveries that form the basis for our efforts to discover and develop new products are relatively new. While there are a number of RNAi therapeutics in development, very few product candidates based on these discoveries have ever been tested in humans and there can be no assurance that any RNAi therapeutic product will be approved for commercial use.
If we are not successful in developing a product with our research and development efforts, we may be required to change the scope and direction of our product development activities. In that case, we may not be able to identify and implement successfully an alternative product development strategy.
We expect to depend in part on our existing collaborators for a significant portion of our revenues and to develop, conduct clinical trials with, obtain regulatory approvals for, and manufacture, market and sell some of our product candidates. If these collaborations are unsuccessful, or anticipated milestone payments are not received, our business could be adversely affected.
We expect that we will depend in part on our licensing agreements with Alnylam, Gritstone, and Spectrum to provide revenue to fund our operations, especially in the near term. Furthermore, our strategy is to enter into various additional arrangements with corporate and academic collaborators, licensors, licensees and others for the research, development, clinical testing, manufacturing, marketing and commercialization of our products. We may be unable to continue to establish such collaborations, and any collaborative arrangements we do establish may be unsuccessful, or we may not receive milestone payments as anticipated.
Should any collaborative partner fail to develop or ultimately successfully commercialize any of the products to which it has obtained rights, our business may be adversely affected. In addition, once initiated, there can be no assurance that any of these collaborations will be continued or result in successfully commercialized products. Failure of a collaborative partner to continue funding any particular program could delay or halt the development or commercialization of any products arising out of such program. In addition, there can be no assurance that the collaborative partners will not pursue alternative technologies or develop alternative products either on their own or in collaboration with others, including our competitors, as a means for developing treatments for the diseases targeted by our programs.
We expect to spend substantial amounts to acquire additional drug candidates, to conduct further research and development and preclinical testing and clinical trials of our drug candidates, to seek regulatory approvals for our drug candidates and to launch and commercialize any drug candidates for which we receive regulatory approval. These expenditures will include costs associated with our and our subsidiary’s licensing agreements with Blumberg or Drexel. Under the terms of these agreements, we are obligated to make significant cash payments upon the achievement of specified development, regulatory and sales performance milestones, as well as royalty payments in connection with the sale of licensed products, to our licensors.
We rely on third parties to conduct our clinical trials, and if they fail to fulfill their obligations, our development plans may be adversely affected.
We rely on independent clinical investigators, contract research organizations and other third-party service providers to assist us in managing, monitoring and otherwise carrying out our clinical trials. We have contracted with, and we plan to continue to contract with, certain third parties to provide certain services, including site selection, enrollment, monitoring and data management services. Although we depend heavily on these parties, we do not control them and therefore, we cannot be assured that these third parties will adequately perform all of their contractual obligations to us. If our third-party service providers cannot adequately fulfill their obligations to us on a timely and satisfactory basis or if the quality or accuracy of our clinical trial data is compromised due to failure to adhere to our protocols or regulatory requirements, or if such third parties otherwise fail to meet deadlines, our development plans may be delayed or terminated.
We have no sales, marketing or distribution experience and would have to invest significant financial and management resources to establish these capabilities.
We have no sales, marketing or distribution experience. We currently expect to rely heavily on third parties to launch and market certain of our products, if approved. However, if we elect to develop internal sales, distribution and marketing capabilities, we will need to invest significant financial and management resources. For products where we decide to perform sales, marketing and distribution functions ourselves, we could face a number of additional risks, including:
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we may not be able to attract and build a significant marketing or sales force;
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the cost of establishing a marketing or sales force may not be justifiable in light of the revenues generated by any particular product; and
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our direct sales and marketing efforts may not be successful.
If we are unable to develop our own sales, marketing and distribution capabilities, we will not be able to successfully commercialize our products, if approved, without reliance on third parties.
We will rely on third-party manufacturers to manufacture our products (if approved) in commercial quantities, which could delay, prevent or increase the costs associated with the future commercialization of our products.
Our product candidates have not yet been manufactured for commercial use. If any of our product candidates become approved for commercial sale, in order to supply our or our collaborators’ commercial requirements for such an approved product, we will need to establish third-party manufacturing capacity. Any third-party manufacturing partner may be required to fund capital improvements to support the scale-up of manufacturing and related activities. The third-party manufacturer may not be able to establish scaled manufacturing capacity for an approved product in a timely or economic manner, if at all. If a manufacturer is unable to provide commercial quantities of such an approved product, we will have to successfully transfer manufacturing technology to a new manufacturer. Engaging a new manufacturer for such an approved product could require us to conduct comparative studies or utilize other means to determine bioequivalence of the new and prior manufacturers’ products, which could delay or prevent our ability to commercialize such an approved product. If any of these manufacturers is unable or unwilling to increase its manufacturing capacity or if we are unable to establish alternative arrangements on a timely basis or on acceptable terms, the development and commercialization of such an approved product may be delayed or there may be a shortage in supply. Any inability to manufacture our products in sufficient quantities when needed would seriously harm our business.
Manufacturers of our approved products, if any, must comply with current good manufacturing practices (cGMP) requirements enforced by the FDA and Health Canada through facilities inspection programs. These requirements include quality control, quality assurance, and the maintenance of records and documentation. Manufacturers of our approved products, if any, may be unable to comply with these cGMP requirements and with other FDA, Health Canada, state, and foreign regulatory requirements. We have little control over our manufacturers’ compliance with these regulations and standards. A failure to comply with these requirements may result in fines and civil penalties, suspension of production, suspension or delay in product approval, product seizure or recall, or withdrawal of product approval. If the safety of any quantities supplied is compromised due to our manufacturer’s failure to adhere to applicable laws or for other reasons, we may not be able to obtain regulatory approval for or successfully commercialize our products, which would seriously harm our business.
Risks Related to Our Financial Results and Need for Financing
We will require substantial additional capital to fund our operations. If additional capital is not available, we may need to delay, limit or eliminate our research, development and commercialization processes and may need to undertake a restructuring.
Within the next several years, substantial additional funds will be required to continue with the active development of our pipeline products and technologies. In particular, our funding needs may vary depending on a number of factors including:
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revenues earned from our partners, including Alnylam, Gritstone, and Spectrum;
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closure costs associated with our organizational restructuring and expected savings from gains in efficiency:
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the extent to which we continue the development of our product candidates or form collaborative relationships to advance our products;
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our decisions to in-license or acquire additional products or technology for development;
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our ability to attract and retain corporate partners, and their effectiveness in carrying out the development and ultimate commercialization of our product candidates;
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whether batches of drugs that we manufacture fail to meet specifications resulting in delays and investigational and remanufacturing costs;
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the decisions, and the timing of decisions, made by health regulatory agencies regarding our technology and products;
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competing technological and market developments;
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prosecuting and enforcing our patent claims and other intellectual property rights; and
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impact of the potential spin out of certain of Arbutus' assets.
We will seek to obtain funding to maintain and advance our business from a variety of sources including public or private equity or debt financing, collaborative arrangements with pharmaceutical and biotechnology companies, licensing our LNP technology, and government grants and contracts. There can be no assurance that funding will be available at all or on acceptable terms to permit further development of our products especially in light of the current difficult climate for investment in biotechnology companies.
If adequate funding is not available, we may be required to delay, reduce or eliminate one or more of our research or development programs or reduce expenses associated with non-core activities. We may need to obtain funds through arrangements with collaborators or others that may require us to relinquish most or all of our rights to product candidates at an earlier stage of development or on less favorable terms than we would otherwise seek if we were better funded. Insufficient financing may also mean failing to prosecute our patents or relinquishing rights to some of our technologies that we would otherwise develop or commercialize.
We have incurred losses in nearly every year since our inception and we anticipate that we will not achieve sustained profits for the foreseeable future. To date, we have had no product revenues.
With the exception of the years ended December 31, 2006 and December 31, 2012, we have incurred losses each fiscal year since inception until December 31, 2017 and have not received any revenues other than from research and development collaborations, royalties, license fees and milestone payments. From inception to December 31, 2017, we have an accumulated net deficit of $738.1 million. As we continue our research and development and clinical trials and seek regulatory approval for the sale of our product candidates, we do not expect to attain sustained profitability for the foreseeable future. We do not expect to achieve sustained profits until such time as strategic alliance payments, product sales and royalty payments, if any, generate sufficient revenues to fund our continuing operations. We cannot predict if we will ever achieve profitability and, if we do, we may not be able to remain consistently profitable or increase our profitability.
We are subject to risks associated with currency fluctuations, and changes in foreign currency exchange rates could impact our results of operations.
Prior to January 1, 2016, our functional currency was the Canadian dollar. On January 1, 2016, our functional currency changed from the Canadian dollar to the U.S. dollar based on our analysis of the changes in the primary economic environment in which we operate. As a result, changes in the exchange rate between the Canadian dollar and the U.S. dollar could materially impact our reported results of operations and distort period to period comparisons. In particular, to the extent that foreign currency-denominated (i.e., non-U.S. dollar) monetary assets do not equal the amount of our foreign currency denominated monetary liabilities, foreign currency gains or losses could arise and materially impact our financial statements. As a result of such foreign currency fluctuations, it could be more difficult to detect underlying trends in our business and results of operations. In addition, to the extent that fluctuations in currency exchange rates cause our results of operations to differ from our expectations or the expectations of our investors, the trading price of our Common Shares could be adversely affected.
From time to time, we may engage in exchange rate hedging activities in an effort to mitigate the impact of exchange rate fluctuations. Any hedging technique we implement may fail to be effective. If our hedging activities are not effective, changes in currency exchange rates may have a more significant impact on our financial results and the trading price of our common shares.
Changes in tax laws or exposures to additional tax liabilities could negatively impact our operating results.
Changes in tax laws or regulations could negatively impact our effective tax rate and results of operations. On December 22, 2017, the U.S. enacted The Tax Cuts and Jobs Act (the TCJA). The TCJA introduces significant changes to U.S. corporate income tax law that will have a meaningful impact on our provision for income taxes. Such changes include, among other things, reducing the marginal U.S. corporate income tax rate from 35 percent to 21 percent, introducing a capital investment deduction, limiting the current deduction for net interest expense, limiting the use of net operating losses to offset future taxable income and making extensive changes to the way in which income earned outside the U.S. is taxed in the U.S. Accounting for the income tax effects of the TCJA requires significant judgments to be made in interpreting its provisions. Due to the timing of the enactment and the complexity involved in applying the provisions of the TCJA, we made reasonable estimates of the effects and recorded provisional amounts in the financial statements for fiscal year 2017. These provisional amounts are based on the initial analysis of the TCJA. Anticipated guidance from the U.S. Treasury about implementing the TCJA, and the potential for additional guidance from the Securities and Exchange Commission or the Financial Accounting Standards Board related to the TCJA, may result in adjustments to these estimates which could materially affect our financial position and results of operations as well as the effective tax rate in the period in which the adjustments are made.
Risks Related to Managing Our Operations
Our planned reorganization, including a site consolidation and organizational restructuring, may cause disruptions in the operation of our business and may not yield the anticipated benefits.
On February 8, 2018 we announced a site consolidation and organizational restructuring to better align our HBV business in Warminster, PA. To achieve this alignment, we will reduce our global workforce by approximately 31% and plan to close our Burnaby facility. We will incur restructuring costs related to one-time employee termination benefits, employee relocation costs, and site closure costs currently estimated to be $5.0 million, which will be primarily paid in cash in the second quarter of 2018. The reorganization may negatively affect our current business operations, including disrupting clinical development and harming relationships with employees, existing or potential customers, and collaborators. Further, the restructuring may exceed estimated costs and may not follow the anticipated timeline. We may not experience the anticipated benefits of the restructuring to the extent expected.
If we are unable to attract and retain qualified key management, scientific staff, consultants and advisors, our ability to implement our business plan may be adversely affected.
We depend upon our senior executive officers as well as key scientific, management and other personnel. The competition for qualified personnel in the biotechnology field is intense. We rely heavily on our ability to attract and retain qualified managerial, scientific and technical staff. The loss of the service of any of the members of our senior management, including Dr. Mark Murray, our President and Chief Executive Officer, may adversely affect our ability to develop our technology, add to our pipeline, advance our product candidates and manage our operations. We recently experienced turnover in our Chief Financial Officer role and currently have an interim Chief Financial Officer in place. We will be searching for a new, permanent Chief Financial Officer which may prove difficult and may take an extended period of time due to the competition to hire from a limited pool of qualified candidates. This transition period may prove to be disruptive to our business and may inhibit our ability to execute our business plan efficiently. We do not carry key person life insurance on any of our employees.
We rely on consultants and advisors, including scientific and clinical advisors, to assist us in formulating our research and development and commercialization strategy. Our consultants and advisors may be employed by other entities and may have commitments under consulting or advisory contracts with those entities that may limit their availability to us. If we are unable to continue to attract and retain highly qualified personnel, our ability to develop and commercialize our product candidates will be limited.
We may have difficulty managing our growth and expanding our operations successfully as we seek to evolve from a company primarily involved in discovery and preclinical testing into one that develops products through clinical development and commercialization.
As product candidates we develop enter and advance through clinical trials, we will need to expand our development, regulatory, manufacturing, clinical and medical capabilities or contract with other organizations to provide these capabilities for us. As our operations expand, we expect that we will need to manage additional relationships with various collaborators, suppliers and other organizations. Our ability to manage our operations and growth will require us to continue to improve our operational, financial and management controls, reporting systems and procedures. We may not be able to implement improvements to our management information and control systems in an efficient or timely manner and may discover deficiencies in existing systems or controls.
We could face liability from our controlled use of hazardous and radioactive materials in our research and development processes.
We use certain radioactive materials, biological materials and chemicals, including organic solvents, acids and gases stored under pressure, in our research and development activities. Our use of radioactive materials is regulated by the Canadian Nuclear Safety Commission and the U.S. Nuclear Regulatory Commission for the possession, transfer, import, export, use, storage, handling and disposal of radioactive materials. Our use of biological materials and chemicals, including the use, manufacture, storage, handling and disposal of such materials and certain waste products is regulated by a number of federal, state and local laws and regulations. Although we believe that our safety procedures for handling such materials comply with the standards prescribed by such laws and regulations, the risk of accidental contamination or injury from these materials cannot be completely eliminated. In the event of such an accident, we could be held liable for any damages that result and any such liability could exceed our resources. We are not specifically insured with respect to this liability.
Our business, reputation, and operations could suffer in the event of information technology system failures, such as a cybersecurity breach.
We are increasingly dependent on sophisticated software applications and computing infrastructure to conduct critical operations. Disruption, degradation, or manipulation of these applications and systems through intentional or accidental means could impact key business processes. Despite the implementation of security measures, our internal computer systems and those of our contractors and consultants are vulnerable to damage from computer viruses, cybersecurity breaches and other forms of unauthorized access, as well as natural disasters, terrorism, war, and telecommunication and electrical failures. Such events could result in exposure of confidential information, the modification of critical data, and/or the failure or interruption of critical operations. For example, the loss of pre-clinical trial data or data from completed or ongoing clinical trials for our product candidates could result in delays in our regulatory filings and development efforts and significantly increase our costs. To the extent that any disruption or security breach will result in a loss of or damage to our data, or inappropriate disclosure of confidential or proprietary information, we could incur liability and the development of our product candidates could be delayed. While we have implemented security measures, including controls over unauthorized access, our internal computer systems and those of our contractors and consultants are vulnerable to damage from these events. There can be no assurance that our efforts to protect data and systems will prevent service interruption or the loss of critical or sensitive information from our or third party providers’ databases or systems that could result in financial, legal, business or reputational harm to us or that our insurance would provide any or adequate coverage of any such loss.
If we fail to maintain an effective system of internal control over financial reporting, we may not be able to accurately report our financial reports, which could have a material adverse effect on our stock price and our ability to raise capital.
A failure to maintain effective internal control over financial reporting or disclosure controls and procedures could adversely affect our ability to report our financial results accurately and on a timely basis, which could result in material misstatement in our financial statements, a loss of investor confidence in our financial reporting or adversely affect our access to sources of liquidity. Furthermore, because of the inherent limitations of any system of internal control over financial reporting, including the possibility of human error, the circumvention or overriding of controls and fraud, even effective internal controls may not prevent or detect all misstatements. Frequent or rapid changes in procedures, methodologies, systems and technology exacerbate the challenge of developing and maintaining a system of internal controls and can increase the cost and level of effort to develop and maintain such systems.
See Item 9A, "Controls and Procedures" in this Form 10-K for additional information and management's assessment of internal controls.
We rely on and will incur additional expense in connection with our research collaboration with Blumberg.
In June 2016, Arbutus Inc. entered into an amended agreement with Blumberg under which Arbutus Inc. will provide annual funding in the amount of $1.1 million per year through October 29, 2018, and which is renewable for two additional one year terms at our option, for Blumberg to conduct research projects in HBV and liver cancer pursuant to a research plan to be agreed upon by the parties. In exchange, Arbutus Inc. has the right to obtain an exclusive, royalty bearing, worldwide license to intellectual property generated by Blumberg in the course of the funded research and we believe that Blumberg’s HBV research platform will continue to be a source of potentially novel hepatitis B targets, drug candidates, assays and other HBV specific technologies. As a result, we are dependent, in part, upon the success of Blumberg in performing its responsibilities under this research collaboration. Blumberg may not cooperate with us or perform its obligations under the agreement. We cannot control the amount and timing of Blumberg’s resources that will be devoted to research and development activities related to our research collaboration. Further, development costs associated with our research projects may be difficult to anticipate and exceed our expectations. If funding is unable to continue to financially support the collaboration, if we do not obtain exclusive licenses from Blumberg to the resulting intellectual property, or if we fail to comply with our obligations under those license agreements, its development efforts may be materially harmed.
Risks Related to Development, Clinical Testing and Regulatory Approval of Our Product Candidates
If testing of a particular product candidate does not yield successful results, then we will be unable to commercialize that product candidate.
We must demonstrate our product candidates’ safety and efficacy in humans through extensive clinical testing. Our research and development programs are at an early stage of development. We may experience numerous unforeseen events during, or as a result of, the testing process that could delay or prevent commercialization of any products, including the following:
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decreased demand for our product candidates;
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impairment of our business reputation;
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withdrawal of clinical trial participants;
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costs of related litigation;
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substantial monetary awards to patients or other claimants;
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loss of revenues; and
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inability to commercialize our product candidates.
Although we currently have product liability insurance coverage for our clinical trials for expenses or losses, our insurance coverage is limited to $10 million per occurrence, and $10 million in the aggregate, and may not reimburse us or may not be sufficient to reimburse us for any or all expenses or losses we may suffer. Moreover, insurance coverage is becoming increasingly expensive and, in the future, we may not be able to maintain insurance coverage at a reasonable cost or in sufficient amounts to protect us against losses due to liability. We intend to expand our insurance coverage to include the sale of commercial products if we obtain marketing approval for our product candidates in development, but we may be unable to obtain commercially reasonable product liability insurance for any products approved for marketing. On occasion, large judgments have been awarded in class action lawsuits based on products that had unanticipated side effects. A successful product liability claim or series of claims brought against us could cause our stock price to fall and, if judgments exceed our insurance coverage, could decrease our cash and adversely affect our business.
The manufacture and sale of human therapeutic products are governed by a variety of statutes and regulations. There can be no assurance that our product candidates will obtain regulatory approval.
To obtain marketing approval, U.S. and Canadian laws require:
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controlled research and human clinical testing;
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establishment of the safety and efficacy of the product for each use sought;
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government review and approval of a submission containing manufacturing, pre-clinical and clinical data;
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adherence to Good Manufacturing Practice Regulations during production and storage; and
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control of marketing activities, including advertising and labeling.
The product candidates we currently have under development will require significant development, preclinical and clinical testing and investment of significant funds before their commercialization. Some of our product candidates, if approved, will require the completion of post-market studies. There can be no assurance that such products will be developed. The process of completing clinical testing and obtaining required approvals is likely to take a number of years and require the use of substantial resources. If we fail to obtain regulatory approvals, our operations will be adversely affected. Further, there can be no assurance that product candidates employing a new technology will be shown to be safe and effective in clinical trials or receive applicable regulatory approvals.
Other markets have regulations and restrictions similar to those in the U.S. and Canada. Investors should be aware of the risks, problems, delays, expenses and difficulties which we may encounter in view of the extensive regulatory environment which affects our business in any jurisdiction where we develop product candidates.
Research and development goals may not be achieved in the time frames that we publicly estimate, which could have an adverse impact on our business and could cause our stock price to decline.
We set goals, and make public statements regarding our expectations, regarding the timing of certain accomplishments, developments and milestones under our research and development programs. The actual timing of these events can vary significantly due to a number of factors, including, without limitation, the amount of time, effort and resources committed to our programs by us and any collaborators and the uncertainties inherent in the clinical development and regulatory approval process. As a result, there can be no assurance that we or any collaborators will initiate or complete clinical development activities, make regulatory submissions or receive regulatory approvals as planned or that we or any collaborators will be able to adhere to our current schedule for the achievement of key milestones under any of our programs. If we or any collaborators fail to achieve one or more of the milestones as planned, our business could be materially adversely affected and the price of our Common Shares could decline.
Recently enacted and future legislation may increase the difficulty and cost for us to obtain marketing approval of and commercialize our drug candidates and affect the prices we may obtain.
In the United States and some foreign jurisdictions, there have been a number of legislative and regulatory changes and proposed changes regarding the healthcare system that could, among other things, prevent or delay marketing approval of our drug candidates, restrict or regulate post approval activities and affect our ability to profitably sell any products for which we obtain marketing approval.
For example, in March 2010, the Patient Protection and Affordable Care Act, as amended by the Health Care Education Reconciliation Act, or collectively the Affordable Care Act, was enacted to broaden access to health insurance, reduce or constrain the growth of healthcare spending, enhance remedies against fraud and abuse, add new transparency requirements for health care and health insurance industries, impose new taxes and fees on the health industry and impose additional health policy reforms. Additionally, the Drug Supply Chain Security Act, enacted in 2013, imposed new obligations on manufacturers of pharmaceutical products related to product tracking and tracing.
Members of Congress and the Trump Administration have considered legislation to fundamentally change or repeal the Affordable Care Act. While Congress has not passed repeal legislation to date, the Tax Cuts and Jobs Act
(TCJA) includes a provision repealing the individual insurance coverage mandate included in the Affordable Care Act, effective January 1, 2019. Further, President Trump signed an Executive Order directing federal agencies with authorities and responsibilities under the Affordable Care Act to waive, defer, grant exemptions from, or delay the implementation of any provision of the Affordable Care Act that would impose a fiscal or regulatory burden on states, individuals, healthcare providers, health insurers, or manufacturers of pharmaceuticals or medical devices. On October 13, 2017, the President signed an Executive Order terminating the cost-sharing subsidies that reimburse insurers under the Affordable Care Act. Several state Attorneys General filed suit to stop the administration from terminating the subsidies, but their request for a restraining order was denied by a federal judge in California on October 25, 2017. In addition, the Centers for Medicare and Medicaid Services has recently proposed regulations that would give states greater flexibility in setting benchmarks for insurers in the individual and small group marketplaces, which may have the effect of relaxing the essential health benefits required under the Affordable Care Act for plans sold through such marketplaces. Congress may consider other legislation to replace elements of the Affordable Care Act. The implications of the Affordable Care Act, its possible repeal, any legislation that may be proposed to replace the Affordable Care Act, or the political uncertainty surrounding any repeal or replacement legislation for our business and financial condition, if any, are not yet clear.
We cannot predict what healthcare reform initiatives may be adopted in the future. Further federal and state legislative and regulatory developments are likely, and we expect ongoing initiatives in the United States to increase pressure on drug pricing. Such reforms could have an adverse effect on anticipated revenues from product candidates that we may successfully develop and for which we may obtain regulatory approval and may affect our overall financial condition and ability to develop drug candidates.
Legislative and regulatory proposals have also been made to expand post approval requirements and restrict sales and promotional activities for pharmaceutical products. Any healthcare reforms enacted in the future may, like the Affordable Care Act, be phased in over a number of years but, if enacted, could reduce our revenue, increase our costs, or require us to revise the ways in which we conduct business or put us at risk for loss of business. We are not sure whether additional legislative changes will be enacted, or whether the current regulations, guidance or interpretations will be changed, or what the impact of such changes on our business, if any, may be.
Coverage and adequate reimbursement may not be available for our drug candidates, which could make it difficult for us to sell our products profitably.
Market acceptance and sales of any drug candidates that we develop will depend in part on the extent to which reimbursement for these products and related treatments will be available from third party payors, including government health administration authorities and private health insurers. Third party payors decide which drugs they will pay for and establish reimbursement levels. Third party payors often rely upon Medicare coverage policy and payment limitations in setting their own reimbursement policies. However, decisions regarding the extent of coverage and amount of reimbursement to be provided for each of our drug candidates will be made on a plan by plan basis. One payor's determination to provide coverage for a product does not assure that other payors will also provide coverage, and adequate reimbursement, for the product. Additionally, a third party payor's decision to provide coverage for a drug does not imply that an adequate reimbursement rate will be approved. Each plan determines whether or not it will provide coverage for a drug, what amount it will pay the manufacturer for the drug, and on what tier of its formulary the drug will be placed. The position of a drug on a formulary generally determines the copayment that a patient will need to make to obtain the drug and can strongly influence the adoption of a drug by patients and physicians. Patients who are prescribed treatments for their conditions and providers performing the prescribed services generally rely on third party payors to reimburse all or part of the associated healthcare costs. Patients are unlikely to use our products unless coverage is provided and reimbursement is adequate to cover a significant portion of the cost of our products.
A primary trend in the U.S. healthcare industry and elsewhere is cost containment. Third party payors have attempted to control costs by limiting coverage and the amount of reimbursement for particular medications. We cannot be sure that coverage and reimbursement will be available for any product that we commercialize and, if reimbursement is available, what the level of reimbursement will be. Inadequate coverage and reimbursement may impact the demand for, or the price of, any product for which we obtain marketing approval. If coverage and adequate reimbursement is not available, or is available only to limited levels, we may not be able to successfully commercialize any drug candidates that we develop.
Additionally, there have been a number of legislative and regulatory proposals to change the healthcare system in the United States and in some foreign jurisdictions that could affect our ability to sell any future drugs profitably. These legislative and regulatory changes may negatively impact the reimbursement for any future drugs, following approval.
We are subject to U.S. and Canadian healthcare laws and regulations, which could expose us to criminal sanctions, civil penalties, contractual damages, reputational harm, fines, disgorgement, exclusion from participation in government healthcare programs, curtailment or restricting of our operations and diminished profits and future earnings.
Healthcare providers, physicians and others will play a primary role in the recommendation and prescription of any products for which we obtain marketing approval. Our future arrangements with healthcare providers, patients and third party payors will expose us to broadly applicable U.S. and Canadian fraud and abuse and other healthcare laws and regulations that may constrain the business or financial arrangements and collaborative partners through which we market, sell and distribute any products for which we obtain marketing approval.
Efforts to ensure that our collaborations with third parties, and our business generally, will comply with applicable U.S. and Canadian healthcare laws and regulations will involve substantial costs. It is possible that governmental authorities will conclude that our business practices may not comply with current or future statutes, regulations or case law involving applicable fraud and abuse or other healthcare laws and regulations. If our operations are found to be in violation of any of these laws or any other governmental laws and regulations that may apply to us, we may be subject to significant civil, criminal and administrative penalties, damages, fines, imprisonment, exclusion of products from government funded healthcare programs, contractual damages, reputational harm, disgorgement, curtailment or restricting of our operations, any of which could substantially disrupt our operations and diminish our profits and future earnings. If any of the physicians or other providers or entities with whom we expect to do business is found not to be in compliance with applicable laws, they may be subject to criminal, civil or administrative sanctions, including exclusions from government funded healthcare programs. The risk of our being found in violation of these laws is increased by the fact that many of them have not been fully interpreted by the regulatory authorities or the courts, and their provisions are open to a variety of interpretations.
Risks Related to Patents, Licenses and Trade Secrets
Other companies or organizations may assert patent rights that prevent us from developing or commercializing our products.
RNA interference and capsid inhibitors as well as our other novel HBV assets are relatively new scientific fields that have generated many different patent applications from organizations and individuals seeking to obtain patents in the field. These applications claim many different methods, compositions and processes relating to the discovery, development and commercialization of these therapeutic products. Because the field is so new, very few of these patent applications have been fully processed by government patent offices around the world, and there is a great deal of uncertainty about which patents will be issued, when, to whom, and with what claims. It is likely that there could be litigation and other proceedings, such as interference and opposition proceedings in various patent offices, relating to patent rights in RNAi, capsid inhibitors and other small molecule compounds targeted at HBV.
In addition, there are many issued and pending patents that claim aspects of RNAi trigger chemistry technology that we may need to apply to our product candidates. There are also many issued patents that claim genes or portions of genes that may be relevant for RNAi trigger drug products we wish to develop. Thus, it is possible that one or more organizations will hold patent rights to which we will need a license. If those organizations refuse to grant us a license to such patent rights on reasonable terms, we will not be able to market products or perform research and development or other activities covered by these patents.
Our patents and patent applications may be challenged and may be found to be invalid, which could adversely affect our business.
Certain Canadian, U.S. and international patents and patent applications we own involve complex legal and factual questions for which important legal principles are largely unresolved. For example, no consistent policy has emerged for the breadth of biotechnology patent claims that are granted by the U.S. Patent and Trademark Office or enforced by the U.S. federal courts. In addition, the coverage claimed in a patent application can be significantly reduced before a patent is issued. Also, we face the following intellectual property risks:
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some or all patent applications may not result in the issuance of a patent;
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patents issued may not provide the holder with any competitive advantages;
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patents could be challenged by third parties;
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the patents of others, including Alnylam, could impede our ability to do business;
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competitors may find ways to design around our patents; and
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competitors could independently develop products which duplicate our products.
A number of industry competitors and institutions have developed technologies, filed patent applications or received patents on various technologies that may be related to or affect our business. Some of these technologies, applications or patents may conflict with our technologies or patent applications. Such conflict could limit the scope of the patents, if any, that we may be able to obtain or result in the denial of our patent applications. In addition, if patents that cover our activities are issued to other companies, there can be no assurance that we would be able to obtain licenses to these patents at a reasonable cost or be able to develop or obtain alternative technology. If we do not obtain such licenses, we could encounter delays in the introduction of products, or could find that the development, manufacture or sale of products requiring such licenses is prohibited. In addition, we could incur substantial costs in defending patent infringement suits brought against us or in filing suits against others to have such patents declared invalid. As publication of discoveries in the scientific or patent literature often lags behind actual discoveries, we cannot be certain we or any licensor was the first creator of inventions covered by pending patent applications or that we or such licensor was the first to file patent applications for such inventions. Any future proceedings could result in substantial costs, even if the eventual outcomes are favorable. There can be no assurance that our patents, if issued, will be held valid or enforceable by a court or that a competitor’s technology or product would be found to infringe such patents.
Our business depends, in part, on our ability to use RNAi technology that we have licensed or will in the future license from third parties, including Alnylam, and, if these licenses were terminated or if we were unable to license additional technology we may need in the future, our business will be adversely affected.
We currently hold licenses for certain technologies that are or may be applicable to our current and subsequent product candidates. These include a license to patents held or applied for by Alnylam and a license to UNA technology from Arcturus Therapeutics. The licenses are subject to termination in the event of a breach by us of the license, if we fail to cure the breach following notice and the passage of a cure period. The UBC license, which is sublicensed to Alnylam, is subject to termination with respect to one or more particular patents if we and Alnylam were to cease patent prosecution or maintenance activities with respect to such patent(s), or in the event of a breach by us of the license, if we fail to cure the breach following notice and the passage of a cure period. There can be no assurance that these licenses will not be terminated. We may need to acquire additional licenses in the future to technologies developed by others, including Alnylam. For example, Alnylam has granted us a worldwide license for the discovery, development and commercialization of RNAi products directed to thirteen gene targets (three exclusive and ten non-exclusive licenses). Licenses for the five non-exclusive targets and one exclusive target have already been granted. We have rights to select the gene targets for up to two more exclusive licenses and five more nonexclusive licenses from Alnylam, which would be made available to us only if they have not been previously selected by Alnylam or one of its other partners. This will limit the targets available for selection by us, and we may never be able to select gene targets or may be required to make our selection from gene targets that have minimal commercial potential. Furthermore, future license agreements may require us to make substantial milestone payments. We will also be obligated to make royalty payments on the sales, if any, of products resulting from licensed RNAi technology. For some of our licensed RNAi technology, we are responsible for the costs of filing and prosecuting patent applications. The termination of a license or the inability to license future technologies on acceptable terms may adversely affect our ability to develop or sell our products.
Our business depends, in part, on our ability to use the technology that we have licensed or will in the future license from third parties, including Blumberg, and, if these licenses were terminated or if we were unable to license additional technology we may need in the future, our business will be adversely affected.
We have licensed certain of our intellectual property from Blumberg. Our current technology licenses are important to our business and we expect to enter into additional licenses in the future. If we fail to comply with our obligations under these agreements or any future license agreements, we may be subject to a bankruptcy, or if we grant a sublicense in the future and our sublicense does not comply with our obligations under these agreements or becomes subject to a bankruptcy, the licensor may have the right to terminate the license, in which event we would not be able to develop or market products covered by the license or may face other penalties under the agreements, which could have a materially adverse effect on our business. In addition, applicable laws involving bankruptcy or similar proceeding by licensors in some jurisdictions outside the United States may provide the trustee or receiver in such proceeding with the right to set aside or otherwise terminate or seek to modify the license. Any termination of these agreements or reduction or elimination of our rights under these agreements may result in our having to negotiate new or amended agreements with less favorable terms, or cause us to lose our rights under these agreements, including our rights to important intellectual property and technologies that form the basis of our technology, which may then be in licensed by one or more of our competitors.
We may incur substantial costs as a result of litigation or other proceedings relating to patent and other intellectual property rights which could have a material adverse effect on our business, financial condition and results of operations and could cause the market value of our Common Shares to decline.
There has been significant litigation in the biotechnology industry over contractual obligations, patents and other proprietary rights, and we may become involved in various types of litigation that arise from time to time. Involvement in litigation could consume a substantial portion of our resources, regardless of the outcome of the litigation. Counterparties in litigation may be better able to sustain the costs of litigation because they have substantially greater resources. If claims against us are successful, in addition to any potential liability for damages, we could be required to obtain a license, grant cross-licenses, and pay substantial milestones or royalties in order to continue to develop, manufacture or market the affected products. Involvement and continuation of involvement in litigation may result in significant and unsustainable expense, and divert management’s attention from ongoing business concerns and interfere with our normal operations. Litigation is also inherently uncertain with respect to the time and expenses associated therewith, and involves risks and uncertainties in the litigation process itself, such as discovery of new evidence or acceptance of unanticipated or novel legal theories, changes in interpretation of the law due to decisions in other cases, the inherent difficulty in predicting the decisions of judges and juries and the possibility of appeals. Ultimately we could be prevented from commercializing a product or be forced to cease some aspect of our business operations as a result of claims of patent infringement or violation of other intellectual property rights and the costs associated with litigation, which could have a material adverse effect on our business, financial condition, and operating results and could cause the market value of our Common Shares to decline.
Confidentiality agreements with employees and others, including collaborators, may not adequately prevent disclosure of trade secrets and other proprietary information.
Much of our know-how and technology may constitute trade secrets. There can be no assurance, however, that we will be able to meaningfully protect our trade secrets. In order to protect our proprietary technology and processes, we rely in part on confidentiality agreements with our collaborators, employees, vendors, consultants, outside scientific collaborators and sponsored researchers, and other advisors. These agreements may not effectively prevent disclosure of confidential information and may not provide an adequate remedy in the event of unauthorized disclosure of confidential information. In addition, others may independently discover trade secrets and proprietary information, and in such cases we could not assert any trade secret rights against such party. Costly and time consuming litigation could continue to be necessary to enforce and determine the scope of our proprietary rights, and failure to obtain or maintain trade secret protection could adversely affect our competitive business position.
We have licensed important portions of our intellectual property from Blumberg and Drexel, and are subject to significant obligations under those license agreements.
The rights we hold under our license agreements with Blumberg and Drexel are important to our business. Our discovery and development platform is built, in part, around patents exclusively in licensed from these parties.
We have licenses with Blumberg and Drexel, both directly and through its acquisition of Enantigen, that grant us the exclusive (except in some cases as to know how that is not unique or specific to the licensed products or compound series, which are non-exclusive and subject to retained rights for non-commercial research use), worldwide license to make, have made, use, import, offer for sale and sell products incorporating one or more licensed compounds, which include capsid assembly inhibitors, inhibitors of secretion of HBV antigens, cccDNA inhibitors and hepatocellular carcinoma inhibitors, either for general use in humans or for use in the field of HBV research, diagnosis and treatment.
Under our agreements with Blumberg and Drexel, we are subject to significant obligations, including diligence obligations with respect to development and commercialization activities, payment obligations upon achievement of certain milestones and royalties on product sales, as well as other material obligations. Under our direct agreement with Blumberg and Drexel, we agreed to pay up to $3.5 million in development and regulatory milestones per licensed compound series, up to $92.5 million in sales performance milestones per licensed product, and royalties in the mid-single digits in connection with the sale of licensed products. Under each of the three license agreements that our subsidiary, Enantigen, has with Blumberg and Drexel, we are obligated to pay up to $0.5 million in development and regulatory milestones per licensed product and royalties in the low single digits in connection with the sale of licensed products. If these payments become due under the terms of the agreements, we may be negatively affected.
If there is any conflict, dispute, disagreement or issue of non-performance between us and Blumberg and Drexel regarding our rights or obligations under these license agreements, including any conflict, dispute or disagreement arising from our failure to satisfy diligence or payment obligations under such agreements, Blumberg and Drexel may have a right to terminate the license. The loss of any of these license agreements could materially and adversely affect our ability to use intellectual property that could be critical to our drug discovery and development efforts, as well as our ability to enter into future collaboration, licensing and/or marketing agreements for one or more affected drug candidates or development programs.
Some of our licensors have retained rights to develop and commercialize certain of our drug candidates to treat diseases other than HBV and, as a result, our development and commercialization efforts may be negatively affected.
Our license agreements provide us with the rights to develop and commercialize our drug candidates for HBV; however, some of our licensors have retained rights to develop and commercialize certain of its drug candidates to treat diseases other than HBV, and to license those rights to other third parties.
Risks Related to Competition
The pharmaceutical market is intensely competitive. If we are unable to compete effectively with existing drugs, new treatment methods and new technologies, we may be unable to successfully commercialize any product candidates that we develop.
The pharmaceutical market is intensely competitive and rapidly changing. Many large pharmaceutical and biotechnology companies, academic institutions, governmental agencies and other public and private research organizations are pursuing the development of novel drugs for the same diseases that we are targeting or expect to target. Many of our competitors have:
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much greater financial, technical and human resources than we have at every stage of the discovery, development, manufacture and commercialization process;
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more extensive experience in pre-clinical testing, conducting clinical trials, obtaining regulatory approvals, and in manufacturing, marketing and selling pharmaceutical products;
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product candidates that are based on previously tested or accepted technologies;
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products that have been approved or are in late stages of development; and
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collaborative arrangements in our target markets with leading companies and research institutions.
We will face intense competition from products that have already been approved and accepted by the medical community for the treatment of the conditions for which we are currently developing products. We also expect to face competition from new products that enter the market. We believe a significant number of products are currently under development, and may become commercially available in the future, for the treatment of conditions for which we may try to develop products. These products, or other of our competitors’ products, may be more effective, safer, less expensive or marketed and sold more effectively than any products we develop.
We are aware of several companies that are working to develop drugs that would compete against our drug candidates for HBV treatment. As a significant unmet medical need exists for HBV, there are several large and small pharmaceutical companies focused on delivering therapeutics for treatment of HBV. Further, it is likely that additional drugs will become available in the future for the treatment of HBV. We will face competition from other drugs currently approved or that will be approved in the future for the treatment of chronic hepatitis B.
We anticipate significant competition in the HBV market with several early phase product candidates announced. We will also face competition for other product candidates that we expect to develop in the future.
If we successfully develop product candidates, and obtain approval for them, we will face competition based on many different factors, including the following:
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safety and effectiveness of our products;
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ease with which our products can be administered and the extent to which patients and physicians accept new routes of administration;
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timing and scope of regulatory approvals for these products;
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availability and cost of manufacturing, marketing and sales capabilities;
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price;
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reimbursement coverage; and
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patent position.
Our competitors may develop or commercialize products with significant advantages over any products we develop based on any of the factors listed above or on other factors. Our competitors may therefore be more successful in commercializing their products than we are, which could adversely affect our competitive position and business. Competitive products may make any products we develop obsolete or uncompetitive before we can recover the expenses of developing and commercializing our product candidates. Such competitors could also recruit our employees, which could negatively impact our level of expertise and the ability to execute on our business plan. Furthermore, we also face competition from existing and new treatment methods that reduce or eliminate the need for drugs, such as the use of advanced medical devices. The development of new medical devices or other treatment methods for the diseases we are targeting and may target could make our product candidates non-competitive, obsolete or uneconomical.
We face competition from other companies that are working to develop novel products using technology similar to ours. If these companies develop products more rapidly than we do or their technologies, including delivery technologies, are more effective than ours, then our ability to successfully commercialize products will be adversely affected.
We face significant competition from other biotechnology and pharmaceutical companies targeting HBV.
As a significant unmet medical need exists for HBV, there are several large and small pharmaceutical companies focused on delivering therapeutics for treatment of HBV. These companies include Gilead Sciences, Johnson and Johnson, Assembly Biosciences, Roche, Replicor, Spring Bank, Alnylam, Arrowhead, ContraVir, Dicerna, Intellia, Cocrystal, and Enanta. Further, it is likely that additional drugs will become available in the future for the treatment of HBV.
We are aware of several companies that are working to develop drugs that would compete against our drug candidates for HBV treatment. Many of our existing or potential competitors have substantially greater financial, technical and human resources than we do and significantly greater experience in the discovery and development of drug candidates, as well as in obtaining regulatory approvals of those drug candidates in the United States and in foreign countries. Our current and potential future competitors also have significantly more experience commercializing drugs that have been approved for marketing. Mergers and acquisitions in the pharmaceutical and biotechnology industries could result in even more resources being concentrated among a small number of our competitors.
Competition may increase further as a result of advances in the commercial applicability of technologies and greater availability of capital for investment in these industries. Our competitors may succeed in developing, acquiring or licensing, on an exclusive basis, drug candidates that are more effective or less costly than any drug candidate that we may develop.
We will face competition from other drugs currently approved or that will be approved in the future for the treatment of HBV. Therefore, our ability to compete successfully will depend largely on our ability to:
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discover, develop and commercialize drugs that are superior to other products in the market;
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demonstrate through our clinical trials that our drug candidates are differentiated from existing and future therapies;
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attract qualified scientific, product development and commercial personnel;
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obtain patent or other proprietary protection for our drugs and technologies;
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obtain required regulatory approvals;
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successfully collaborate with pharmaceutical companies in the discovery, development and commercialization of new drugs; and
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negotiate competitive pricing and reimbursement with third party payors.
The availability of our competitors’ products could limit the demand, and the price we are able to charge, for any drug candidate we develop. The inability to compete with existing or subsequently introduced drug candidates would have a material adverse impact on our business, financial condition and prospects.
Established pharmaceutical companies may invest heavily to accelerate discovery and development of novel compounds or to in license novel compounds that could make our drug candidates less competitive. In addition, any new product that competes with an approved product must demonstrate compelling advantages in efficacy, convenience, tolerability and safety in order to overcome price competition and to be commercially successful. Accordingly, our competitors may succeed in obtaining patent protection, discovering, developing or receiving FDA approval for or commercializing medicines before we do, which would have a material adverse impact on our business.
Risks Related to the Ownership of our Common Shares
If our stock price fluctuates, our investors could incur substantial losses.
The market price of our Common Shares may fluctuate significantly in response to factors that are beyond our control. The stock market in general has recently experienced extreme price and volume fluctuations. The market prices of securities of pharmaceutical and biotechnology companies have been extremely volatile, and have experienced fluctuations that often have been unrelated or disproportionate to the operating performance of these companies. These broad market fluctuations could result in extreme fluctuations in the price of our Common Shares, which could cause our investors to incur substantial losses.
There is no assurance that an active trading market in our Common Shares will be sustained.
Our Common Shares are listed for trading on the Nasdaq exchange. However, there can be no assurances that an active trading market in our Common Shares on these stock exchanges will be sustained.
We are incorporated in Canada, with our assets and officers located both in Canada and the United States, with the result that it may be difficult for investors to enforce judgments obtained against us or some of our officers.
Arbutus is incorporated under the laws of the Province of British Columbia and some of Arbutus' assets and officers are located outside the United States. While we have appointed National Registered Agents, Inc. as our agent for service of process to effect service of process within the United States upon us, it may not be possible for you to enforce against us or those persons in the United States, judgments obtained in U.S. courts based upon the civil liability provisions of the U.S. federal securities laws or other laws of the United States. In addition, there is doubt as to whether original action could be brought in Canada against us or our directors or officers based solely upon U.S. federal or state securities laws and as to the enforceability in Canadian courts of judgments of U.S. courts obtained in actions based upon the civil liability provisions of U.S. federal or state securities laws.
Conversely, most of Arbutus’ directors and officers reside outside Canada, and with the reorganization around Warminster, PA, the majority of Arbutus' physical assets may also be located outside Canada . While we have appointed Farris, Vaughan, Wills & Murphy LLP as our agent for service of process in Canada, it may not be possible for you to enforce in Canada against our assets or those directors and officers residing outside Canada, judgments obtained in Canadian courts based upon the civil liability provisions of the Canadian securities laws or other laws of Canada.
If we are deemed to be a “passive foreign investment company” for the current or any future taxable year, investors who are subject to United States federal taxation would likely suffer materially adverse U.S. federal income tax consequences.
We generally will be a “passive foreign investment company” under the meaning of Section 1297 of the U.S. Internal Revenue Code of 1986, as amended (the “Code”), (a “PFIC”) if (a) 75% or more of our gross income is “passive income” (generally, dividends, interest, rents, royalties, and gains from the disposition of assets producing passive income) in any taxable year, or (b) if at least 50% or more of the quarterly average value of our assets produce, or are held for the production of, passive income in any taxable year. We have determined that we have not been a PFIC for the three taxable years ended December 31, 2017. If we are a PFIC for any taxable year during which a U.S. person holds our Common Shares, it would likely result in materially adverse U.S. federal income tax consequences for such U.S. person, including, but not limited to, any gain from the sale of our Common Shares would be taxed as ordinary income, as opposed to capital gain, and such gain and certain distributions on our Common Shares would be subject to an interest charge, except in certain circumstances. It may be possible for U.S. persons to fully or partially mitigate such tax consequences by making a “qualifying electing fund election,” as defined in the Code (a “QEF Election”), but there is no assurance that we will provide such persons with the information that we are required to provide to them in order to assist them in making a QEF Election. In addition, U.S. persons that hold Common Shares issuable upon exercise of warrants are generally not eligible to make certain elections available under the Code that are intended to mitigate the adverse tax consequences of PFIC rules with respect to such warrant shares unless such holders also elect to make a deemed taxable sale of their warrant shares. The PFIC rules are extremely complex and investors are urged to consult their own tax advisers to assess the implications of these rules as applicable to their own facts and circumstances.
Our articles and certain Canadian laws could delay or deter a change of control.
Our preferred shares are available for issuance from time to time at the discretion of our board of directors, without shareholder approval. Our articles allow our board, without shareholder approval, to determine the special rights to be attached to our preferred shares, and such rights may be superior to those of our Common Shares.
In addition, limitations on the ability to acquire and hold our Common Shares may be imposed by the Competition Act in Canada. This legislation permits the Commissioner of Competition of Canada to review any acquisition of a significant interest in us. This legislation grants the Commissioner jurisdiction to challenge such an acquisition before the Canadian Competition Tribunal if the Commissioner believes that it would, or would be likely to, result in a substantial lessening or prevention of competition in any market in Canada. The Investment Canada Act subjects an acquisition of control of a company by a non-Canadian to government review if the value of our assets, as calculated pursuant to the legislation, exceeds a threshold amount. A reviewable acquisition may not proceed unless the relevant minister is satisfied that the investment is likely to result in a net benefit to Canada. Any of the foregoing could prevent or delay a change of control and may deprive or limit strategic opportunities for our shareholders to sell their shares.
The exercise of all or any number of outstanding stock options, the award of any additional options, bonus shares or other stock-based awards or any issuance of shares to raise funds or acquire a business may dilute your Common Shares.
We have in the past and may in the future grant to some or all of our directors, officers and employees options to purchase our Common Shares and other stock-based awards as non-cash incentives to those persons. The issuance of any equity securities could, and the issuance of any additional shares will, cause our existing shareholders to experience dilution of their ownership interests.
Any additional issuance of shares or a decision to acquire other businesses through the sale of equity securities may dilute our investors’ interests, and investors may suffer dilution in their net book value per share depending on the price at which such securities are sold. Such issuance may cause a reduction in the proportionate ownership and voting power of all other shareholders. The dilution may result in a decline in the price of our Common Shares or a change in control.
We do not expect to pay dividends for the foreseeable future.
We have not paid any cash dividends to date and we do not intend to declare dividends for the foreseeable future, as we anticipate that we will reinvest future earnings, if any, in the development and growth of our business. Therefore, investors will not receive any funds unless they sell their Common Shares, and shareholders may be unable to sell their shares on favorable terms or at all. We cannot assure you of a positive return on investment or that you will not lose the entire amount of your investment in our Common Shares. Prospective investors seeking or needing dividend income or liquidity should not purchase our Common Shares.
The value of our securities, including our Common Shares, might be affected by matters not related to our operating performance and could subject us to securities litigation.
The value of our Common Shares may be reduced for a number of reasons, many of which are outside our control, including:
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general economic and political conditions in Canada, the United States and globally;
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governmental regulation of the health care and pharmaceutical industries;
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failure to achieve desired drug discovery outcomes by us or our collaborators;
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failure to obtain industry partner and other third party consents and approvals, when required;
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stock market volatility and market valuations;
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competition for, among other things, capital, drug targets and skilled personnel;
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the need to obtain required approvals from regulatory authorities;
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revenue and operating results failing to meet expectations in any particular period;
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investor perception of the health care and pharmaceutical industries;
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limited trading volume of our Common Shares;
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announcements relating to our business or the businesses of our competitors; and
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our ability or inability to raise additional funds.
The concentration of the Common Shares ownership with insiders, as well as director nomination rights held by the largest shareholder, will likely limit the ability of the other shareholders to influence corporate matters.
As of December 31, 2017, executive officers, directors, five percent or greater shareholders, and their respective affiliated entities of the Arbutus beneficially own, in the aggregate, approximately ~53% of Arbutus' outstanding Common Shares. As a result, these shareholders, acting together, have significant influence over most matters that require approval by Arbutus' shareholders, including the election of directors and approval of significant corporate transactions. Corporate actions might be taken even if other shareholders oppose them. This concentration of ownership might also have the effect of delaying or preventing a corporate transaction that other shareholders may view as beneficial.
Further, on October 16, 2017 and January 12, 2018, respectively, Arbutus completed an issuance and sale to Roivant Sciences Ltd. of two tranches of series A participating convertible preferred shares in the capital of Arbutus, for an aggregate of 1,164,000 preferred shares. The preferred shares do not have voting rights prior to conversion (except as required by applicable law). The preferred shares plus an amount equal to 8.75% per annum, compounded annually, will initially be convertible into 22,833,922 Common Shares of Arbutus, no par value, which conversion will occur mandatorily four years after issuance. Assuming conversion of all of the preferred shares held by Roivant, Roivant will hold 38,847,462, or, without further dilution, 49.9% of the outstanding Common Shares in the capital of Arbutus (based on the total number of issued and outstanding Common Shares as at March 31, 2017, but assuming only the conversion of all of the preferred shares into Common Shares). The ownership by Roivant of these preferred shares and underlying Common Shares will likely further limit the ability of the other shareholders to influence corporate matters.
In addition, at the special meeting of Arbutus’ shareholders held on January 11, 2018, the shareholders approved amendments to Arbutus’ Articles such that Roivant has the right to nominate a certain number of directors to the board of directors of Arbutus, which right will terminate upon the earlier of (i) October 16, 2019 and (ii) when Roivant no longer meets certain beneficial ownership thresholds. With respect to the beneficial ownership thresholds, for so long as Roivant has beneficial ownership or exercises control or direction over not less than (i) 30% of the issued and outstanding Common Shares, Roivant has the right to nominate three individuals for election to the board of directors of Arbutus, one of whom must be “independent” within the meaning of applicable law and the rules and regulations of The Nasdaq Stock Market LLC, not including the rules related to the independence of audit committee members; (ii) 20% of the issued and outstanding Common Shares, Roivant has the right to nominate two individuals for election to the board of directors of Arbutus; and (iii) 10% of the issued and outstanding Common Shares, Roivant has the right to nominate one individual for election to the board of directors of Arbutus. For so long as Roivant has the right to nominate one or more directors to Arbutus’ board of directors, the total number of directors of Arbutus will not, without the prior written consent of Roivant, be permitted to exceed seven directors, the majority of whom must be “independent”.
If securities analysts do not publish research or reports about the business of Arbutus, or if they publish negative evaluations, the price of Arbutus' Common Shares could decline.
The trading market for the Arbutus Common Shares may be impacted by the availability or lack of research and reports that third-party industry or financial analysts publish about Arbutus. There are many large, publicly traded companies active in the biopharmaceutical industry, which may mean it will be less likely that Arbutus receives widespread analyst coverage. Furthermore, if one or more of the analysts who do cover Arbutus downgrade its stock, its stock price would likely decline. If Arbutus does not receive adequate coverage by reputable analysts that have an understanding of Arbutus' business and industry, it could fail to achieve visibility in the market, which in turn could cause its stock price to decline.
Item 1B.
Item 1B. Unresolved Staff Comments
There are currently no unresolved staff comments.
Item 2.
Item 2. Properties
Our head office and principal place of business is currently located at 100-8900 Glenlyon Parkway, Burnaby, British Columbia, Canada, V5J 5J8. The Company leases a 51,000 square foot facility under an agreement that expires on July 31, 2019, but we have the option to extend the lease to 2024, 2029, and 2034.
Our U.S. Office is located at 701 Veterans Circle, Warminster, Pennsylvania, 18974 in approximately 35,000 square feet of leased lab facilities and office space. We believe that the total space available to us under our current lease will meet our needs for the foreseeable future and that additional space would be available to us on commercially reasonable terms if required.
As part of our reorganization (see Item 1. Business) we expect to move our principal place of business to Warminster, PA and close the Burnaby, BC site.
Item 3.
Item 3. Legal Proceedings
We are involved with various legal matters arising in the ordinary course of business. We make provisions for liabilities when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. Such provisions are reviewed at least quarterly and adjusted to reflect the impact of any settlement negotiations, judicial and administrative rulings, advice of legal counsel, and other information and events pertaining to a particular case. Litigation is inherently unpredictable. Although the ultimate resolution of these various matters cannot be determined at this time, we do not believe that such matters, individually or in the aggregate, will have a material adverse effect on our consolidated results of operations, cash flows, or financial condition.
Acuitas Therapeutics Inc.
On August 29, 2016, Arbutus provided Acuitas with notice that Arbutus considered Acuitas to be in material breach of their cross-license agreement. The cross-license agreement provides that it may be terminated upon any material breach by the other party 60 days after receipt of written notice of termination describing the material breach in reasonable detail. On October 25, 2016, Acuitas filed a Notice of Civil Claim in the Supreme Court of British Columbia seeking an order that Arbutus perform its obligations under the cross license agreement, for damages ancillary to specific performance, injunctive relief, interest and costs. We disputed Acuitas' position and filed a counterclaim seeking, among other relief, a declaration that the cross-license agreement had been terminated.
On January 10, 2017, we filed an application seeking an order to enjoin Acuitas from entering into any further agreements purporting to sublicense Arbutus' technology from the date of the order to the date of trial or further order from the court. Acuitas filed a response to Arbutus' application and the matter was the subject of a hearing on January 26, 2017, which resulted in the Supreme Court of British Columbia granting a pre-trial injunction against Acuitas. Under the terms of the pre-clinical trial injunction, Acuitas was prevented from entering into any new agreements which include sublicensing of Arbutus’ LNP. On March 7, 2017, Acuitas appealed the injunction decision and on April 3, 2017, the appeal was denied. On September 29, 2017, the injunction order was extended by consent to March 2, 2018. On February 21, 2018, the contractual issues concerning the cross-license agreement (excluding the claims for damages) were settled out of court, resulting in the termination of Acuitas’ rights to further use or sublicense our LNP technology, making permanent the effect of the Court’s prior injunction. We have now consolidated our LNP intellectual property estate, which is the most clinically validated delivery technology suitable for RNAi, mRNA therapeutics, and gene editing applications. The settlement stipulates that the four non-exclusive viral vaccine sublicenses previously granted to Moderna are the only sublicenses to survive. These four sublicenses, previously granted by Acuitas to Moderna under the pre-April 15, 2010 LNP patent families are each limited to a specific viral target. Moderna has no other rights to Arbutus’ broad suite of LNP intellectual property. No other sublicenses of Arbutus technology were provided to third parties by Acuitas and accordingly, no other sublicenses of Arbutus technology by Acuitas survived the settlement. This milestone further establishes us as the owner and only source of an industry-leading LNP delivery technology with the ability to develop a full range of nucleic acid-based applications.
University of British Columbia (UBC)
Certain early work on liposomal delivery systems and related inventions was undertaken at Inex Pharmaceuticals Inc. and assigned to UBC. These inventions are licensed to us by UBC under a license agreement initially entered into in 1998 and subsequently amended in 2001, 2006 and 2007. We have granted sublicenses to these inventions to Alnylam. Alnylam has in turn sublicensed these inventions back to us for discovery, development and commercialization of RNAi products.
On November 10, 2014, the University of British Columbia filed a demand for arbitration against Arbutus Biopharma Corp., BCICAC File No.: DCA-1623. We received UBC’s Statement of Claims on January 16, 2015. In its Statement of Claims, UBC alleges that it is entitled to $3.5 million in allegedly unpaid royalties based on publicly available information, and an unspecified amount based on non-public information. UBC also seeks interest and costs, including legal fees. Arbutus filed its Statement of Defense to UBC’s Statement of Claims on April 27, 2015, denying that UBC is entitled to any unpaid royalties. Arbutus also filed a Counterclaim involving a patent application that Arbutus alleges UBC wrongly licensed to a third party rather than to Arbutus. Arbutus seeks any license payments for said application, and an exclusive worldwide license to said application. The proceeding has been bifurcated into phases, beginning with a liability phase, addressing UBC’s Claims and Arbutus’ Counterclaim, that took place June 2017. The arbitrator determined in the first phase which agreements are sublicense agreements within UBC's claim, and which are not. No finding was made as to whether any licensing fees are due to UBC under these agreements; this will be the subject of the second phase of arbitration. The arbitrator also held that the patent application that is the subject of the Counterclaim was not required to be licensed to Arbutus. A schedule for the remaining phases has not yet been set.
Item 4.
Item 4. Mine Safety Disclosures
Not applicable.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common shares trade on the Nsdaq Global Market under the symbol "ABUS" following our Company name change to Arbutus Biopharma Corporation on July 31, 2015. From November 15, 2010 to July 31, 2015 our common shares traded on the NASDAQ Global Market under the symbol “TKMR”. Our common shares previously traded on the Toronto Stock Exchange (TSX) in Canada under the symbol “TKM”. We voluntarily delisted from the TSX on March 3, 2015. As at March 6, 2018, there were 105 registered holders of common shares and 55,070,037 common shares issued and outstanding.
The following table shows the high and low intraday trading prices of our common shares on the Nasdaq Global Market periods listed:
Material Modifications to the Rights of Security Holders/Use of Proceeds
Not applicable.
Purchase of Equity Securities by the Issuer and Affiliated Purchasers
Not applicable.
Recent Sales of Unregistered Securities
None.
Stock Performance Graph
The following performance graph and related information shall not be deemed “soliciting material” or to be “filed” with the SEC, nor shall such information be incorporated by reference into any future filing under the Securities Act of 1933 or Securities Exchange Act of 1934, each as amended, except to the extent that we specifically incorporate it by reference into such filing.
The following graph compares the cumulative shareholder return on an investment of US$100 in the Common Shares of the Company on the Nasdaq from December 31, 2012, with a cumulative total shareholder return on the Nasdaq Composite and Nasdaq Biotechnology Indices.
Geographic Breakdown of Shareholders
As of March 6, 2018, our shareholder register indicates that our common shares are held as follows:
As of March 6, 2018 we also have 1,164,000 preferred shares issued and outstanding. These shares are held by Roivant Sciences Ltd, a company registered in Bermuda. These shares are convertible to 22,589,601 common shares on October 18, 2021. Based on the number of shares outstanding as at March 6, 2018, upon conversion to common shares on October 18, 2021, Roivant would own 49.9% of the common shares of the Company. The preferred shares are not voting. See notes to the Financial Statements for further information on the preferred shares.
Our securities are recorded in registered form on the books of our transfer agent, CST Trust Company, located at 1600-1066 West Hastings Street, Vancouver, BC, V6E 3X1. However, the majority of such shares are registered in the name of intermediaries such as brokerage houses and clearing houses (on behalf of their respective brokerage clients). We are permitted, upon request to our transfer agent, to obtain a list of our beneficial shareholders who do not object to their identities being disclosed to us. We are not permitted to obtain from our transfer agent a list of our shareholders who have objected to their identities being disclosed to us.
Shares registered in intermediaries were assumed to be held by residents of the same country in which the clearing house was located.
Dividends
We have not declared or paid any dividends on our common or preferred shares since the date of our incorporation. We intend to retain our earnings, if any, to finance the growth and development of our business and do not expect to pay dividends or to make any other distributions, other than the coupon attached to the preferred shares, in the near future. Our board of directors will review this policy from time to time having regard to our financing requirements, financial condition and other factors considered to be relevant.
Item 6.
Item 6. Selected Financial Data
The following table presents selected financial data derived from Arbutus' audited consolidated financial statements for each of the five years for the period ending December 31. You should read this information in conjunction with our financial statements for the periods presented, as well as Item 1 “ Business ” and Item 7
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
Arbutus is a publicly traded (Nasdaq Global Market: ABUS) therapeutic solutions company dedicated to discovering, developing and commercializing a cure for patients suffering from chronic HBV infection. To pursue our strategy of developing a curative combination regimen, we have assembled an HBV pipeline consisting of multiple drug candidates with complementary mechanisms of action. HBV represents a significant unmet medical need and is the cause of the most common serious liver infection in the world. The World Health Organization estimates that 257 million people worldwide are chronically infected, and other estimates suggest this could include approximately 2 million people in the United States. Given the complex biology of HBV, we believe combination therapies are the key to HBV treatment and a potential cure, and development can be accelerated when multiple components of a combination therapy regimen are controlled by the same company.
Arbutus’ head office and principal place of business is currently located at 100-8900 Glenlyon Parkway, Burnaby, British Columbia, Canada, V5J 5J8. This facility includes 51,000 square feet of combined research and development laboratory and office space. Our primary U.S. site is located at 701 Veterans Circle, Warminster, Pennsylvania, USA, 18974. This facility includes 35,000 square feet of combined research and development laboratory and office space. As part of our reorganization, we expect to move our principal place of business to Warminster, PA and close the Burnaby, BC site.
We continued the development of our lead clinical candidate ARB-1467 in 2017. We announced Phase II data demonstrating significant reductions in serum HBsAg, including step-wise, additive reductions with each subsequent dose of ARB-1467, proving both its safety and efficacy in patients. These data are the first of their kind for an RNAi product candidate in chronic HBV patients. We advanced ARB-1467 into the first drug combination study with HBV standard or care therapies for deeper reductions in HBsAg and HBV DNA in patients, which are the endpoints accepted as an HBV cure.
Our first-generation capsid inhibitor AB-423 entered into healthy volunteer clinical studies in 2017 and initiated Investigational New Drug (IND)-enabling studies on a next generation capsid inhibitor AB-506 as well as a novel HBV RNA Destabilizer AB-452 (formerly known as our oral HBsAg inhibitor program) for potential clinical advancement in 2018.
We continued a number of research programs aimed at discovery and development of novel HBV candidates with different and complementary mechanisms of action. We have designed a number of highly potent HBV-targeting RNAi payloads for use with our proprietary GalNAc conjugate platform to enable subcutaneous delivery and have ongoing discovery efforts focused on cccDNA targeting and checkpoint inhibition.
We presented clinical and preclinical data from our proprietary HBV assets in 2017.
Change in Functional Currency
Prior to January 1, 2016, our functional currency was the Canadian dollar. As such, all dollar amounts in this MD&A related to periods prior to and including the year ended December 31, 2015 are presented in U.S. dollars with the functional currency as the Canadian dollar. On January 1, 2016, our functional currency changed from the Canadian dollar to the U.S. dollar based on our analysis of changes in the primary economic environment in which we operate. The change in functional currency is accounted for prospectively from January 1, 2016 and financial statements for the periods prior to and including the year ended December 31, 2015 will not be restated for the change in functional currency. Past translation gains and losses from the application of the U.S. dollar as the reporting currency while the Canadian dollar was the functional currency are included as part of cumulative currency translation adjustment, which is reported as a component of shareholder's equity under accumulated other comprehensive loss.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The significant accounting policies that we believe to be most critical in fully understanding and evaluating our financial results are revenue recognition, stock-based compensation, and goodwill and intangible asset impairment. These accounting policies require us to make certain estimates and assumptions. We believe that the estimates and assumptions upon which we rely are reasonable, based upon information available to us at the time that these estimates and assumptions are made. Actual results may differ from our estimates. Our critical accounting estimates affect our net income or loss calculation.
Revenue Recognition / Our primary sources of revenue have been derived from research and development collaborations and contracts, and licensing fees comprised of initial fees and milestone payments. Payments received under research and development agreements and contracts, which are non-refundable, are recorded as revenue as services are performed and as the related expenditures are incurred pursuant to the agreement, provided collectability is reasonably assured. Revenue earned under research and development collaborations and contracts where we do not bear any risk of product manufacture failure is recognized in the period the work is performed. Revenue earned under contractual arrangements upon the achievement of substantive milestones is recognized in its entirety in the period the payment has been received. We evaluate whether milestones under research and development arrangements are substantive by considering: whether substantive uncertainty exists upon the execution of the arrangement; the event can only be achieved based in whole or in part on our performance or occurrence of a specific outcome resulting from our performance; any future performance required and payment is reasonable relative to all deliverables; and, payment terms in the arrangement. Initial fees and non-substantive milestone payments are deferred and amortized into income over the estimated period of our involvement as we fulfill our obligations under our agreements.
The revenue that we recognize is a critical accounting estimate because of the volume and nature of the revenues we receive. Some of the research, development and licensing agreements that we have entered into contain multiple revenue elements that are to be recognized for accounting in accordance with our revenue recognition policy. We need to make estimates as to what period the services will be delivered with respect to up-front licensing fees and milestone payments received because these payments are deferred and amortized into income over the estimated period of our ongoing involvement. The actual period of our ongoing involvement may differ from the estimated period determined at the time the payment is initially received and recorded as deferred revenue. This may result in a different amount of revenue that should have been recorded in the period and a longer or shorter period of revenue amortization. When an estimated period changes we amortize the remaining deferred revenue over the estimated remaining time to completion. The rate at which we recognize revenue from payments received for services to be provided under research and development agreements depends on our estimate of work completed to date and total work to be provided. The actual total services provided to earn such payments may differ from our estimates. Refer to Note 2 to our consolidated financial statements for our analysis of the impact of the adoption of ASC 606 - Revenue from Contracts with Customers, effective January 1, 2018.
Our revenue for 2017 was $10.7 million (2016 - $1.5 million, 2015 - $23.3 million). Our deferred revenue balance at December 31, 2017 was $2.7 million (December 31, 2016 - nil).
Stock-based compensation / The stock-based compensation that we record is a critical accounting estimate due to the value of compensation recorded, the volume of our stock option activity, and the many assumptions that are required to be made to calculate the compensation expense.
Compensation expense is recorded for stock options issued to employees and directors using the fair value method. We must calculate the fair value of stock options issued and amortize the fair value to stock compensation expense over the vesting period, and adjust the expense for stock option forfeitures and cancellations. We use the Black-Scholes model to calculate the fair value of stock options issued which requires that certain estimates, including the expected life of the option and expected volatility of the stock, be made at the time that the options are issued. This accounting estimate is reasonably likely to change from period to period as further stock options are issued and adjustments are made for stock option forfeitures and cancellations. Effective October 1, 2016, we early adopted ASU 2016-09 and elected an entity-wide accounting policy to recognize forfeitures as they occur. The term "forfeitures" is distinct from "cancellations" or "expirations" and represents only the unvested portion of the surrendered stock option. For the purpose of calculating fair value, the expected life of stock options granted is five years for employees and eight years for directors and executives. We amortize the fair value of stock options using the straight-line method over the vesting period of the options, generally a period of three years for employees and immediate vesting for directors.
We recorded stock-based compensation expense for our equity-classified awards in 2017 of $14.9 million (2016 of $38.2 million, 2015 - $22.1 million) which includes compensation expense related to the expiration of repurchase rights on certain shares held by the founders of Arbutus Inc. of $8.0 million (2016 - $32.0 million) - refer to Note 2 to our consolidated financial statements.
Goodwill and intangible assets - Impairment / Intangible assets classified as indefinite-lived and goodwill are not amortized, but are evaluated for impairment annually using a measurement date of December 31. In addition, if there is a major event indicating that the carrying value of an asset may not be recoverable, then management will perform an impairment test in an interim period by comparing the discounted cash flow values to each asset’s carrying value to determine if a write down is necessary. Such indicators include, but are not limited to, on an ongoing basis: (a) industry and market considerations such as an increased competitive environment or an adverse change in legal factors including an adverse assessment by regulators; (b) an accumulation of costs significantly in excess of the amount originally expected for the development of the asset; (c) current period operating or cash flow loss combined with a history of operating or cash flow losses or a projection or forecast that demonstrates continuing losses associated with the use of the asset; (d) adverse research and development program results; and (e) if applicable, a sustained decrease in share price.
In assessing impairment, significant judgments are required to be made by management to estimate the timing and extent of future net cash flows, appropriate discount rates, probability of program success and other estimates and assumptions that could materially affect the determination of fair value. These judgments include the use of, but are not limited to: projected results of operations and forecast cash flows based on our corporate budgets as approved by our board of directors, third party forecasts and data and other macroeconomic indicators that forecasts market conditions and our estimated future revenues and growth, market-based discount rates and other market-comparative data. As assumptions related to the probability of program success and timing and amount of potential future cash flows related to these programs is highly uncertain due to the unpredictable nature of each phase of these programs, management risk adjusts the estimated cash flows to reflect these uncertainties.
During the year ended December 31, 2017, we recorded a total net impairment charge of $23.9 million (impairment charge of $40.8 million less a corresponding income tax benefit of $16.9 million) against our identified intangible assets for the discontinuance of STING agonists, which represented the entire remaining acquired Immune Modulator drug class.
We perform our annual impairment analysis at December 31st each year. Effective October 1, 2017, we early adopted ASU 2017-04 and eliminated Step 2 from the goodwill impairment test, which required a hypothetical purchase price allocation, and permits a qualitative assessment to determine if a quantitative assessment (Step 1) is required. At December 31, 2017, we performed a qualitative assessment using factors including but not limited to: (a) macroeconomic conditions; (b) industry and market considerations; (c) cost factors; (d) overall financial performance; (e) other relevant entity-specific events; (f) events affecting a reporting unit; and (g) if applicable, a sustained decrease in share price in absolute terms and relative to peers. Based on our qualitative assessment, we concluded that as at December 31, 2017, it was not more likely than not that the fair value of the Company`s single reporting unit was less than its carrying amount; therefore, a quantitative assessment was not necessary.
Fair value determinations require considerable judgment and are sensitive to changes in underlying assumptions and factors, and any key assumptions in the cash flow projections are interdependent on each other. A change in any one or combination of these assumptions could impact the estimated fair value of the reporting unit. Although we believe our assumptions are reasonable, the significant level of judgment needed to determine our assumptions, the uncertainty inherent in these assumptions and the extended time frame over which we are required to make our estimates, increases the risk that actual results will vary significantly. Given the dependency of our cash flow models on the successful development, production and sale of products from our existing programs, if any significant programs are unsuccessful then, excluding other possible changes in our forecasts, our estimated future cash flows will be reduced and such reduction may be significant enough to result in an impairment of the carrying value of our intangible assets. The outcome of our programs are subject to a variety of risks, including but not limited to, technological risk associated with IPR&D assets, dependency on regulatory approval and competitive, legal and other regulatory forces. See the "Risk Factors" in this annual report on Form 10-K for additional risk factors.
SUMMARY OF QUARTERLY RESULTS
The following table presents our unaudited quarterly results of operations for each of our last eight quarters. These data have been derived from our unaudited condensed consolidated financial statements, which were prepared on the same basis as our annual audited financial statements and, in our opinion, include all adjustments necessary, consisting solely of normal recurring adjustments, for the fair presentation of such information.
(in millions $ except per share data) - unaudited
Quarterly Trends
Revenue / Our revenue is derived from research and development collaborations and contracts, licensing fees, milestone and royalty payments.
In March 2017, we signed a License Agreement with Alexion that granted them exclusive use of our proprietary lipid nanoparticle ("LNP") technology in one of Alexion's rare disease programs. Under the terms of the license agreement, we received a $7.5 million non-refundable upfront payment in April 2017, which was recognized over the expected period we provide services to Alexion. In Q3 2017, we received notice of termination from Alexion for our LNP license agreement, and completed close out procedures. The termination was driven by a strategic review of Alexion's business and research and development portfolio, which included a decision to discontinue development of mRNA therapeutics. As such, we recorded the remaining deferred revenue of $6.7 million for the non-refundable upfront payment, as well as revenue for any work done related to closeout procedures.
On October 16, 2017, the Company entered into a license agreement with Gritstone that entitles Gritstone to research, develop, manufacture and commercialize products with our LNP technology. The total potential payments under this arrangement include upfront, development and commercial milestone payments and royalty payments on future product sales. During Q4 2017, we recorded $2.5 million in revenue under this arrangement.
Expenses / Expenses consist primarily of clinical and pre-clinical trial expenses, personnel expenses, consulting and third party expenses, reimbursable collaboration expenses, consumables and materials, patent filing expenses, facilities, stock-based compensation and general corporate costs. Impairment of intangible assets and goodwill is also included in operating expenses.
Since Q1 2016, we have incurred significant R&D expense related to our HBV programs, including initiation of our ARB-1467 in Phase 2 clinical trials, and incurred costs since Q4 2016 to advance our AB-423 to Phase 1 clinical trials. In Q2 and Q3 2017, we also incurred costs related to our recently nominated product candidates: a second capsid inhibitor (AB-506) and a HBV RNA destabilizer (AB-452, formerly known as our oral surface antigen (HBsAg) inhibitor program). In Q4 2017, we continued a number of research programs aimed at discovery and development of novel HBV candidates with different and complementary mechanisms of action, prepared for the initiation of combination studies for ARB-1467 and incurred R&D expense related to services provided to Gritstone.
In Q2, 2016, we recorded an impairment charge of $156.3 million (before deferred tax) for the discontinuance of the ARB-1598 program in the Immune Modulators drug class after extensive research and analysis, as well as a delay for additional exploration of the biology of the cccDNA Sterilizer drug class. In Q4 2016, we recorded an impairment charge of $96.9 million for our intangible assets (before deferred tax) and impairment charge of $138.1 million for our goodwill which resulted from a change in estimated cost of capital and resulting discount rate used in our annual impairment assessment.
In Q4 2017, we recorded an impairment charge of $40.8 million (before deferred tax) for the discontinuance of our STING agonist program, which represented the entire remaining acquired Immune Modulator drug class.
Following the merger with Arbutus Inc. in March 2015, we have recorded non-cash compensation expense of $56.9 million related to the expiry of repurchase rights on shares issued as part of the consideration paid for the merger with Arbutus Inc. - see "Results of Operations". The final tranche of repurchase rights expired in Q3 2017 so no further expense will be recorded.
Other income (losses) / Other income (losses) consist primarily of changes in the fair value of our contingent consideration, interest income and expense and foreign exchange gains and losses. We have recorded increases in the fair value of contingent consideration since first recording this liability as a result of the merger with Arbutus Inc. in March 2015. This reflects the progress of our HBV programs that bring us closer to triggering the contingent amounts.
We have recorded foreign exchange gains and losses over the past eight quarters, largely related to Canadian dollar cash and investment holdings and fluctuations in the U.S./Canadian dollar exchange rate. We expect to record future foreign exchange gains and losses, on translation from the Canadian dollar, to the U.S. dollar, as the functional currency for the company changed to the U.S. dollar effective January 1, 2016. This change in functional currency results in a smaller proportion of our cash and investments being held in a foreign currency and therefore reduces the level of gains and losses we expect to record in this respect compared to periods prior to January 1, 2016.
Income tax benefit / Income tax benefit primarily relates to the decrease in deferred tax liability associated with the impairment charge recorded on acquired intangible assets. In Q2 2016 and in Q4 2016, we recorded $64.8 million and $40.1 million in income tax benefit associated with the impairment charges described above. In Q4 2017, we recorded a total of $24.3 million of income tax benefit, which consists of $16.9 million related to the impairment charge and a $7.4 million benefit on our remaining intangible assets due to a reduction in US federal taxes - see Note 8 of our consolidated financial statements.
Net loss / Fluctuations in our net loss are explained by changes in revenue, expenses, other income (losses) and income tax as discussed above.
Fourth quarter of 2017 / Our Q4 2017 net loss was $37 million ($0.67 basic and diluted loss per common share) as compared to a net loss of $218.7 million ($4.05 basic and diluted per common share) for Q4 2016.
Revenue in Q4 2017 was related to the earned portion of the upfront payment received from our license agreement with Gritstone.
Research, development, collaborations and contracts expenses remained consistent at $17.8 million in Q4 2017 as compared to $17.2 million in Q4 2016. In Q4 2017, we incurred expenses related to our HBV programs as we continue to move candidates through clinical trials. In Q4 2017, we continued a number of research programs aimed at discovery and development of novel HBV candidates with different and complementary mechanisms of action, and incurred R&D expense related to our services provided to Gritstone. In Q4 2017, we recorded an impairment charge of $40.8 million related to our intangible assets (before deferred tax) as we discontinued our STING agonist program, which represented the entire remaining acquired Immune Modulator drug class.
RESULTS OF OPERATIONS
The following summarizes the results of our operations for the 2017, 2016, and 2015 fiscal years, in millions except per share data:
Year ended December 31, 2017 compared to the year ended December 31, 2016
For the fiscal year ended December 31, 2017, our net loss was $84.4 million ($1.56 basic and diluted loss per common share) as compared to a net loss of $384.2 million ($7.24 basic and diluted loss per common share) for 2016.
Revenue / Revenue is summarized in the following table, in millions:
Revenue contracts are described in more detail in "Item 1. Business".
Alexion revenue
In March 2017, we signed a License Agreement with Alexion that granted them exclusive use of our proprietary lipid nanoparticle (LNP) technology in one of Alexion's rare disease programs. In July 2017, we received notice of termination from Alexion for our LNP license agreement. The termination was driven by a strategic review of Alexion's business and research and development portfolio, which included a decision to discontinue development of mRNA therapeutics. Revenue recorded for the year-ended December 31, 2017 included the upfront license payment, as well as services provided to Alexion related to technology development, manufacturing and regulatory support for the advancement of Alexion's mRNA product candidate.
Gritstone revenue
On October 16, 2017, we entered into a license agreement with Gritstone that entitles Gritstone to research, develop, manufacture and commercialize products with the Company’s LNP technology. In October 2017, we received the upfront license payment, and are eligible to receive further potential payments for development and commercial milestone payments and royalty payments on future product sales. Revenue recognized for the year-ended December 31, 2017 relates to the earned portion of the upfront license fee, as well as services provided to Gritstone.
Dicerna revenue
In November 2014, we signed a License Agreement and a Development and Supply Agreement with Dicerna for the use of our proprietary delivery technology and related technology intended to develop, manufacture, and commercialize products related to the treatment of PH1. In September 2016, Dicerna announced the discontinuation of their DCR-PH1 program using the Company's technology. As such, we revised the estimated completion date of performance period to September 30, 2016, at which time we had no further remaining performance obligations, and recognized the remaining deferred upfront license payment.
Other milestone and royalty payments
Under our licensing and collaboration arrangements with Alnylam and Acuitas, we earn licensing fee revenue from Acuitas as well as further potential development and commercial milestones from Alnylam for the use of our LNP technology.
In September 2013, Spectrum announced that they had shipped the first commercial orders of Marqibo. We continue to earn royalties on the sales of Marqibo, which uses a license to our technology.
Expenses / Expenses are summarized in the following table, in millions:
Research, development, collaborations and contracts
Research, development, collaborations and contracts expenses consist primarily of clinical and pre-clinical trial expenses, personnel expenses, consulting and third party expenses, consumables and materials, as well as a portion of stock-based compensation and general overhead costs.
R&D expenses remained consistent during 2017 and 2016. In all periods presented, our R&D expense relates primarily to our HBV programs. During 2017, we initiated a Phase 1 clinical trial for AB-423 and incurred clinical costs as we continued our trials for ARB-1467, as well as costs for IND enabling studies for our recent candidate nominations, a second capsid inhibitor (AB-506) and a HBV RNA destabilizer (AB-452, formerly known as our oral surface antigen (HBsAg) inhibitor program). We also continued a number of research programs aimed at discovery and development of novel HBV candidates with different and complementary mechanisms of action, as well as incurred R&D expense related to our services provided to Alexion and Gritstone.
A significant portion of our research, development, collaborations and contracts expenses are not tracked by project as they benefit multiple projects or our technology platform and because our most-advanced programs are not yet in late-stage clinical development. However, our collaboration agreements contain cost-sharing arrangements pursuant to which certain costs incurred under the project are reimbursed. Costs reimbursed under collaborations typically include certain direct external costs and hourly or full-time equivalent labor rates for the actual time worked on the project. As a result, although a significant portion of our research, development, collaborations and contracts expenses are not tracked on a project-by-project basis, we do, however, track direct external costs attributable to, and the actual time our employees worked on our collaborations.
General and administrative
General and administrative expenses decreased in 2017 compared to 2016 due to a decrease in non-cash compensation expense related to the expiry of repurchase rights effective Q2 2016 related to the departure of two of the four former Arbutus Inc. founders in June 2016. As a result of this change, our quarterly non-cash compensation general and administrative expense decreased to $1.5 million per quarter. The repurchase right provisions for the other two Arbutus Inc. founders expired in Q3 2017, and no further compensation expense was incurred thereafter. We recorded a total of $4.0 million in non-cash G&A compensation expense for the year-ended December 31, 2017, as compared to a total of $26.0 million for the year-ended December 31, 2016. See the 2016 compared to 2015 discussion for further details.
Impairment of intangible assets and goodwill
During the year-ended December 31, 2017, the Company recorded a total impairment charge of $40.8 million and a corresponding income tax benefit of $16.9 million against its identified intangible assets, for the discontinuance of our STING agonist program, which represented the entire remaining acquired Immune Modulators drug class.
For the year ended December 31, 2016, we recorded a net impairment charge of $148.2 million on intangible assets ($253.2 million less deferred taxes of $105.0 million). $156.3 million was recorded in the second quarter for the discontinuance of the ARB-1598 program in the Immune Modulator drug class after extensive research and analysis, as well as a delay for additional exploration of the biology of the cccDNA Sterilizer drug class. A further $96.4 million was recorded in the fourth quarter as a result of a change in the estimated cost of capital and resulting discount rate used in our annual impairment assessment. This change in discount rate was made to address the sustained discrepancy between our market capitalization and the carrying value of our intangible assets.
On December 31, we performed our annual impairment analysis for goodwill. No impairment was recorded for goodwill for the year ended December 31, 2017. We recorded an impairment of $138.1 million for the year ended December 31, 2016 resulting from our reassessment of the discount rate used in our valuation models used to assess the carrying value of goodwill and intangible assets for impairment as a result of the sustained discrepancy between market capitalization, carrying values and fair values.
Other income (losses) / Other income (losses) are summarized in the following table, in millions:
Foreign exchange gains
We continue to incur substantial expenses and hold cash and investment balances in Canadian dollars, and as such, will remain subject to risks associated with foreign currency fluctuations. For the year ended December 31, 2017, we recorded a foreign exchange gain of $2.3 million, which is primarily an unrealized gain related to an appreciation in the value of our Canadian dollar funds, from the previous period, when converted to our functional currency of U.S. dollars.
Gain on disposition of financial instrument
On March 4, 2016, Monsanto exercised its option to acquire 100% of the outstanding shares of our wholly-owned subsidiary, PADCo, as described below and paid us an exercise fee of $1.0 million.
Decrease in fair value of warrant liability
On March 1, 2017, any remaining outstanding warrants expired.
Increase in fair value of contingent consideration
Contingent consideration is a liability assumed from our acquisition of Arbutus Inc. in March 2015. In general, increases in the fair value of the contingent consideration are related to the progress of our programs as they get closer to triggering contingent payments that are based on development milestones and commercial sales. The first milestone is payable upon the commencement of first HBV patient dosing in our AB-423 program.
Income tax benefit
For the year ended December 31, 2017, we recorded an income tax benefit of $24.3 million due to the decrease in deferred tax liability resulting from the impairment charge to intangible assets of $16.9 million, and the reduction in federal tax rates from the U.S. tax reform of $7.4 million on our remaining intangible assets.
Year ended December 31, 2016 compared to the year ended December 31, 2015
For the fiscal year ended December 31, 2016, our net loss was $384.2 million ($7.24 basic and diluted loss per common share) as compared to a net loss of $62.7 million ($1.38 basic and diluted loss per common share) for 2015.
Revenue / Revenue is summarized in the following table, in millions:
DoD revenue
In July 2015, we announced that Ebola related activities were being suspended and, in Q4 2015, we received formal notification from the DoD terminating the contract, subject to the completion of certain post-termination obligations. We do not expect to record significant revenue from the DoD contract after December 31, 2015 and did not receive any revenue from the DoD contract in 2016.
Monsanto revenue
In January 2014, we signed an Option Agreement and a Services Agreement (together, the “Agreements”) with Monsanto. Under the Agreements, Monsanto had an option to obtain a license to use our proprietary delivery technology and related intellectual property for use in agriculture.
Under the Agreements, we established a wholly-owned subsidiary, PADCo. We determined that PADCo was a variable interest entity (“VIE”); however, Monsanto was the primary beneficiary of the arrangement. PADCo was established to perform research and development activities, which were funded by Monsanto in return for a call option to acquire the equity or all of the assets of PADCo. On March 4, 2016, Monsanto exercised its option to acquire 100% of the outstanding shares of PADCo and paid us an option exercise fee of $1.0 million. From the acquisition of PADCo, Monsanto received a worldwide, exclusive right to use our proprietary delivery technology in the field of agriculture. We recorded the exercise fee received as gain on disposition of financial instrument on our consolidated statement of operations and comprehensive loss for the year ended December 31, 2016.
Dicerna revenue
In November 2014, we signed a License Agreement and a Development and Supply Agreement with Dicerna for the use of our proprietary delivery technology and related technology intended to develop, manufacture, and commercialize products related to the treatment of PH1. Licensing fee revenue recognized for the year ended December 31, 2015 relates to the earned portion of the upfront payment of $2.5 million for the use our of technology, which was being recognized over the period over which we provided services to Dicerna. In September 2016, Dicerna announced the discontinuation of their DCR-PH1 program using the Company's technology. As such, we revised the estimated completion date of performance period from March 2017 to September 30, 2016, at which time we had no further remaining performance obligations. This resulted in the recognition of $1.1 million in Dicerna license fee revenue for the year ended December 31, 2016.
Other milestone and royalty payments
Under our licensing arrangements with Alnylam and Alexion we have the potential to earn further development and commercial milestones and royalties for the use of our LNP technology.
In September 2013, Spectrum announced that they had shipped the first commercial orders of Marqibo. We continue to earn royalties on the sales of Marqibo, which uses a license to our technology.
Expenses / Expenses are summarized in the following table, in millions:
Research, development, collaborations and contracts
Research, development, collaborations and contracts expenses consist primarily of clinical and pre-clinical trial expenses, personnel expenses, consulting and third party expenses, consumables and materials, as well as a portion of stock-based compensation and general overhead costs.
R&D expenses increased during 2016 as compared to 2015 as we increased our spending on our HBV programs as we continue to advance them through the clinic in 2016 when we initiated Phase 2 clinical trials for ARB-1467 and ARB-1740, and prepared to advance AB-423 to Phase 1 clinical trial. We also continue to incur incremental costs related to an increase in activities for research and preclinical HBV programs, focusing on advancing the development of our candidates to support future clinical combination studies.
R&D compensation expense increased in 2016 as compared to 2015 due to an increase in the number of employees in support of our expanded portfolio of product candidates, as well as from our merger with Arbutus Inc. In addition, in the year ended December 31, 2016, we incurred a total of $32.0 million of non-cash compensation expense related to the expiry of repurchase rights on shares issued as part of the consideration paid for the merger with Arbutus Inc. (see table of quarterly charges below and refer to notes to the financial statements for further details), of which $6.0 million has been included as part of research, development, collaborations and contracts expense, and $26.0 million included as part of general and administrative expense.
A significant portion of our research, development, collaborations and contracts expenses are not tracked by project as they benefit multiple projects or our technology platform and because our most-advanced programs are not yet in late-stage clinical development. However, our collaboration agreements contain cost-sharing arrangements pursuant to which certain costs incurred under the project are reimbursed. Costs reimbursed under collaborations typically include certain direct external costs and hourly or full-time equivalent labor rates for the actual time worked on the project. In addition, we have been reimbursed under government contracts for certain allowable costs including direct internal and external costs. As a result, although a significant portion of our research, development, collaborations and contracts expenses are not tracked on a project-by-project basis, we do track direct external costs attributable to, and the actual time our employees worked on, our collaborations and government contracts.
General and administrative
General and administrative expenses increased in 2016 compared to 2015 due largely to an increase in compensation expense linked to our increase in employee base and incremental corporate expenses to support the growth of the Company following the completion of our merger with Arbutus Inc. This includes a non-cash compensation expense of $26.0 million we incurred related to the expiry of repurchase rights on shares issued as part of consideration paid for the merger with Arbutus Inc. (see above). In Q2 2016, we incurred an acceleration of incremental non-cash compensation expense due to the expiration of repurchase rights triggered by the departure of two of the four Arbutus Inc. founders. The following table summarizes the non-cash compensation expense recorded related to the expiry of repurchase rights, in millions:
Acquisition costs
In 2015, we incurred $9.7 million in costs for professional fees related to completing the merger with Arbutus Inc. - see "Item 1. Business". This cost is specific to the merger with Arbutus Inc., and such costs are only incurred when a business combination occurs.
Impairment of intangible assets and goodwill
For the year ended December 31, 2016, we recorded a net impairment charge of $148.2 million on intangible assets ($253.2 million less deferred taxes of $105.0 million). $156.3 million was recorded in the second quarter for the discontinuance of the ARB-1598 program in the Immune Modulator drug class after extensive research and analysis, as well as a delay for additional exploration of the biology of the cccDNA Sterilizer drug class. A further $96.9 million was recorded in the fourth quarter as a result of a change in the estimated cost of capital and resulting discount rate used in our annual impairment assessment. This change in discount rate was made to address the sustained discrepancy between our market capitalization and the carrying value of our intangible assets. For the year-ended December 31, 2015, we recorded an impairment charge of $39.0 million, with an offsetting income tax benefit of $16.2 million based on our decision to discontinue our cyclophilin inhibitors program, OCB-030.
On December 31, we performed our annual impairment analysis for goodwill and recorded an impairment of $138.1 million for the year ended December 31, 2016. As discussed above, we re-assessed the discount rate used in our valuation models used to assess the carrying value of goodwill and intangible assets for impairment as a result of the sustained discrepancy between market capitalization, carrying values and fair values.
Other income (losses) / Other income (losses) are summarized in the following table, in millions:
Foreign exchange gains
On January 1, 2016, our functional currency changed from the Canadian dollar to the U.S. dollar based on our analysis of changes in the primary economic environment in which we operate. We will continue to incur substantial expenses and hold cash and investment balances in Canadian dollars, and as such, will remain subject to risks associated with foreign currency fluctuations. For the year ended December 31, 2016, we recorded a foreign exchange gain of $1.1 million which is primarily an unrealized gain related to an appreciation in the value of our Canadian dollar funds from the previous period, when translated to our functional currency of U.S. dollars. For the year ended December 31, 2015, the foreign exchange gain of $21.8 million was related to the appreciation in value of our U.S. dollar funds from the previous period, when translated to our functional currency of Canadian dollars in that year.
Gain on disposition of financial instrument
On March 4, 2016, Monsanto exercised its option to acquire 100% of the outstanding shares of our wholly-owned subsidiary, PADCo, as described above and paid us an exercise fee of $1.0 million.
Decrease in fair value of warrant liability
In conjunction with equity and debt financing transactions in 2011 and 2012, we issued warrants to purchase our common share. We are accounting for the warrants under the authoritative guidance on accounting for derivative financial instruments indexed to, and potentially settled in, a company’s own stock, on the understanding that in compliance with applicable securities laws, the registered warrants require the issuance of registered securities upon exercise and do not sufficiently preclude an implied right to net cash settlement. At each balance sheet date, the warrants are revalued using the Black-Scholes model and the change in value is recorded in the consolidated statement of operations and comprehensive income (loss). In June 2016, the warrants from our 2011 debt financing expired and the fair value of unexercised warrants were recorded in decrease in fair value of warrant liability for the year ended December 31, 2016.
Generally, a decrease in our share price from the previous reporting date results in a decrease in the fair value of our warrant liability and vice versa.
Increase in fair value of contingent consideration
The contingent consideration represents the estimated regulatory, development and sales milestone payments payable to the previous Enantigen shareholders. Enantigen was acquired by Arbutus Inc. in 2014. As at the acquisition date of Arbutus Inc., the contingent consideration had an estimated fair value of approximately $6.7 million. Contingent consideration is a financial liability, and we determine its fair value at each reporting period with any changes in fair value from the previous reporting period recorded in the statement of operations and comprehensive loss. For the period ended December 31, 2016, we performed an evaluation of the fair value of the contingent consideration using the probability weighted assessment of likelihood of milestone payments as described above and determined the fair value of the contingent consideration has increased by $1.6 million to $9.1 million from $7.5 million as at December 31, 2015. The increase in fair value has been recorded in other losses in the statement of operations and comprehensive loss for the year ended December 31, 2016.
Income tax benefit
For the year ended December 31, 2016, we recorded an income tax benefit of $105.0 million due to the decrease in deferred tax liability resulting from the impairment charge to intangible assets.
LIQUIDITY AND CAPITAL RESOURCES
The following table summarizes our cash flow activities for the periods indicated, in millions:
At December 31, 2017, we had cash and cash equivalents of $54.3 million, short-term investments of $72.1 million, and restricted investments of $12.6 million, totaling $139.0 million as compared to cash, cash equivalents, short-term investments and restricted cash of $143.2 million at December 31, 2016.
Since our incorporation, we have financed our operations through the sales of shares, units, debt, revenues from research and development collaborations and licenses with corporate partners, interest income on funds available for investment, and government contracts, grants and tax credits.
Operating activities used $48.6 million in cash in 2017 as compared to $57.9 million used in 2016 and $56.4 million used in 2015. The decrease in cash used from operating activities was primarily due to the upfront license payments we received from Alexion and Gritstone during 2017. Significant non-cash items to reconcile net loss used by operating activities include impairment of intangible assets of $40.8 million, deferred income tax benefit of $24.3 million (comprised of $16.9 million corresponding to the impairment charge, and a $7.4 million recovery in deferred tax liability on remaining intangible asset balance sheet value related to reduced US federal taxes), and stock-based compensation.
Investing activities provided cash of $27.8 million in 2017 compared to cash used of $99.1 million in 2016 and cash provided of $7.7 million in 2015. Cash provided increased in 2017 due to short-term investments that matured during the year.
On March 25, 2015, we completed an underwritten public offering of 7,500,000 common shares, at a price of $20.25 per share, representing gross proceeds of $151.9 million, and net proceeds of $142.2 million. On December 27, 2016, we obtained a $12.0 million loan from Wells Fargo, secured by $12.6 million in restricted cash. The loan is due on December 27, 2019, and we are able to partially or wholly repay the borrowings at any time. We used these proceeds primarily to renovate leased laboratory and office space in Warminster, Pennsylvania where we have expanded our U.S. research and development activities.
On October 16, 2017, we closed the sale of 500,000 Series A participating convertible preferred shares ("Preferred Shares") to Roivant for gross proceeds of $50.0 million. A second tranche of $66.4 million for 664,000 Preferred Shares closed on January 12, 2018, following receipt of the approval of Arbutus' shareholders on January 11, 2018. We are using these proceeds to develop and advance product candidates through clinical trials, as well as for working capital and general corporate purposes.
Cash requirements / At December 31, 2017 we held an aggregate of $139.0 million in cash, comprised of $54.3 million in cash and cash equivalents, $72.1 million in short-term investments, and $12.6 million in restricted cash (investments) and subsequent to December 31, 2017 we received an additional $66.4 million in cash from the close of the second tranche of Preferred Shares. On a proforma basis, including the second tranche proceeds, our 2017 ending cash balance was $205.4 million. We believe we have sufficient cash resources for at least the next 12 months. In the future, substantial additional funds will be required to continue with the active development of our pipeline products and technologies. In particular, our funding needs may vary depending on a number of factors including:
•
the need for additional capital to fund future business development programs;
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closure costs associated with our organizational restructuring and expected savings from gains in efficiency:
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revenues earned from our existing licensing agreements, including milestone and royalty payments from Gritstone, Alnylam and Spectrum;
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the extent to which we continue the development of our product candidates, add new product candidates to our pipeline, or form collaborative relationships to advance our products;
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our decisions to in-license or acquire additional products or technology for development, in particular for our HBV programs;
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our ability to attract and retain corporate partners, and their effectiveness in carrying out the development and ultimate commercialization of our product candidates;
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extent of cash inflow from licensing our LNP technology and royalty entitlements;
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whether batches of drugs that we manufacture fail to meet specifications resulting in delays and investigational and remanufacturing costs;
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the decisions, and the timing of decisions, made by health regulatory agencies regarding our technology and products;
•
competing technological and market developments; and
•
costs associated with prosecuting and enforcing our patent claims and other intellectual property rights, including litigation and arbitration arising in the course of our business activities.
We will seek to obtain funding to maintain and advance our business from a variety of sources, including public or private equity or debt financing, collaborative arrangements with pharmaceutical companies and government grants and contracts. There can be no assurance that funding will be available at all or on acceptable terms to permit further development of our products, especially in light of the current difficult climate for investment in early stage biotechnology companies.
If adequate funding is not available, we may be required to delay, reduce or eliminate one or more of our research or development programs or reduce expenses associated with non-core activities. We may need to obtain funds through arrangements with collaborators or others that may require us to relinquish most or all of our rights to product candidates at an earlier stage of development or on less favorable terms than we would otherwise seek if we were better funded. Insufficient financing may also mean failing to prosecute our patents or relinquishing rights to some of our technologies that we would otherwise develop or commercialize.
Material commitments for capital expenditures / As at the date of this discussion we do not have any material commitments for capital expenditures.
OFF-BALANCE SHEET ARRANGEMENTS
We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors.
CONTRACTUAL OBLIGATIONS
Facility lease
On June 23, 2014, we signed an agreement to renew the lease for our Burnaby office and lab facility. The lease term is for five years, commencing August 1, 2014 with three additional renewal terms of five years each.
On August 9, 2016, we signed a new lease agreement effective November 1, 2016, subsequently amended to October 7, 2016, to enable moving our U.S. operations to 701 Veterans Circle, Warminster, Pennsylvania. The new location has approximately 35,000 square feet of laboratory facilities and office space. The lease expires on April 30, 2027. We also have the option of extending the lease for two further five-year terms.
Product development partnership with the Canadian Government
We entered into a Technology Partnerships Canada (TPC) agreement with the Canadian Federal Government on November 12, 1999. Under this agreement, TPC agreed to fund 27% of our costs incurred prior to March 31, 2004, in the development of certain oligonucleotide product candidates up to a maximum contribution from TPC of $7.2 million (C$9.3 million). As at December 31, 2017, a cumulative contribution of $3.0 million (C$3.7 million) had been received and we do not expect any further funding under this agreement. In return for the funding provided by TPC, we agreed to pay royalties on the share of future licensing and product revenue, if any that is received by us on certain non-siRNA oligonucleotide product candidates covered by the funding under the agreement. These royalties are payable until a certain cumulative payment amount is achieved or until a pre-specified date. In addition, until a cumulative amount equal to the funding actually received under the agreement has been paid to TPC, we agreed to pay a 2.5% royalty on any royalties we receive for Marqibo.
In September 2013, we began to earn royalties on Marqibo and the cumulative amount paid or accrued up to December 31, 2017 was $0.02 million resulting in the contingent amount due to TPC being $2.9 million (C$3.7 million).
Contingent consideration from Arbutus Inc. acquisition of Enantigen and License Agreements between Enantigen and Blumberg and Drexel
In October 2014, Arbutus Inc. acquired all of the outstanding shares of Enantigen pursuant to a stock purchase agreement. Through this transaction, Arbutus Inc. acquired a HBV surface antigen secretion inhibitor program and a capsid assembly inhibitor program, each of which are now assets of Arbutus, following the Company’s merger with Arbutus Inc. in March 2015.
Under the stock purchase agreement, Arbutus Inc. agreed to pay up to a total of $21.0 million to Enantigen’s selling stockholders upon the achievement of certain triggering events related to HBV therapies. The first triggering event is enrollment of the first patient in a Phase 1b clinical trial in HBV patients, which we expect may occur in the next twelve month period.
The regulatory, development and sales milestone payments have an estimated fair value of approximately $6.7 million as at the date of acquisition of Arbutus Inc. in March 2015, and have been treated as contingent consideration payable in the purchase price allocation. Contingent consideration is a financial liability, and measured at its fair value at each reporting period with any changes in fair value from the previous reporting period recorded in the statement of operations and comprehensive loss. For the period ended December 31, 2017, we performed an evaluation of the fair value of the contingent consideration using the probability weighted assessment of likelihood of milestone payments as described above. We determined the fair value of the contingent consideration has increased to $10.4 million. An increase in fair value of $1.4 million has been recorded in other losses in the statement of operations and comprehensive loss for the year ended December 31, 2017.
Drexel and Blumberg
In February 2014, Arbutus Inc. entered into a license agreement with Blumberg and Drexel that granted an exclusive, worldwide, sub-licensable license to three different compound series: cccDNA inhibitors, capsid assembly inhibitors and HCC inhibitors.
In partial consideration for this license, Arbutus Inc. paid a license initiation fee of $0.2 million and issued warrants to Blumberg and Drexel. Under this license agreement, Arbutus Inc. also agreed to pay up to $3.5 million in development and regulatory milestones per licensed compound series, up to $92.5 million in sales performance milestones per licensed product, and royalties in the mid-single digits based upon the proportionate net sales of licensed products in any commercialized combination. We are obligated to pay Blumberg and Drexel a double digit percentage of all amounts received from the sub-licensees, subject to customary exclusions.
In November 2014, Arbutus Inc. entered into an additional license agreement with Blumberg and Drexel pursuant to which it received an exclusive, worldwide, sub-licensable license under specified patents and know-how controlled by Blumberg and Drexel covering epigenetic modifiers of cccDNA and STING agonists. In consideration for these exclusive licenses, Arbutus Inc. made an upfront payment of $0.1 million. Under this agreement, we will be required to pay up to $1.0 million for each licensed product upon the achievement of a specified regulatory milestone and a low single digit royalty, based upon the proportionate net sales of compounds covered by this intellectual property in any commercialized combination. We are also obligated to pay Blumberg and Drexel a double digit percentage of all amounts received from its sub-licensees, subject to exclusions.
Research Collaboration and Funding Agreement with Blumberg
In October 2014, Arbutus Inc. entered into a research collaboration and funding agreement with Blumberg under which we will provide $1.0 million per year of research funding for three years, renewable at our option for an additional three years, for Blumberg to conduct research projects in HBV and liver cancer pursuant to a research plan to be agreed upon by the parties. Blumberg has exclusivity obligations to Arbutus with respect to HBV research funded under the agreement. In addition, Arbutus has the right to match any third party offer to fund HBV research that falls outside the scope of the research being funded under the agreement. Blumberg has granted Arbutus the right to obtain an exclusive, royalty bearing, worldwide license to any intellectual property generated by any funded research project. If we elect to exercise its right to obtain such a license, we will have a specified period of time to negotiate and enter into a mutually agreeable license agreement with Blumberg. This license agreement will include the following pre negotiated upfront, milestone and royalty payments: an upfront payment in the amount of $0.1 million; up to $8.1 million upon the achievement of specified development and regulatory milestones; up to $92.5 million upon the achievement of specified commercialization milestones; and royalties at a low single to mid-single digit rates based upon the proportionate net sales of licensed products from any commercialized combination.
On June 5, 2016, we entered into an amended and restated research collaboration and funding agreement with Blumberg, primarily to: (1) increase the annual funding amount to Blumberg from $1.0 to $1.1 million; (ii) extend the initial term through to October 29, 2018; (iii) provide an option for us to extend the term past October 29, 2018 for two additional one year terms; and (iv) expand our exclusive license under the Agreement to include the sole and exclusive right to obtain an exclusive, royalty-bearing, worldwide and all-fields license under Blumberg's rights in certain other inventions described in the agreement.
The following table summarizes our contractual obligations as at December 31, 2017:
We in-license technology from a number of sources. Pursuant to these in-license agreements, we will be required to make additional payments if and when we achieve specified development, regulatory, financial and commercialization milestones. To the extent we are unable to reasonably predict the likelihood, timing or amount of such payments; we have excluded them from the table above. Our technology in-licenses are further described in "Item 1. Business".
We also have contracts and collaborative arrangements that require us to undertake certain research and development work as further explained elsewhere in this discussion. It is not practicable to estimate the amount of these obligations.
IMPACT OF INFLATION
Inflation has not had a material impact on our operations.
RELATED PARTY TRANSACTIONS
On October 16, 2017, we closed the sale of 500,000 Series A participating convertible preferred shares ("Preferred Shares") to Roivant for gross proceeds of $50.0 million. A second financing of $66.4 million for 664,000 Preferred Shares closed on January 12, 2018, following receipt of the approval by Arbutus' shareholders on January 11, 2018. The Preferred Shares are non-voting and are convertible into common shares at a conversion price of $7.13 per share (which represents a 15% premium to the closing price of $6.20 per share on October 16, 2017). The purchase price for the Preferred Shares plus an amount equal to 8.75% per annum, compounded annually, will be subject to mandatory conversion into common shares on October 18, 2021 (subject to limited exceptions in the event of certain fundamental corporate transactions relating to Arbutus’ capital structure or assets, which would permit earlier conversion at Roivant’s option).
After conversion of the Preferred Shares into common shares, based on the number of common shares outstanding on October 2, 2017, Roivant would hold 49.90% of the Company's common shares. Roivant has agreed to a four year lock-up period for this investment and its existing holdings in Arbutus. Roivant has also agreed to a four year standstill whereby Roivant will not acquire greater than 49.99% of the Company's common shares or securities convertible into common shares.
We are currently negotiating a structure to jointly develop our LNP and GalNAc technologies with Roivant.
OUTSTANDING SHARE DATA
At March 6, 2018, we had 55,070,037 common shares issued and outstanding. In addition, we had outstanding 1,164,000 Series A participating convertible preferred shares outstanding, which will be mandatorily convertible into 22,589,601 common shares on October 18, 2021. Assuming the convertible preferred shares were converted as of March 6, 2018, we would have had 77,659,638 common shares outstanding at March 6, 2018.
RECENT ACCOUNTING PRONOUNCEMENTS
From time to time, new accounting pronouncements are issued by the Financial Accounting Standards Board (FASB) or other standard setting bodies that we adopt as of the specified effective date. Unless otherwise discussed, we believe that the impact of recently issued standards that are not yet effective will not have a material impact on our financial position or results of operations upon adoption.
Please refer to Note 2 to our consolidated financial statements included in Part II, Item 8, "Financial Statements and Supplementary Data," of this annual report on Form 10-K for a description of recent accounting pronouncements applicable to our business.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Interest rate risk
We are exposed to market risk related to changes in interest rates, which could adversely affect the value of our interest rate sensitive assets and liabilities. We do not hold any instruments for trading purposes and investment decisions are governed by a Board approved Investment Policy. As at December 31, 2017, we had cash and cash equivalents of $54.3 million and short-term and restricted investments of $84.7 million, as compared to $23.4 million of cash and cash equivalents and $119.7 million of short- and long-term investments as at December 31, 2016. We invest our cash reserves in high interest saving accounts and guaranteed investment certificates and term deposits with varying terms to maturity (not exceeding two years) issued by major banks, selected with regard to the expected timing of expenditures for continuing operations and prevailing interest rates.
The fair value of our cash investments as at December 31, 2017 is equal to the face value of those investments and the value reported in our balance sheet. Due to the relatively short-term nature of the investments that we hold, we do not believe that the results of operations or cash flows would be affected to any significant degree by a sudden change in market interest rates relative to our investment portfolio. Our debt instrument sensitive to changes in interest rate is our liability-classified stock options, with its fair value determined using the Black-Scholes model, which uses interest rate as an input. We have estimated the effects on our liability-classified stock options based on a one percentage point hypothetical adverse change in interest rates as of December 31, 2017 and 2016. We determined the hypothetical fair value using the same Black-Scholes model, and determined that an increase in the interest rates of one percentage point would have had an immaterial change to our liability-classified stock option awards as at December 31, 2017 and 2016.
Foreign currency exchange risk
In addition, we are exposed to market risk related to changes in foreign currency exchange rates. We have not entered into any agreements or purchased any instruments to hedge possible currency risks at this time. We manage our exchange rate risk by using cash received in a currency to pay for expenses in that same currency, whenever possible. Our policy is to maintain US and Canadian dollar cash and investment balances based on long term forecasts of currency needs thereby creating a natural currency hedge. As of December 31, 2017 and 2016, an adverse change of one percentage point in the foreign currency exchange rates of Canadian to US dollars would have resulted in an incremental loss of $0.3 million and $0.4 million, respectively. We recorded foreign exchange gains of $2.3 million and $1.1 million for the fiscal years ended December 31, 2017 and 2016, respectively.
On January 1, 2016, our functional currency changed from the Canadian dollar to the U.S. dollar based on our analysis of changes in the primary economic environment in which we operate. We will continue to incur substantial expenses and hold cash and investment balances in Canadian dollars, and as such, will remain subject to risks associated with foreign currency fluctuations.
Item 8.
Item 8. Financial Statements and Supplementary Data
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report Of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors of Arbutus Biopharma Corporation
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of Arbutus Biopharma Corporation (the Company) as of December 31, 2017 and 2016, the related consolidated statements of operations and comprehensive loss, stockholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2017, and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2017, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated March 15, 2018 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB and in accordance with the ethical requirements that are relevant to our audit of the consolidated financial statements in Canada.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ KPMG
Chartered Professional Accountants
We have served as the Company’s auditor since 2002.
Vancouver, Canada
March 15, 2018
Report Of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors of Arbutus Biopharma Corporation
Opinion on Internal Control Over Financial Reporting
We have audited Arbutus Biopharma Corporation’s (the Company) internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2017 and 2016, the related consolidated statements of operations and comprehensive loss, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2017, and the related notes (collectively, the consolidated financial statements), and our report dated March 15, 2018, expressed an unqualified opinion on those consolidated financial statements.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB and in accordance with the ethical requirements that are relevant to our audit of the financial statements in Canada.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ KPMG
Chartered Professional Accountants
Vancouver, Canada
March 15, 2018
ARBUTUS BIOPHARMA CORPORATION
Consolidated Balance Sheets
(Expressed in thousands of US Dollars, except share and per share amounts)
(Prepared in accordance with US GAAP)
Nature of business and future operations (note 1)
Contingencies and commitments (note 10)
Subsequent events (note 14)
See accompanying notes to the consolidated financial statements.
ARBUTUS BIOPHARMA CORPORATION
Consolidated Statements of Operations and Comprehensive Loss
(Expressed in thousands of US Dollars, except share and per share amounts)
(Prepared in accordance with US GAAP)
See accompanying notes to the consolidated financial statements.
ARBUTUS BIOPHARMA CORPORATION
Consolidated Statement of Stockholders’ Equity
(Expressed in thousands of US Dollars, except share and per share amounts)
(Prepared in accordance with US GAAP)
See accompanying notes to the consolidated financial statements.
ARBUTUS BIOPHARMA CORPORATION
Consolidated Statements of Cash Flows
(Expressed in thousands of US Dollars, except share and per share amounts)
(Prepared in accordance with US GAAP)
See accompanying notes to the consolidated financial statements.
ARBUTUS BIOPHARMA CORPORATION
Notes to Consolidated Financial Statements
(Tabular amounts in thousands of US Dollars, except share and per share amounts)
1. Nature of business and future operations
Arbutus Biopharma Corporation (the “Company” or “Arbutus”) is a biopharmaceutical business dedicated to discovering, developing, and commercializing a cure for patients suffering from chronic hepatitis B infection, a disease of the liver caused by the hepatitis B virus (“HBV”). To pursue our strategy of developing a curative combination regimen, we have assembled an HBV pipeline consisting of multiple drug candidates with differing and complementary mechanisms of action (MOA).
The success of the Company is dependent on obtaining the necessary regulatory approvals to bring its products to market and achieve profitable operations. The continuation of the research and development activities and the commercialization of its products are dependent on the Company’s ability to successfully complete these activities and to obtain adequate financing through a combination of financing activities and operations. It is not possible to predict either the outcome of future research and development programs or the Company’s ability to continue to fund these programs in the future.
2. Significant accounting policies
Basis of presentation
Arbutus Biopharma Corporation was incorporated in Canada on October 6, 2005 as an inactive wholly owned subsidiary of Inex Pharmaceuticals Corporation (Inex). Pursuant to a “Plan of Arrangement” effective April 30, 2007, the business and substantially all of the assets and liabilities of Inex were transferred to the Company. The consolidated financial statements for all periods presented herein include the consolidated operations of Inex until April 30, 2007 and the operations of the Company thereafter.
The Company has two wholly-owned subsidiaries as at December 31, 2017: Arbutus Biopharma, Inc. (Arbutus Inc. formerly OnCore Biopharma, Inc.) and Protiva Biotherapeutics Inc. ("Protiva"). Protiva was acquired on May 30, 2008. Arbutus Inc. was acquired by way of a Merger Agreement on March 4, 2015. On January 1, 2018, Protiva was amalgamated with Arbutus Biopharma Corporation.
In addition to Arbutus Inc. and Protiva, the Company's former wholly-owned subsidiary, Protiva Agricultural Development Company Inc. ("PADCo"), was previously recorded by the Company using the equity method. On March 4, 2016, Monsanto exercised its option to acquire 100% of the outstanding shares of PADCo, as described in note 4(d).
These consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, Arbutus Inc. and Protiva. All intercompany transactions and balances have been eliminated on consolidation.
Recast of Comparative Financial Statements
Certain comparative figures in the Statements of Operations and Comprehensive Loss, Stockholders' Equity, and Cash Flows have been recast to decrease revenues and decrease cumulative translation loss adjustment by $1,597,000, due to translation adjustments from the Company's Canadian dollar functional currency to the U.S. dollar reporting currency for the year-ended December 31, 2015. The cumulative effect of the adjustment has been reflected in the Consolidated Balance Sheets for the year-ended December 31, 2016 as an increase in Deficit and decrease in Accumulated Other Comprehensive Income of $1,597,000. The recast had no effect on operating cash flows for fiscal 2015, 2016, and 2017. As of January 1, 2016, the Company's functional and reporting currency is the U.S. dollar, as described below.
Foreign currency translation and functional currency conversion
Prior to January 1, 2016, the Company's functional currency was the Canadian dollar. Translation gains and losses from the application of the U.S. dollar as the reporting currency during the period that the Canadian dollar was the functional currency are included as part of cumulative currency translation adjustment, which is reported as a component of shareholders' equity under accumulated other comprehensive loss.
The Company re-assessed its functional currency and determined as at January 1, 2016, its functional currency changed from the Canadian dollar to the U.S. dollar based on management's analysis of changes in the primary economic environment in which the Company operates. The change in functional currency is accounted for prospectively from January 1, 2016 and financial statements prior to and including the period ended December 31, 2015 have not been restated for the change in functional currency.
For periods commencing January 1, 2016, monetary assets and liabilities denominated in foreign currencies are translated into U.S. dollars using exchange rates in effect at the balance sheet date. Opening balances related to non-monetary assets and liabilities are based on prior period translated amounts, and non-monetary assets and non-monetary liabilities incurred after January 1, 2016 are translated at the approximate exchange rate prevailing at the date of the transaction. Revenue and expense transactions are translated at the approximate exchange rate in effect at the time of the transaction. Foreign exchange gains and losses are included in the statement of operations and comprehensive loss as foreign exchange gains.
Use of estimates
The preparation of the consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions about future events that affect the reported amounts of assets, liabilities, revenue, expenses, contingent assets and contingent liabilities as at the end or during the reporting period. Actual results could significantly differ from those estimates. Significant areas requiring the use of management estimates relate valuation of intangible assets and goodwill, recognition of revenue, stock-based compensation, and financial instruments, and the amounts recorded as accrued liabilities, contingent consideration, and income tax recovery.
Cash and cash equivalents
Cash and cash equivalents are all highly liquid instruments with an original maturity of three months or less when purchased. Cash equivalents are recorded at cost plus accrued interest. The carrying value of these cash equivalents approximates their fair value.
Short-term investments
Short-term investments have original maturities exceeding three months, and have remaining maturities less than one year. Short-term investments accrue interest daily based on a fixed interest rate for the term. The carrying value of these investments are recorded at cost plus accrued interest, which approximates their fair value. All investments are governed by the Board approved Investment Policy for the Company.
Loan payable and restricted investment
The Company obtained a loan from Wells Fargo for the purpose of financing its operations, including the expansion of laboratory facilities for its U.S. operations. The loan accrues interest daily based on an interest rate with a variable and fixed component. The variable component is the one-month London Interbank Offered Rate (LIBOR), and the fixed component is a margin based on the amount of collateral cash the Company maintains with the lender - see note 9. The loan is due December 2019. The loan is recorded at amortized cost.
The Company must maintain a cash or investment balance as collateral for the loan payable to Wells Fargo. The cash or investment is restricted from the Company's use until the loan is repaid. The Company does not expect to repay the loan within twelve months of the balance sheet date so has classified the restricted investment as a long-term asset. The restricted cash balance has been used to purchase a two year investment maturing on December 23, 2018 and accruing interest at a fixed interest rate of 1.25%. The carrying value of the restricted investment is recorded at cost plus any accrued interest not yet received, which approximates its fair value.
Fair value of financial instruments
We measure certain financial instruments and other items at fair value.
To determine the fair value, we use the fair value hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs market participants would use to value an asset or liability and are developed based on market data obtained from independent sources. Unobservable inputs are inputs based on assumptions about the factors market participants would use to value an asset or liability. The three levels of inputs that may be used to measure fair value are as follows:
•
Level 1 inputs are quoted market prices for identical instruments available in active markets.
•
Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability either directly or indirectly. If the asset or liability has a contractual term, the input must be observable for substantially the full term. An example includes quoted market prices for similar assets or liabilities in active markets.
•
Level 3 inputs are unobservable inputs for the asset or liability and will reflect management’s assumptions about market assumptions that would be used to price the asset or liability.
Assets and liabilities are classified based on the lowest level of input that is significant to the fair value measurements. Changes in the observability of valuation inputs may result in a reclassification of levels for certain securities within the fair value hierarchy.
The Company’s financial instruments consist of cash and cash equivalents, short-term, and restricted investments, accounts receivable, accounts payable and accrued liabilities, warrants, and loan payable . Restricted investments approximate fair value due to the interest rates being at prevailing market rates.
The carrying values of cash and cash equivalents, short-term investments, accounts receivable and accounts payable and accrued liabilities approximate their fair values due to the immediate or short-term maturity of these financial instruments.
As quoted prices for the warrants are not readily available, the Company has used a Black-Scholes pricing model, as described in note 6, to estimate fair value. These are level 3 inputs as defined above.
To determine the fair value of the contingent consideration, the Company uses a probability weighted assessment of the likelihood the milestones would be met and the estimated timing of such payments, and then the potential contingent payments were discounted to their present value using a probability adjusted discount rate that reflects the early stage nature of the development program, time to complete the program development, and overall biotech indices, as detailed in note 10. The Company determined the fair value of the contingent consideration was $10,424,000 and the increase of $1,359,000 has been recorded in other losses in the statement of operations and comprehensive loss for the year ended December 31, 2017. The assumptions used in the discounted cash flow model are level 3 inputs as defined above.
The following tables present information about the Company’s assets and liabilities that are measured at fair value on a recurring basis, and indicates the fair value hierarchy of the valuation techniques used to determine such fair value:
The following table presents the changes in fair value of the Company’s warrants:
The following table presents the changes in fair value of the Company’s liability-classified stock option awards:
(1) Upon functional currency conversion on January 1, 2016 - see functional currency conversion above.
The following table presents the changes in fair value of the Company’s contingent consideration:
(1) As at acquisition date of March 4, 2015.
Property and equipment
Property and equipment is recorded at cost less impairment losses, accumulated depreciation, related government grants and investment tax credits. The Company records depreciation using the straight-line method over the estimated useful lives of the capital assets as follows:
Leasehold improvements are depreciated over their estimated useful lives but in no case longer than the lease term, except where lease renewal is reasonably assured.
If there is a major event indicating that the carrying value of property and equipment may be impaired then management will perform an impairment test and if the carrying value exceeds the recoverable value, based on undiscounted future cash flows, then such assets are written down to their fair values.
Goodwill and intangible assets
The costs incurred in establishing and maintaining patents for intellectual property developed internally are expensed in the period incurred.
Intangible assets consist of in-process research and development arising from the Company’s acquisition of Arbutus Inc. in 2015. In-process research and development (IPR&D) intangible assets are classified as indefinite-lived and are not amortized. IPR&D becomes definite-lived upon the completion or abandonment of the associated research and development efforts. Intangible assets with finite useful lives are amortized on a straight-line basis over their estimated useful lives, which are the respective patent terms. Amortization begins when intangible assets with finite lives are put into use. If there is a major event indicating that the carrying value of intangible assets may be impaired, then management will perform an impairment test in an interim period and if the carrying value exceeds the recoverable value, based on discounted future cash flows, then such assets are written down to their fair values.
The Company reviews the recoverable amount of intangible assets and goodwill on an annual basis, and the annual evaluation is performed as of December 31 each year. In addition, the Company evaluates for events or changes in the business that could indicate impairment and earlier testing. Such indicators include, but are not limited to, on an ongoing basis: (a) industry and market considerations such as increased competitive environment or adverse change in legal factors including an adverse assessment by regulators; (b) an accumulation of costs significantly in excess of the amount originally expected for the development of the asset; (c) current period operating or cash flow loss combined with a history of operating or cash flow losses or a projection or forecast that demonstrates continuing losses associated with the use of the asset; (d) adverse research and development program results; and (e) if applicable, a sustained decrease in share price.
Goodwill represents the excess of purchase price over the value assigned to the net tangible and identifiable intangible assets of Arbutus Inc. - see note 3. Goodwill has an indefinite accounting life and is therefore not amortized. Instead, goodwill is assessed for impairment on an annual basis, unless the Company identifies impairment indicators that would require earlier testing. For the period ended December 31, 2017, the Company has elected to early adopt ASU 2017-04, which simplifies the subsequent measurement of goodwill by eliminating Step 2 from the goodwill impairment test, which required a hypothetical purchase price allocation. A goodwill impairment will now be the amount by which a reporting unit's carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. All other goodwill impairment guidance remains substantially unchanged, and management continues to have the ability to perform a qualitative assessment to determine if a quantitative impairment test is necessary. The Company performs its qualitative analysis using factors including but not limited to: (a) macroeconomic conditions; (b) industry and market considerations; (c) cost factors; (d) overall financial performance; (e) other relevant entity-specific events; (f) events affecting a reporting unit; and (g) if applicable, a sustained decrease in share price in absolute terms and relative to peers. The qualitative assessment for the period ended December 31, 2017 did not indicate an impairment of goodwill and no further quantitative assessment was necessary.
Revenue recognition
The Company earns revenue from research and development collaboration and contract services, licensing fees, milestone and royalty payments. In arrangements with multiple deliverables, the delivered item or items is considered a separate unit of accounting if: (1) the delivered item has value to the customer on a standalone basis; and (2) if the arrangement includes a general right of return relative to the delivered item, delivery or performance of the undelivered item is considered probably and substantially in the Company's control. If the elements of the arrangement do not meet both of the criteria above, they are recognized as a single unit of accounting. If the elements do meet the criteria above, arrangement consideration is allocated to the separate units of accounting based on their relative selling price. Non-refundable payments received under collaborative research and development agreements are recorded as revenue as services are performed and related expenditures are incurred. Non-refundable upfront license fees from collaborative licensing and development arrangements are recognized as the Company fulfills its obligations related to the various elements within the agreements, in accordance with the contractual arrangements with third parties and the term over which the underlying benefit is being conferred. If non-refundable license fees have values to the customer on a standalone basis, separate from the undelivered performance obligations, they are recognized upon delivery. To date, the Company has not recognized any non-refundable license fees upon delivery.
The Company evaluates new arrangements for any substantive milestones by considering: whether substantive uncertainty exists upon execution of the arrangement; if the event can only be achieved based in whole or in part on the Company’s performance, or occurrence of a specific outcome resulting from the Company’s performance; any future performance required, and payment is reasonable relative to all deliverables; and, the payment terms in the arrangement. Payments received upon the achievement of substantive milestones are recognized as revenue in their entirety. Payments received upon the occurrence of milestones that are non-substantive are deferred and recognized as revenue over the estimated period of performance applicable to the associated collaborative agreement.
Revenue earned under research and development manufacturing collaborations where the Company bears some or all of the risk of a product manufacturing failure is recognized when the purchaser accepts the product and there are no remaining rights of return.
Revenue earned under research and development collaborations where the Company does not bear any risk of product manufacturing failure is recognized in the period the work is performed. For contracts where the manufacturing amount is specified, revenue is recognized as product is manufactured in proportion to the total amount specified under the contract.
Cash or other compensation received in advance of meeting the revenue recognition criteria is recorded on the balance sheet as deferred revenue. Revenue meeting recognition criteria but not yet received or receivable is recorded on the balance sheet as accrued revenue.
Leases and lease inducements
Leases entered into are classified as either capital or operating leases. Leases which substantially transfer all benefits and risks of ownership of property to the Company are accounted for as capital leases. At the time a capital lease is entered into, an asset is recorded together with its related long-term obligation to reflect the purchase and financing.
All other leases are accounted for as operating leases wherein rental payments are expensed as incurred.
Lease inducements represent leasehold improvement allowances and reduced or free rent periods and are amortized on a straight-line basis over the term of the lease and are recorded as a reduction of rent expense.
Research and development costs
Research and development costs, including acquired in-process research and development expenses for which there is no alternative future use, are charged as an expense in the period in which they are incurred.
Net loss attributable to common shareholders per share
The Company follows the two-class method when computing net loss attributable to common shareholders per share as the Company has issued Preferred Shares (note 6) that meet the definition of participating securities. The Preferred Shares entitle the holders to participate in dividends but do not require the holders to participate in losses of the Company. Accordingly, if the Company reports a net loss attributable to common shareholders net losses are not allocated to Preferred Shareholders.
Net loss attributable to common shareholders per share is calculated based on the weighted average number of common shares outstanding. Diluted net loss attributable to common shareholders per share does not differ from basic net loss attributable to common shareholders per share for the years ended December 31, 2017, 2016 and 2015, since the effect of the Company’s stock options and warrants is anti-dilutive.
The following table sets out the computation of basic and diluted net loss attributable to common shareholders per share:
For the year ended December 31, 2017, potential common shares of 12,521,550 were excluded from the calculation of income per common share because their inclusion would be anti-dilutive (December 31, 2016 - 4,645,864; December 31, 2015 - 2,899,331). On January 12, 2018 a further 664,000 preferred shares were issued (see note 6), which increased the total potential common shares excluded from the calculation of income per common share to 21,878,002 as at that date.
Government grants and refundable investment tax credits
Government grants and tax credits provided for current expenses are included in the determination of income or loss for the year, as a reduction of the expenses to which they relate.
Deferred income taxes
Income taxes are accounted for using the asset and liability method of accounting. Deferred income taxes are recognized for the future income tax consequences attributable to differences between the carrying values of assets and liabilities and their respective income tax bases and for loss carry-forwards. Deferred income tax assets and liabilities are measured using enacted income tax rates expected to apply to taxable income in the periods in which temporary differences are expected to be recovered or settled. The effect on deferred income tax assets and liabilities of a change in tax laws or rates is included in earnings in the period that includes the enactment date. When realization of deferred income tax assets does not meet the more-likely-than-not criterion for recognition, a valuation allowance is provided.
Equity classified stock option awards
The Company grants stock options to employees, directors and consultants pursuant to share incentive plans described in note 6. Compensation expense is recorded for issued stock options using the fair value method with a corresponding increase in additional paid-in capital. Any consideration received on the exercise of stock options is credited to share capital.
The fair value of equity classified stock options is measured at the grant date and amortized on a straight-line basis over the vesting period.
Liability-classified stock option awards
The Company accounts for liability-classified stock option awards ("liability options") under ASC 718 - Compensation - Stock Compensation ("ASC 718"), under which awards of options that provide for an exercise price that is not denominated in: (a) the currency of a market in which a substantial portion of the Company's equity securities trades, (b) the currency in which the employee's pay is denominated, or (c) the Company's functional currency, are required to be classified as liabilities. Due to the change in functional currency as of January 1, 2016, certain stock option awards with exercise prices denominated in Canadian dollars changed from equity classification to liability classification. As such, the historic equity classification of these stock option awards changed to liability classification effective January 1, 2016. The change in classification resulted in reclassification of these awards from additional paid-in capital to liability-classified options.
Liability options are re-measured to their fair values at each reporting date with changes in the fair value recognized in share-based compensation expense or additional paid-in capital until settlement or cancellation. Under ASC 718, when an award is reclassified from equity to liability, if at the reclassification date the original vesting conditions are expected to be satisfied, then the minimum amount of compensation cost to be recognized is based on the grant date fair value of the original award. Fair value changes below this minimum amount are recorded in additional paid-in capital.
Replacement awards
Replacement awards are share-based payment awards exchanged for awards held by employees of Arbutus Inc. As part of the Company’s acquisition of Arbutus Inc., Arbutus shares were exchanged for Arbutus Inc.’s shares subject to repurchase rights held by Arbutus Inc.’s employees.
As at the date of acquisition of Arbutus Inc., the Company determined the total fair value of replacement awards and attributed a portion of the replacement awards to pre-combination service as part of the total acquisition consideration, and a portion to post-combination service, which is recognized as compensation expense over the expiry period of repurchase provision rights subsequent to the acquisition date.
The replacement awards consist of common shares that were issued at acquisition. Accordingly, as stock compensation expense related to these awards is recognized, share capital is increased by a corresponding amount. Replacement awards are excluded in the calculation of basic net income (loss) per common share until the repurchase rights have expired.
Warrants
The Company accounts for the warrants under the authoritative guidance on accounting for derivative financial instruments indexed to, and potentially settled in, a company’s own stock, on the understanding that in compliance with applicable securities laws, the registered warrants require the issuance of registered securities upon exercise and do not sufficiently preclude an implied right to net cash settlement. The Company classifies warrants in its consolidated balance sheet as a liability which is revalued at each balance sheet date subsequent to the initial issuance. The Company uses the Black-Scholes pricing model to value the warrants. Determining the appropriate fair-value model and calculating the fair value of registered warrants requires considerable judgment. A small change in the estimates used may cause a relatively large change in the estimated valuation. The estimated volatility of the Company’s common stock at the date of issuance, and at each subsequent reporting period, is based on historic fluctuations in the Company’s stock price. The risk-free interest rate is based on the Government of Canada rate for bonds with a maturity similar to the expected remaining life of the warrants at the valuation date. The expected life of the warrants is based on the historical pattern of exercises of warrants.
Preferred Shares
The Company accounts for Preferred Shares under ASC 480, which provides guidance for equity instruments with conversion features. The Company classifies Preferred Shares in its consolidated balance sheet wholly as equity, with no bifurcation of conversion feature from the host contract, given that the Preferred Shares cannot be cash settled and the redemption features, which include a fixed conversion ratio with predetermined timing and proceeds, are within the Company's control. The Company accrues for the 8.75% per annum compounding accrual at each reporting period end date as an increase to share capital, and an increase to deficit (see note 6).
Segment information
The Company operates in a single reporting segment. Substantially all of the Company’s revenues to date were earned from customers or collaborators based in the United States. Substantially all of the Company’s premises, property and equipment are located in Canada and the United States.
Recent accounting pronouncements
From time to time, new accounting pronouncements are issued by the Financial Accounting Standards Board (FASB) or other standard setting bodies that are adopted by the Company as of the specified effective date. Unless otherwise discussed, we believe that the impact of recently issued standards that are not yet effective will not have a material impact on our financial position or results of operations upon adoption.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (ASC 606). The standard, as subsequently amended (ASU 2015-14, ASU 2016-08, ASU 2016-10, ASU 2016-12, ASU 2016-20), is intended to clarify the principles for recognizing revenue and to develop a common revenue standard for U.S. GAAP and IFRS by creating a new Topic 606, Revenue from Contracts with Customers. This guidance supersedes the revenue recognition requirements in ASC 605, Revenue Recognition, and supersedes some cost guidance included in Subtopic 605-35, Revenue Recognition - Construction-Type and Production-Type Contracts. The core principle of the accounting standard is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those good or services. The amendments should be applied by either (1) retrospectively to each prior reporting period presented; or (2) retrospectively with the cumulative effect of initially applying this ASU recognized at the date of initial application. The new guidance is effective for fiscal years beginning after December 15, 2017, which for the Company means January 1, 2018. The Company will be applying the modified retrospective method for its implementation. Based on its evaluation, the Company believes that there will be no quantitative impact on its consolidated financial statements, but there will be disclosure changes mostly related to the timing and recognition of licensing and collaboration contracts that are described in note 4.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842): Recognition and Measurement of Financial Assets and Financial Liabilities. The update supersedes Topic 840, Leases and requires the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under previous GAAP. Topic 842 retains a distinction between finance leases and operating leases, with cash payments from operating leases classified within operating activities in the statement of cash flows. The amendments in this update are effective for fiscal years beginning after December 15, 2018 for public business entities, which for the Company means January 1, 2019. The Company does not plan to early adopt this update. The extent of the impact of this adoption has not yet been determined.
In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. The update addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice. Under this update, the classification of cash receipts and payments that have aspects of more than one class of cash flows should be determined first by applying specific guidance in GAAP. In the absence of specific guidance, 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. An entity should then classify each separately identifiable source or use within the cash receipts and payments on the basis of their nature in financing, investing, or operating activities. 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 amendments in this update are effective for public business entities for fiscal years beginning after December 31, 2017, which for the Company means January 1, 2018, and interim periods within those fiscal years. Early adoption is permitted. The amendments in this update should be applied using a retrospective transition method to each period presented. If it is impracticable to apply the amendments retrospectively for some of the issues, the amendments for those issues would be applied prospectively as of the earliest date practicable. The Company is currently evaluating the extent of the impact of this adoption.
In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Statement of Cash Flows: Restricted Cash. The update requires the statement of cash flows to explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The amendments in this update are effective for public business entities for fiscal years beginning after December 15, 2017, which for the Company means January 1, 2018. Early adoption is permitted, including adoption in an interim period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that included that interim period. The amendments in this update should be applied using a retrospective transition method to each period presented. The Company does not expect the extent of the impact of this adoption to be significant.
In May 2017, the FASB issued ASU 2017-09, Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting. The amendments in this Update provide guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting under Topic 718. An entity should account for effects of a modification unless all of the following are met: (1) the fair value of the modified award is the same as the fair value of the original award immediately before the original award is modified; (2) the vesting conditions of the modified award are the same as the vesting conditions of the original award immediately before the original award is modified; (3) the classification of the modified award as an equity instrument or a liability instrument is the same as the classification of the original award immediately before the original award is modified. The amendments in this Update are effective for all entities for annual periods and interim periods within those annual periods, beginning after December 15, 2017, which for the Company means January 1, 2018. Early adoption is permitted, including adoption in any interim period for public business entities for reporting periods for which financial statements have not yet been issued. The amendments in this Update should be applied prospectively to an award modified on or after the adoption date. The Company early adopted the amendments in this Update effective April 1, 2017. This adoption did not have a material effect on the Company's statement of operations and comprehensive loss for the period beginning on the adoption date, to the period ended December 31, 2017, as no significant award modifications occurred.
3. Impairment evaluations for intangible assets and goodwill
All in-process research and development (IPR&D) acquired is currently classified as indefinite-lived and is not currently being amortized. IPR&D becomes definite-lived upon the completion or abandonment of the associated research and development efforts, and will be amortized from that time over an estimated useful life based on respective patent terms. The Company evaluates the recoverable amount of intangible assets on an annual basis and performs an annual evaluation of goodwill as of December 31 each year, unless there is an event or change in the business that could indicate a requirement to test at an interim period.
Impairment of intangible assets
During the year-ended December 31, 2017, the Company recorded a total impairment charge of $40,798,000 for the discontinuance of the STING agonists. This charge represents the remaining value of the acquired Immune Modulator drug class. In addition, the Company recorded an income tax benefit of $16,926,000 corresponding to the impairment charge - see note 8.
At December 31, 2016, the Company re-assessed the discount rate used in its valuation models used to assess the carrying value of goodwill and intangible assets for impairment as a result of the sustained discrepancy between the Company’s market capitalization compared to carrying values and management’s assessment of fair values. The change in discount rate resulted in an impairment charge of $96,873,000 to the Company’s intangible assets at December 31, 2016.
The following table summarizes the carrying values, net of impairment of the intangible assets as at December 31, 2017:
Annual impairment evaluation of goodwill
Goodwill was recorded as a result of the acquisition of Arbutus Inc. as described in note 2. As part of the evaluation of the recoverability of goodwill, the Company has identified only one reporting unit to which the total carrying amount of goodwill has been assigned. The Company performs its annual impairment evaluation of goodwill on December 31.
The Company determines the fair value of the reporting unit using accepted valuation methods, including the use of discounted cash flows supplemented by market-based assessments of fair value. The income approach is used for the quantitative assessment to estimate the fair value of the reporting unit, which requires estimating future cash flows and risk-adjusted discount rates in the Company's discounted cash flow model. The overall market outlook and cash flow projections of the reporting unit involves the use of key assumptions, including cash flows, discount rates and probability of success. Due to uncertainties in the estimates that are inherent to the Company's industry, actual results could differ significantly from the estimates made. Many key assumptions in the cash flow projections are interdependent on each other. A change in any one or combination of these assumptions could impact the estimated fair value of the reporting unit. See note 2 for additional discussion of the Company's policy for accounting for goodwill.
As at December 31, 2016, the Company re-assessed the discount rate used in the calculation of fair value, consistent with the change to the discount rate used in the intangible assets impairment assessment (described above). As a result of the increased discount rate, the carrying value of the reporting unit determined in step one of the impairment assessment exceeded the fair value of the reporting unit, and as such the Company proceeded to the second step of the impairment test, which measures the amount of an impairment charge. In the second step, the carrying value of goodwill is compared to the fair value of goodwill that is implied by performing a hypothetical purchase price allocation based on identifiable assets at the date of the assessment. The remaining implied goodwill of $24,364,000 is the result of deferred taxes in the hypothetical purchase price allocation. As a result, the Company recorded an impairment for $138,150,000 against goodwill for the year ended December 31, 2016.
For the period ended December 31, 2017, the Company has elected to early adopt ASU 2017-04 (as described in note 2 above). On December 31, 2017, the Company conducted its annual impairment evaluation of goodwill and performed a comprehensive qualitative analysis using factors including but not limited to: (a) macroeconomic conditions; (b) industry and market considerations; (c) cost factors; (d) overall financial performance; (e) other relevant entity-specific events; (f) events affecting a reporting unit; and (g) if applicable, a sustained decrease in share price in absolute terms and relative to peers. The qualitative assessment did not indicate an impairment of goodwill and no further quantitative assessment was necessary.
The Company determines the fair value of the reporting unit each reporting period using accepted valuation methods, including the use of discounted cash flows supplemented by market-based assessments of fair value.
4. Collaborations, contracts and licensing agreements
The following tables set forth revenue recognized under collaborations, contracts and licensing agreements:
The following table sets forth deferred collaborations and contracts revenue:
(a) License Agreement with Alexion
On March 16, 2017, the Company signed a license agreement with Alexion that entitles Alexion to research, develop, manufacture, and commercialize products with the Company's LNP technology in their single orphan disease target. In consideration for the rights granted under the agreement, the Company received a $7,500,000 non-refundable upfront cash payment, as well as payments for services provided. This upfront payment was amortized over the period of expected benefit.
On July 27, 2017, the Company received notice of termination from Alexion for the Company's LNP license agreement. The termination was driven by a strategic review of Alexion's business and research and development portfolio, which included a decision to discontinue development of mRNA therapeutics. The $7,500,000 upfront payment received in March 2017 is non-refundable, and the Company has recorded the upfront payment as well as any revenue and costs related to closeout procedures in the statement of operations and comprehensive loss for the period ended December 31, 2017.
(b) License agreement with Gritstone
On October 16, 2017, the Company entered into a license agreement with Gritstone that entitles Gritstone to research, develop, manufacture and commercialize products with the Company’s LNP technology. The Company received an upfront payment in November 2017, and is eligible to receive future potential payments including research services, development and commercial milestone payments and royalty payments on future product sales.
The Company determined the deliverables under the Agreements included the rights and license granted, involvement in the joint steering committee, and other services provided, as determined under the research plan. The license and involvement in the joint steering committee have been determined by the Company to not have standalone value. Therefore, these deliverables are treated as one unit of accounting and recognized as revenue over the performance period as the Company transfers the technical "know-how" for the customized formulations.
The Company has determined that other materials and services provided have standalone value. The relative fair values are estimated upon the execution of each activity and charged at rates comparable to market with embedded margins on each service activity.
The Company has not recorded any development and commercial milestone payments, as achievements of these were not probable as at December 31, 2017. As such, the accounting treatment for development and commercial milestone payments, as well as royalty payments on future product sales will be accounted for under the Company's application of the new revenue standard, ASC 606 - Revenue from Contracts with Customers, effective January 1, 2018 (see note 2).
(c) License and Development and Supply Agreement with Dicerna
On November 16, 2014, the Company signed a License Agreement and a Development and Supply Agreement (together, the “Agreements”) with Dicerna related to development, manufacture, and commercialization of products directed to the treatment of PH1. In consideration for the rights granted under the Agreements, Dicerna paid the Company an upfront cash payment of $2,500,000, as well as payments for manufacturing and services provided.
In September 2016, Dicerna announced the discontinuation of their DCR-PH1 program using the Company's technology. As such, the Company revised the completion date of performance period from March 2017 to September 30, 2016, at which time the Company had no further remaining performance obligations. This resulted in the recognition of $1,066,000 in Dicerna license fee revenue for the year ended December 31, 2016 and no revenue thereafter.
(d) Option and Services Agreements with Monsanto
On January 13, 2014, the Company and Monsanto signed an Option Agreement and a Services Agreement, which granted Monsanto an option to obtain a license to use the Company’s LNP delivery technology and related intellectual property for use in agriculture. Following the completion of the Phase A extension period in October 2015, no further research activities were conducted under the arrangement, as Monsanto did not elect to proceed to Phase B of the research plan. This resulted in the full release of Monsanto deferred revenue and a recognition of $13,384,000 in Monsanto revenue for the year ended December 31, 2015.
Under the Agreements, the Company has established a wholly-owned subsidiary, PADCo. The Company has determined that PADCo is a variable interest entity (“VIE”); however, Monsanto is the primary beneficiary of the arrangement. PADCo was established to perform research and development activities, which have been funded by Monsanto in return for a call option to acquire the equity or all of the assets of PADCo. On March 4, 2016, Monsanto exercised its option to acquire 100% of the outstanding shares of PADCo and paid the Company an option exercise fee of $1,000,000. From the acquisition of PADCo, Monsanto received a worldwide, exclusive right to use the Company’s proprietary delivery technology in the field of agriculture. The Company recorded the exercise fee received as a gain on disposition of a financial instrument in its consolidated statement of operations and comprehensive loss for the year ended December 31, 2016.
(e) Contract with United States Government’s Department of Defense (“DoD”) to develop TKM-Ebola
On July 14, 2010, the Company signed a contract with the DoD to advance TKM-Ebola, an RNAi therapeutic utilizing the Company’s lipid nanoparticle technology to treat Ebola virus infection.
Under the contract, the Company is reimbursed for costs incurred, including an allocation of overhead costs, and is paid an incentive fee. At the beginning of the fiscal year, the Company estimates its labor and overhead rates for the year ahead. At the end of the year the actual labor and overhead rates are calculated and revenue is adjusted accordingly. The Company’s actual labor and overhead rates will differ from its estimated rates based on actual costs incurred and the proportion of the Company’s efforts on contracts and internal products versus indirect activities. Within minimum and maximum collars, the amount of incentive fee the Company can earn under the contract varies based on costs incurred versus budgeted costs. During the contractual period, incentive fee revenue and total costs are impacted by management’s estimate and judgments which are continuously reviewed and adjusted as necessary using the cumulative catch-up method. For the years ended December 31, 2015 and 2016, the Company believes it can reliably estimate the final contract costs so has recognized the portion of expected incentive fee which has been earned to date.
On October 1, 2015, the Company received formal notification from the DoD that, due to the unclear development path for TKM-Ebola and TKM-Ebola-Guinea, the Ebola-Guinea Manufacturing and the Ebola-Guinea IND submission statements of work had been terminated, subject to the completion of certain post-termination obligations. The TKM-Ebola portion of the contract was completed in November 2015. The Company is currently conducting contract close out procedures with the DoD.
(f) Agreements with Spectrum Pharmaceuticals, Inc. (“Spectrum”)
On May 6, 2006, the Company signed a number of agreements with Talon Therapeutics, Inc. (“Talon”, formerly Hana Biosciences, Inc.) including the grant of worldwide licenses (the “Talon License Agreement”) for three of the Company’s chemotherapy products, Marqibo®, Alocrest ™ (Optisomal Vinorelbine) and Brakiva ™ (Optisomal Topotecan).
On August 9, 2012, the Company announced that Talon had received accelerated approval for Marqibo from the FDA for the treatment of adult patients with Philadelphia chromosome negative acute lymphoblastic leukemia in second or greater relapse or whose disease has progressed following two or more anti-leukemia therapies. Marqibo is a liposomal formulation of the chemotherapy drug vincristine. In the year ended December 31, 2012, the Company received a milestone of $1,000,000 based on the FDA’s approval of Marqibo and will receive royalty payments based on Marqibo’s commercial sales. There are no further milestones related to Marqibo but the Company is eligible to receive total milestone payments of up to $18,000,000 on Alocrest and Brakiva.
Talon was acquired by Spectrum in July 2013. The acquisition did not affect the terms of the license between Talon and the Company. On September 3, 2013, Spectrum announced that they had shipped the first commercial orders of Marqibo. In the year ended December 31, 2017, the Company recorded $191,000 in Marqibo royalty revenue (2016 - $212,000, 2015 -$240,000). In the year ended December 31, 2017, the Company accrued $5,000 in royalties due to TPC in respect of the Marqibo royalty earned by the Company (see note 10, contingencies and commitments).
5. Property and equipment
As at December 31, 2017, all of the Company’s property and equipment is currently in use and no impairment has been recorded.
6. Share capital
(a) Financing
On March 25, 2015, the Company announced that it had completed an underwritten public offering of 7,500,000 common shares, at a price of $20.25 per share, representing gross proceeds of $151,875,000. The Company also granted the underwriters a 30-day option to purchase an additional 1,125,000 shares for an additional $22,781,000 to cover any over-allotments. The underwriters did not exercise the option. The cost of financing, including commissions and professional fees, was $9,700,000, resulting in net proceeds of $142,177,000.
(b) Authorized share capital
The Company’s authorized share capital consists of an unlimited number of common and 1,164,000 preferred shares without par value.
(c) Series A participating convertible preferred shares ("Preferred Shares")
On October 2, 2017, the Company announced that it entered into a subscription agreement with Roivant for the sale of Preferred Shares to Roivant for gross proceeds of $116,400,000. The Preferred Shares are non-voting and are convertible into common shares at a conversion price of $7.13 per share (which represents a 15% premium to the closing price of $6.20 per share). The purchase price for the Preferred Shares plus an amount equal to 8.75% per annum, compounded annually, will be subject to mandatory conversion into common shares on October 18, 2021 (subject to limited exceptions in the event of certain fundamental corporate transactions relating to Arbutus’ capital structure or assets, which would permit earlier conversion at Roivant’s option). After conversion of the Preferred Shares into common shares, based on the number of common shares outstanding on October 2, 2017, Roivant would hold 49.90% of the Company's common shares. Roivant has agreed to a four year lock-up period for this investment and its existing holdings in Arbutus. Roivant has also agreed to a four year standstill whereby Roivant will not acquire greater than 49.99% of the Company's common shares or securities convertible into common shares.
The initial investment of $50,000,000 closed on October 16, 2017, and the remaining amount of $66,400,000 closed on January 12, 2018 following regulatory and shareholder approvals, as applicable, under Canadian securities law.
The Company records the Preferred Shares wholly as equity under ASC 480, with no bifurcation of conversion feature from the host contract, given that the Preferred Shares cannot be cash settled and the redemption features are within the Company's control, which include a fixed conversion ratio with predetermined timing and proceeds. The Company accrues for the 8.75% per annum compounding coupon at each reporting period end date as an increase to share capital, and an increase to deficit (see statement of stockholder's equity).
(d) Warrants to purchase common shares
During the year ended December 31, 2017, there were 179,000 warrants exercised for $353,000 in cash (December 31, 2016 - 170,500 warrants for $445,000) and no warrants were exercised using the cashless exercise provision (December 31, 2016 - 0 warrants for 0 common shares). In March 2017, the remaining balance of 22,000 of the Company's warrants expired. The decrease in fair value from the previous balance sheet date relating to the expired warrants has been included in the total decrease in fair value of warrant liability in the Company's statement of comprehensive loss for the year ended December 31, 2017.
The following table summarizes the Company’s warrant activity for the years ended December 31, 2017 and 2016:
The aggregate intrinsic value in the table above is calculated based on the difference between the exercise price of the warrants and the quoted price of the Company’s common stock as of the reporting date.
(e) Stock-based compensation
The Company has seven share-based compensation plans; the “2007 Plan”, the “2011 Plan”, the "2016 Plan", two “Designated Plans” (together, the “Arbutus Plans”), the “Protiva Option Plan”, and the "OnCore Option Plan".
On June 22, 2011, the shareholders of the Company approved an omnibus stock-based compensation plan (the “2011 Plan”). The Company’s pre-existing 2007 Plan was limited to the granting of stock options as equity incentive awards whereas the 2011 Plan also allows for the issuance of tandem stock appreciation rights, restricted stock units and deferred stock units (collectively, and including options, referred to as “Awards”). The 2011 Plan replaced the 2007 Plan. The 2007 Plan continued to govern the options granted thereunder. No further options were granted under the Company’s 2007 Plan.
Under the Company’s 2007 Plan the Board of Directors granted options to employees, directors and consultants of the Company. The exercise price of the options was determined by the Company’s Board of Directors but was always at least equal to the closing market price of the common shares on the day preceding the date of grant and the term of options granted did not exceed 10 years. The options granted generally vested over three years for employees and immediately for directors.
Under the Company’s 2011 Plan the Board of Directors may grant options, and other types of Awards, to employees, directors and consultants of the Company. The exercise price of the options is determined by the Company’s Board of Directors but will be at least equal to the closing market price of the common shares on the day preceding the date of grant and the term may not exceed 10 years. Options granted generally vest over three years for employees and immediately for directors.
At the Company’s annual general and special meeting of shareholders on May 8, 2014 and July 9, 2015, the shareholders of the Company approved respectively, a 800,000 and a 3,500,000 increase in the number of stock-based compensation awards that the Company is permitted to issue under the 2011 Plan.
At the Company’s annual general and special meeting of shareholders on May 19, 2016, the shareholders of the Company approved the adoption of the Company's 2016 Omnibus Share and Incentive Plan (the "2016 Plan") and the reserve of 5,000,000 shares of the Company issuable pursuant to awards under the 2016 Plan. These include both equity-classified and liability-classified stock options. The Company's 2011 Omnibus Share Compensation Plan, as amended, also remains in effect.
Additionally, the Company granted a total of 200,000 options in 2013 to two executive officers in conjunction with their new appointments as executive officers. These options were granted in accordance with the policies of the Toronto Stock Exchange and pursuant to newly designated share compensation plans (the “Designated Plans”). During 2016, one of the two executive officers departed from the Company, and the unexercised options under his Designated Plan expired. No new options can be granted under the Designated Plans, resulting in one Designated Plan remaining at the end of 2017. The Designated Plan is governed by substantially the same terms as the 2011 Plan. Hereafter, information on options governed by the 2007 Plan, the 2011 Plan, the 2016 Plan and the Designated Plan (the "Arbutus Plans") is presented on a consolidated basis as the terms of the five plans are similar. Information on the Protiva Option Plan and the OnCore Option Plan are presented separately.
Stock option activity for the Arbutus Plans
Equity-classified stock option activity:
1.
Due to the change in the Company's functional currency as of January 1, 2016, certain stock option awards with exercise prices denominated in Canadian dollars changed from equity classification to liability classification - see note 2.
Options under the Arbutus Plans expire at various dates from March 31, 2018 to November 7, 2027.
The following table summarizes information pertaining to stock options outstanding at December 31, 2017 under the Arbutus Plans:
At December 31, 2017, there were 1,520,131 options exercisable (December 31, 2016 - 699,241; December 31, 2015 - 938,730). The weighted average remaining contractual life of exercisable options as at December 31, 2017 was 7.4 years.
The aggregate intrinsic value of in-the-money options exercisable at December 31, 2017 was $1,098,000.
A summary of the Company’s non-vested stock option activity and related information for the year ended December 31, 2017 is as follows:
The weighted average remaining contractual life for options expected to vest at December 31, 2017 was 8.3 years and the weighted average exercise price for these options was $6.06 per share.
The aggregate intrinsic value of options expected to vest as at December 31, 2017 was $5,842,000 (December 31, 2016 - $0; December 31, 2015 -$10,000).
The total fair value of options that vested during the year ended December 31, 2017 was $5,657,000 (December 31, 2016 - $5,058,000; December 31, 2015 -$1,718,000).
Valuation assumptions for the Arbutus Plans
On March 3, 2015, the Company voluntarily de-listed from the Toronto Stock Exchange. All stock options granted after March 3, 2015 were denominated in US dollars based on the Company's stock price on the NASDAQ. The methodology and assumptions used to estimate the fair value of stock options at date of grant under the Black-Scholes option-pricing model remain unchanged. Assumptions on the dividend yield are based on the fact that the Company has never paid cash dividends and has no present intention to pay cash dividends. Assumptions about the Company’s expected stock-price volatility are based on the historical volatility of the Company’s publicly traded stock. The risk-free interest rate used for each grant is equal to the zero coupon rate for instruments with a similar expected life. Expected life assumptions are based on the Company’s historical data. The Company recognizes forfeitures as they occur, and the effects of forfeitures are reflected in stock-based compensation expense recorded in the statement of operations and comprehensive loss for the year ended December 31, 2017. The weighted average option pricing assumptions for options granted during the year are as follows:
Liability-classified stock option activity:
Valuation assumptions
Liability options are re-measured to their fair values at each reporting date, using the Black-Scholes valuation model. The methodology and assumptions prevailing at the re-measurement date used to estimate the fair values of liability options remain unchanged from the date of grant of equity classified stock option awards. Assumptions about the Company’s expected stock-price volatility are based on the historical volatility of the Company’s publicly traded stock. The risk-free interest rate used for each grant is equal to the zero coupon rate for instruments with a similar expected life. Expected life assumptions are based on the Company’s historical data. The weighted average Black-Scholes option-pricing assumptions and the resultant fair values as at December 31, 2016 and December 31, 2017, are presented in the following table:
Stock option activity for liability options
Liability options expire at various dates from March 31, 2018 to May 7, 2024.
The following table summarizes information pertaining to liability options outstanding at December 31, 2017:
During the year-ended December 31, 2017, 14,750 options vested with a weighted average exercise price of $12.83 and a total fair value of $36,100. As at December 31, 2017, all liability options were vested.
Protiva Option Plan
On May 30, 2008, as a condition of the acquisition of Protiva Biotherapeutics Inc., a total of 350,457 common shares of the Company were reserved for the exercise of 519,073 Protiva share options (“Protiva Options”). The Protiva Options have an exercise price of C$0.30, were fully vested and exercisable as of May 30, 2008. As at December 31, 2017, the outstanding options expire on March 1, 2018 and upon exercise each option will be converted into approximately 0.6752 shares of the Company (the same ratio at which Protiva common shares were exchanged for Company common shares at completion of the acquisition of Protiva). The Protiva Options are not part of the Arbutus Plans and the Company is not permitted to grant any further Protiva Options.
The following table sets forth outstanding options under the Protiva Option Plan:
The weighted average remaining contractual life of exercisable Protiva Options as at December 31, 2017 was 0.2 years.
The aggregate intrinsic value of Protiva Options outstanding at December 31, 2017 was $127,000. The intrinsic value of Protiva Options exercised in the year ended December 31, 2017 was $10,000 (2016 - $49,000; 2015 -$1,249,000).
OnCore Option Plan
As at the acquisition date in March 2015, the Company reserved 184,332 shares for the future exercise of OnCore (Arbutus Inc.) stock options. The total fair value of OnCore stock options at the date of acquisition has been determined to be $3,287,000, using the Black-Scholes pricing model with an assumed risk-free interest rate of 0.97%, volatility of 78%, a zero dividend yield and an expected life of 8 years, which are consistent with the assumption inputs used by the Company to determine the fair value of its options. Of the total fair value, $1,127,000 has been attributed as pre-combination service and included as part of the total acquisition consideration. The post-combination attribution of $2,160,000 will be recognized as compensation expense over the vesting period of the stock options through to December 2018.
Following the merger, the Company is not permitted to grant any further options under the OnCore Option Plan. The Company has included $576,000 of compensation expense related to the vesting of Arbutus Inc. stock options for the year ended December 31, 2017.
The following table sets forth outstanding options under the OnCore Option Plan:
At December 31, 2017, there were 150,913 OnCore options (151,978 Arbutus equivalent) exercisable with a weighted average exercise price of $0.56. The weighted average remaining contractual life of exercisable options as at December 31, 2017 was 6.9 years. The aggregate intrinsic value of in-the-money options exercisable at December 31, 2017 was $682,000.
A summary of the OnCore Option Plan's non-vested stock option activity and related information for the year ended December 31, 2017 is as follows:
The weighted average remaining contractual life for options expected to vest at December 31, 2017 was 6.9 years and the weighted average exercise price for these options was $0.57 per share.
The aggregate intrinsic value of options expected to vest as at December 31, 2017 was $144,000.
The total fair value of options that vested during the year ended December 31, 2017 was $611,000.
Stock-based compensation expense
Total stock-based compensation expense is comprised of: (1) the vesting options awarded to employees under the Arbutus and OnCore option plans calculated in accordance with the fair value method as described above; and (2) the expiration of repurchase rights related to the post-combination service portion of the total fair value of shares issued to Arbutus Inc.'s employees.
The total stock-based compensation has been recorded in the consolidated statement of operations and comprehensive income (loss) as follows:
At December 31, 2017, there remains $5,747,000 of unearned compensation expense related to unvested equity employee stock options to be recognized as expense over a weighted-average period of approximately 20 months.
Awards outstanding and available for issuance
Combining all of the Company’s share-based compensation plans, at December 31, 2017, the Company has 5,381,163 options outstanding and a further 5,084,189 Awards available for issuance.
(f) Replacement awards
Included in the total consideration transferred for the acquisition of Arbutus Inc. in March 2015 are common shares issued as replacement awards, which are subject to repurchase provisions. The total fair value of these common shares attributed to the post acquisition period was approximately $56,934,000 and is being recognized as compensation expense over the expiry period of repurchase provision rights subsequent to the acquisition date.
For the year-ended December 31, 2017, all remaining repurchase provision rights expired and the Company recorded compensation expense $7,972,000 (2016 - $31,986,000; 2015 - $16,687,000) in stock-based compensation.
7. Refundable investment tax credits
Refundable investment tax credits have been recorded as a reduction in research and development expenses.
The Company’s estimated claim for refundable Scientific Research and Experimental Development investment tax credits for the year ended December 31, 2017 is $183,000 (2016 - $145,000).
8. Income taxes
Income tax (recovery) expense varies from the amounts that would be computed by applying the combined Canadian federal and provincial income tax rate of 26% (2015 - 26%; 2014 - 26%) to the loss before income taxes as shown in the following tables:
Effective November 2, 2017, the British Columbia provincial corporate tax rate increased from 11% to 12%, starting January 1, 2018. The overall increase in tax rates in 2018 will result in an increase in the Company's statutory tax rate from 26% in 2017 to 27% in 2018 and onward.
On December 22, 2017, the Tax Cuts and Jobs Act (the “2017 Tax Act”) was signed into law making significant changes to the Internal Revenue Code. Changes include, but are not limited to, a federal corporate tax rate decrease from 35% to 21% for tax years beginning after December 31, 2017. Certain income tax effects of the 2017 Tax Act, principally due to the write-down of our net deferred tax assets, are reflected in our financial results in accordance with Staff Accounting Bulletin No. 118 (SAB 118), which provides SEC staff guidance regarding the application of Accounting Standards Codification (ASC) Topic 740, Income Taxes, in the reporting period in which the 2017 Tax Act became law. At December 31, 2017, we have not completed our accounting for the tax effects of enactment of the Act; however, we have made a reasonable estimate of the effects on our existing deferred tax balances. We have remeasured certain deferred tax assets and liabilities based on the rates at which they are expected to reverse in the future, which is generally 21%. However, we are still analyzing certain aspects of the Act and refining our calculations, which could potentially affect the measurement of these balances or potentially give rise to new deferred tax amounts. The provisional amount recorded related to the re-measurement of our deferred tax assets was a reduction of $13.4 million to deferred tax liabilities and a reduction of $3.5 million to our deferred tax assets, which have a full valuation allowance provided against them.
On November 23, 2011, the Company was registered as a corporation under the Business Activity Act in the province of British Columbia. Under this program, provincial corporation tax charged on foreign income earned from the Company’s patents will be eligible for a 75% tax refund up to a maximum of C$8,000,000. This program was eliminated on October 23, 2017.
As at December 31, 2017, the Company has investment tax credits available to reduce Canadian federal income taxes of $9,546,000 (December 31, 2016 - $10,245,000) and provincial income taxes of $4,866,000 (December 31, 2016 - $5,337,000), expiring between 2027 and 2037. In addition, the Company has research and development credits of $3,639,000 (December 31, 2016 - $1,454,000) available for indefinite carry-forward, which can be used to reduce future taxable income in the U.S.
At December 31, 2017, the Company has scientific research and experimental development expenditures of $61,493,000 (December 31, 2016 - $65,332,000) available for indefinite carry-forward and $124,451,000 (December 31, 2016 - $71,460,000) of net operating losses due to expire between 2027 and 2037 and which can be used to offset future taxable income in Canada.
As at December 31, 2017, the Company has $13,723,000 (December 31, 2016 - $14,621,000) of net operating losses due to expire between 2030 and 2037, which can be used to offset future taxable income in the U.S. Future use of a portion of the U.S. loss carry-forwards is subject to limitations under the Internal Revenue Code Section 382.
As a result of ownership changes occurring on October 1, 2014 and March 4, 2015, the Company's ability to use these losses may be limited. Losses incurred to date may be further limited if a subsequent change in control occurs.
Significant components of the Company’s deferred tax assets and liabilities are shown below:
9. Loan payable
On December 27, 2016, the Company obtained a loan of $12,001,000 from Wells Fargo in the form of a promissory note for the purpose of financing its operations, including the expansion of laboratory facilities for its U.S. operations. The loan accrues interest daily based on an interest rate with a variable and fixed component. The variable component is the one-month London Interbank Offered Rate (LIBOR), and the fixed component is a margin of 1.25% per annum. The carrying value of the loan is recorded at the principal plus any accrued interest not yet paid. The loan is due on December 27, 2019.
The loan is secured by the Company's cash of $12,601,000, and is restricted from use until the loan has been settled in full. The Company invested the restricted cash in a two-year fixed certificate of deposit with Wells Fargo (see note 2) and is presented as restricted investment in the Company's balance sheet for the period ended December 31, 2017.
10. Contingencies and commitments
Property lease
The total minimum rent and estimated operating cost commitment, net of lease inducements, for both our head office in Burnaby and Warminster facility is as follows:
The Company’s lease expense, for the year ended December 31, 2017 of $1,653,000 has been recorded in the consolidated statements of operations and comprehensive loss (2016 of $1,341,000; 2015 of $1,158,000).
Product development partnership with the Canadian Government
The Company entered into a Technology Partnerships Canada (TPC) agreement with the Canadian Federal Government on November 12, 1999. Under this agreement, TPC agreed to fund 27% of the costs incurred by the Company, prior to March 31, 2004, in the development of certain oligonucleotide product candidates up to a maximum contribution from TPC of $7,179,000 (C$9,330,000). As at December 31, 2017, a cumulative contribution of $2,951,000 (C$3,702,000) had been received and the Company does not expect any further funding under this agreement. In return for the funding provided by TPC, the Company agreed to pay royalties on the share of future licensing and product revenue, if any, that is received by the Company on certain non-siRNA oligonucleotide product candidates covered by the funding under the agreement. These royalties are payable until a certain cumulative payment amount is achieved or until a pre-specified date. In addition, until a cumulative amount equal to the funding actually received under the agreement has been paid to TPC, the Company agreed to pay 2.5% royalties on any royalties the Company receives for Marqibo. For the year ended December 31, 2017, the Company earned royalties on Marqibo sales in the amount of $191,000 (see note 4(f)), resulting in $5,000 recorded by the Company as royalty payable to TPC (2016 - $5,000; 2015 -$6,000). The cumulative amount paid or accrued up to December 31, 2017 was $22,000, resulting in the contingent amount due to TPC being $2,929,000 (C$3,674,000).
Arbitration with the University of British Columbia (“UBC”)
Certain early work on lipid nanoparticle delivery systems and related inventions was undertaken at UBC. These inventions are licensed to the Company by UBC under a license agreement, initially entered in 1998 as amended in 2001, 2006 and 2007. The Company has granted sublicenses under the UBC license to Alnylam. Alnylam has in turn sublicensed back to the Company under the licensed UBC patents for discovery, development and commercialization of siRNA products. Certain sublicenses to other parties were also granted.
On November 10, 2014, UBC filed a demand for arbitration against the Company and on January 16, 2015, filed a Statement of Claim, which alleges entitlement to $3,500,000 in allegedly unpaid royalties based on publicly available information, and an unspecified amount based on non-public information. UBC also seeks interest and costs, including legal fees. The Company filed its Statement of Defense to UBC's Statement of Claims, as well as filed a Counterclaim involving a patent application that the Company alleges UBC wrongly licensed to a third party rather than to the Company. The Company seeks license payments for said application, and an exclusive worldwide license to said application. The proceeding has been divided into three phases, with a first hearing that took place in June 2017. The arbitrator determined in the first phase which agreements are sublicense agreements within UBC's claim, and which are not. No finding was made as to whether any licensing fees are due to UBC under these agreements; this will be the subject of the second phase of arbitration. The arbitrator also held that the patent application that is the subject of the Counterclaim was not required to be licensed to Arbutus. A schedule for the remaining phases has not yet been set. Arbitration and related matters are costly and may divert the attention of the Company's management and other resources that would otherwise be engaged in other activities. However, the Company notes that arbitration is subject to inherent uncertainty and an arbitrator could rule against the Company. The Company has not recorded an estimate of the possible loss associated with this arbitration, due to the uncertainties related to both the likelihood and amount of any possible loss or range of loss. Costs related to the arbitration have been recorded in the statement of operations and comprehensive loss by the Company as incurred.
Litigation with Acuitas Therapeutics (“Acuitas”)
In August 2017, the Company provided Acuitas with notice that it considered Acuitas to be in material breach of the cross-license agreement. The cross-license agreement provides that it may be terminated upon any material breach by the other party 60 days after receipt of written notice of termination describing the material breach in reasonable detail. In October 2016, Acuitas filed a Notice of Civil Claim in the Supreme Court of British Columbia seeking an order that the Company perform its obligations under the Cross License Agreement, for damages ancillary to specific performance, injunctive relief, interest and costs. The Company disputed Acuitas’ position, and filed a Counterclaim seeking a declaration that Acuitas is in breach of the Cross License Agreement, and claiming injunctive relief, damages, interest and costs.
In January 2017, the Company filed an application seeking an order to enjoin Acuitas from, among other things, entering into any further agreements purporting to sublicense Arbutus’ technology from the date of the order to the date of trial or further order from the Court. In February 2017, the Company announced that the Supreme Court of British Columbia granted its request for a pre-trial injunction against Acuitas, preventing Acuitas from further sublicensing of the Company's lipid nanoparticle (LNP) technology until the end of October, or further order of the Court. Under the terms of the pre-trial injunction, Acuitas is prevented from entering into any new agreements which include sublicensing of the Company's LNP. In March 2017, Acuitas sought leave to appeal from the injunction decision and in April 2017, the appeal was denied. In
September 2017, the injunction order was extended by consent to March 2, 2018. In February 2018, the contractual issues concerning the cross-license agreement (excluding the claims for damages) were settled out of court, resulting in the termination of Acuitas’ rights to further use or sublicense our LNP technology, making permanent the effect of the Court’s prior injunction.
Arbitration and related matters are costly and may divert the attention of the Company’s management and other resources that would otherwise be engaged in other activities. Costs related to the arbitration are recorded by the Company as incurred. No contingent asset was recorded by the Company for the period ended December 31, 2017, as the settlement occurred in February 2018, and the terms were determined after December 31.
Contingent consideration from Arbutus Inc. acquisition of Enantigen and License Agreements between Enantigen and Baruch S. Blumberg Institute (Blumberg) and Drexel
In October 2014, Arbutus Inc. acquired all of the outstanding shares of Enantigen pursuant to a stock purchase agreement. Through this transaction, Arbutus Inc. acquired a HBV surface antigen secretion inhibitor program and a capsid assembly inhibitor program, each of which are now assets of Arbutus, following the Company’s merger with Arbutus Inc.
Under the stock purchase agreement, Arbutus Inc. agreed to pay up to a total of $21,000,000 to Enantigen’s selling stockholders upon the achievement of certain triggering events related to HBV therapies. The first triggering event is enrollment of the first patient in a Phase 1b clinical trial in HBV patients, which the Company believes is likely to occur in the next twelve-month period.
The regulatory, development and sales milestone payments had an estimated fair value of approximately $6,727,000 as at the date of acquisition of Arbutus Inc., and were treated as contingent consideration payable in the purchase price allocation. The contingent consideration was calculated based on information available at the date of acquisition, using a probability weighted assessment of the likelihood the milestones would be met and the estimated timing of such payments, and then the potential contingent payments were discounted to their present value using a probability adjusted discount rate that reflects the early stage nature of the development program, time to complete the program development, and market comparatives.
Contingent consideration is a financial liability and measured at its fair value at each reporting period, with any changes in fair value from the previous reporting period recorded in the statement of operations and comprehensive loss (see note 2).
Drexel and Blumberg
In February 2014, Arbutus Inc. entered into a license agreement with Blumberg and Drexel that granted an exclusive, worldwide, sub-licensable license to three different compound series: cccDNA inhibitors, capsid assembly inhibitors and HCC inhibitors.
In partial consideration for this license, Arbutus Inc. paid a license initiation fee of $150,000 and issued warrants to Blumberg and Drexel. The warrants were exercised in 2014. Under this license agreement, Arbutus Inc. also agreed to pay up to $3,500,000 in development and regulatory milestones per licensed compound series, up to $92,500,000 in sales performance milestones per licensed product, and royalties in the mid-single digits based upon the proportionate net sales of licensed products in any commercialized combination. The Company is obligated to pay Blumberg and Drexel a double digit percentage of all amounts received from the sub-licensees, subject to customary exclusions.
In November 2014, Arbutus Inc. entered into an additional license agreement with Blumberg and Drexel pursuant to which it received an exclusive, worldwide, sub-licensable license under specified patents and know-how controlled by Blumberg and Drexel covering epigenetic modifiers of cccDNA and STING agonists. In consideration for these exclusive licenses, Arbutus Inc. made an upfront payment of $50,000. Under this agreement, the Company will be required to pay up to $1,000,000 for each licensed product upon the achievement of a specified regulatory milestone and a low single digit royalty, based upon the proportionate net sales of compounds covered by this intellectual property in any commercialized combination. The Company is also obligated to pay Blumberg and Drexel a double digit percentage of all amounts received from its sub-licensees, subject to exclusions.
Research Collaboration and Funding Agreement with Blumberg
In October 2014, Arbutus Inc. entered into a research collaboration and funding agreement with Blumberg under which the Company will provide $1,000,000 per year of research funding for three years, renewable at the Company’s option for an additional three years, for Blumberg to conduct research projects in HBV and liver cancer pursuant to a research plan to be agreed upon by the parties. Blumberg has exclusivity obligations to Arbutus with respect to HBV research funded under the agreement. In addition, the Company has the right to match any third party offer to fund HBV research that falls outside the scope of the research being funded under the agreement. Blumberg has granted the Company the right to obtain an exclusive, royalty bearing, worldwide license to any intellectual property generated by any funded research project. If the Company elects to exercise its right to obtain such a license, the Company will have a specified period of time to negotiate and enter into a mutually agreeable license agreement with Blumberg. This license agreement will include the following pre negotiated upfront, milestone and royalty payments: an upfront payment in the amount of $100,000; up to $8,100,000 upon the achievement of specified development and regulatory milestones; up to $92,500,000 upon the achievement of specified commercialization milestones; and royalties at a low single to mid-single digit rates based upon the proportionate net sales of licensed products from any commercialized combination.
On June 5, 2016, the Company and Blumberg entered into an amended and restated research collaboration and funding agreement, primarily to: (i) increase the annual funding amount to Blumberg from $1,000,000 to $1,100,000; (ii) extend the initial term through to October 29, 2018; (iii) provide an option for the Company to extend the term past October 29, 2018 for two additional one year terms; and (iv) expand the Company's exclusive license under the Agreement to include the sole and exclusive right to obtain an exclusive, royalty-bearing, worldwide and all-fields license under Blumberg's rights in certain other inventions described in the agreement.
11. Concentrations of business risk
Credit risk
Credit risk is defined by the Company as an unexpected loss in cash and earnings if a collaborative partner is unable to pay its obligations in due time. The Company’s main source of credit risk is related to its accounts receivable balance which principally represents temporary financing provided to collaborative partners in the normal course of operations.
The Company does not currently maintain a provision for bad debts as the majority of accounts receivable are from collaborative partners or government agencies and are considered low risk.
The carrying amount of financial assets represents the maximum credit exposure. The maximum exposure to credit risk at December 31, 2017 was the accounts receivable balance of $402,000 (2016 - $273,000).
All accounts receivable balances were current as at December 31, 2017 and December 31, 2016.
Significant collaborators and customers risk
We depend on a small number of collaborators and customers for a significant portion of our revenues (see note 4).
Liquidity Risk
Liquidity risk results from the Company’s potential inability to meet its financial liabilities, for example payments to suppliers. The Company ensures sufficient liquidity through the management of net working capital and cash balances.
The Company’s liquidity risk is primarily attributable to its cash and cash equivalents, and short-term investments. The Company limits exposure to liquidity risk on its liquid assets through maintaining its cash and cash equivalent, and short-term investments with high-credit quality financial institutions. Due to the nature of these investments, the funds are available on demand to provide optimal financial flexibility.
The Company believes that its current sources of liquidity are sufficient to cover its likely applicable short term cash obligations. The Company’s financial obligations include accounts payable and accrued liabilities which generally fall due within 45 days. The net liquidity of the Company is considered to be the cash and cash equivalents and short-term investments less accounts payable and accrued liabilities.
Foreign currency risk
The results of the Company’s operations are subject to foreign currency transaction and translation risk as the Company’s revenues and expenses are denominated in both Canadian and US dollars. The fluctuation of the Canadian dollar in relation to the US dollar will consequently have an impact upon the Company’s reported income or loss and may also affect the value of the Company’s assets, liabilities, and the amount of shareholders’ equity both as recorded in the Company’s financial statements, in the US functional currency, and as reported, for presentation purposes, in the US dollar.
The Company manages its foreign currency risk by using cash received in a currency to pay for expenses in that same currency, whenever possible. The Company’s policy to maintain US and Canadian dollar cash and investment and short-term investment balances based on long term forecasts of currency needs thereby creating a natural currency hedge.
The Company has not entered into any agreements or purchased any instruments to hedge possible currency risks. The Company’s exposure to Canadian dollar currency expressed in US dollars was as follows:
An analysis of the Company’s sensitivity to foreign currency exchange rate movements is not provided in these financial statements as the Company’s Canadian dollar cash holdings and expected Canadian dollar revenues are sufficient to cover Canadian dollar expenses for the foreseeable future.
12. Supplementary information
Accounts payable and accrued liabilities is comprised of the following:
13. Interim financial data (unaudited)
14. Subsequent events
(a) Closing of Second Tier of a $116.4 million Strategic Investment from Roivant Sciences
On January 12, 2018, the Company closed the Tier 2 issue and sale of 664,000 Series A participating convertible preferred shares to Roivant for gross proceeds of $66,400,000, following receipt of the approval of the Company's shareholders on January 11, 2018. The Tier 2 closing represents the second of two tiers of Preferred Shares issued to Roivant and, together with the previously announced Tier 1 closing in October 2017 (see note 6), comprise the previously announced $116,400,000 strategic investment by Roivant in the Company.
(b) Consolidation of HBV business in Warminster, PA site
On February 2, 2018, the Company announced a site consolidation and organizational structuring to better align its HBV business in Warminster, PA. To achieve this alignment, the Company will reduce its global workforce by approximately 31% and plans to close its Burnaby facility. The Company will incur restructuring costs related to one-time employee termination benefits, employee relocation costs, and site closure costs estimated to be $5,000,000, which will be primarily paid in cash in the second quarter of 2018.
The Company and Roivant are currently negotiating a structure to jointly develop the Company's LNP and GalNAc technologies.
(c) Settlement of Litigation, Terminating Acuitas’ Rights to LNP Technology
In February 2018, the contractual issues concerning the cross-license agreement (excluding the claims for damages) were settled out of court, resulting in the termination of Acuitas’ rights to further use or sublicense our LNP technology, making permanent the effect of the Court’s prior injunction. Refer to note 10 - contingencies and commitments, and Item 3, "Legal Proceedings" in Part I of this annual report on Form 10-K for more information.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
Disclosure Controls and Procedures
As of the end of our fiscal year ended December 31, 2017, an evaluation of the effectiveness of our “disclosure controls and procedures” (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) was carried out by our management, with the participation of our Chief Executive Officer (CEO) and Chief Financial Officer (CFO). Based upon that evaluation, the CEO and CFO have concluded that as of the end of that fiscal year, our disclosure controls and procedures are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in Securities Exchange Commission (the "Commission") rules and forms and (ii) accumulated and communicated to the management of the registrant, including the CEO and CFO, to allow timely decisions regarding required disclosure.
It should also be noted that the CEO and CFO believe that our disclosure controls and procedures provide a reasonable assurance that they are effective, they do not expect that our disclosure controls and procedures or internal control over financial reporting will prevent all errors and fraud. A control system, no matter how well conceived or operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met.
Management’s Annual Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over our financial reporting, as such term is defined in Rule 13a-15(f) of the Securities Exchange Act of 1934. Internal control over financial reporting is defined as process designed by, or under the supervision of, the CEO and CFO, and effected by the issuer's board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that: (1) pertain to the maintenance of records that in reasonable detail accurately reflect the transactions and dispositions of the assets of the issuer, (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the issuer are being made only in accordance with authorizations of management and directors of the issuer, and (3) provide reasonable assurance regarding preventions or timely detection of unauthorized acquisition, use or disposition of the issuer's assets that could have a material effect on the financial statements.
Management has assessed the effectiveness of our internal control over financial reporting as at December 31, 2017. In making its assessment, management used the Committee of Sponsoring Organizations of the Treadway Commission (COSO) framework in Internal Control - Integrated Framework (2013) to evaluate the effectiveness of our internal control over financial reporting. Based on this assessment, management has concluded that our internal control over financial reporting was effective as of December 31, 2017.
Attestation Report of the Registered Public Accounting Firm
The independent registered public accounting firm’s report on the effectiveness of our internal control over financial reporting, is included in Item 8 of this annual report on Form 10-K and is incorporated herein by reference.
Changes in Internal Control over Financial Reporting
During the fiscal quarter ended December 31, 2017, we have implemented an independent third party stock option administration system, which we rely on for various financial reporting calculations including fair value and disclosure information. There have not been any other changes in our internal control over financial reporting that have materially affected or are reasonably likely to materially affect the Company's internal control over financial reporting.
Item 9B.
Item 9B. Other Information
None.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
The information required by this item is incorporated herein by reference to the information contained under the sections captioned “Proposal One - Election of Directors,” “Section 16(a) Beneficial Ownership Reporting Compliance,” Code of Business Conduct for Directors Officers and Employees," and “Corporate Governance” of the Proxy Statement. The information required by this item relating to executive officers is included in Part I, Item 1, “- Business-Executive Officers of the Registrant,” of this annual report on Form 10-K.
Item 11.
Item 11. Executive Compensation
The information required by this item is incorporated herein by reference to the information contained under the sections captioned “Executive Compensation,” "Director Compensation," and “Compensation Committee Report” of the Proxy Statement.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by this item is incorporated herein by reference to the information contained under the sections captioned “Security Ownership of Certain Beneficial Owners and Management,” and “Securities Authorized for Issuance Under Equity Compensation Plans” of the Proxy Statement.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by this item is incorporated herein by reference to the information contained under the sections captioned “Corporate Governance,” and “Certain Relationships and Related Transactions” of the Proxy Statement.
Item 14.
Item 14. Principal Accounting Fees and Services
The information required by this item is incorporated herein by reference to the information contained under the section captioned "Independent Auditor" of the Proxy Statement.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
Financial Statements
See Index to Consolidated Financial Statements under Item 8 of Part II.
Financial Statement Schedules
None
Item 16.
Form 10-K Summary
None
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on March 15, 2018.
ARBUTUS BIOPHARMA CORPORATION
By:
/s/ Mark Murray
Mark Murray
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on March 15, 2018.
Signatures
Capacity in Which Signed
/s/ Vivek Ramaswamy
Director (Chairman)
Vivek Ramaswamy
/s/ Mark Murray
President and Chief Executive Officer and Director
Mark Murray
(Principal Executive Officer)
/s/ Koert VandenEnden
Interim Chief Financial Officer
Koert VandenEnden
(Principal Financial Officer and Accounting Officer)
/s/ Daniel Burgess
Director
Daniel Burgess
/s/ Herbert J. Conrad
Director
Herbert J. Conrad
/s/ Richard C. Henriques
Director
Richard C. Henriques
/s/ Frank Karbe
Director
Frank Karbe
/s/ Keith Manchester
Director
Keith Manchester
/s/ William T. Symonds
Chief Development Officer and Director
William T. Symonds
*
Previously filed
**
Filed herewith
†
Confidential treatment granted as to portions of this exhibit.
††
Confidential treatment has been requested as to portions of this exhibit.
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Management Contract