NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 — ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of the Business

Molecular Templates, Inc. (the “Company” or “Molecular”) is a clinical stage biopharmaceutical company formed in 2001, with a biologic therapeutic platform for the development of novel targeted therapeutics for cancer and other diseases, headquartered in Austin, Texas. The Company’s focus is on the research and development of therapeutic compounds for a variety of cancers. Molecular operates its business as a single segment, as defined by U.S. generally accepted accounting principles (“U.S. GAAP”).

On August 1, 2017, the Company, formerly known as Threshold Pharmaceuticals, Inc. (Nasdaq: THLD) (“Threshold”), completed its business combination with the entity then known as Molecular Templates, Inc., a private Delaware Corporation (“Private Molecular”), in accordance with the terms of an Agreement and Plan of Merger and Reorganization (the “Merger Agreement”) , dated as of March 16, 2017, by and among Threshold, Trojan Merger Sub, Inc., a wholly owned subsidiary of Threshold (“Merger Sub”), and Private Molecular.  Pursuant to the Merger Agreement, Merger Sub merged with and into Private Molecular, with Private Molecular surviving as a wholly-owned subsidiary of Threshold (the “Merger”) and Private Molecular changed its name to “Molecular Templates OpCo, Inc.” Also on August 1, 2017, in connection with, and prior to the completion of the Merger, Threshold effected an 11-for-1 reverse stock split of its common stock (the “Reverse Stock Split”) and changed its name to “Molecular Templates, Inc.” Following the completion of the Merger, the business conducted by Private Molecular became primarily the business conducted by the Company as described in the paragraph above.

Basis of Presentation

These unaudited interim condensed consolidated financial statements reflect the historical results of Private Molecular prior to the completion of the Merger, and do not include the historical results of the Company prior to the completion of the Merger. All share and per share disclosures have been adjusted to reflect the exchange of shares in the Merger, and the 11-for-1 reverse stock split of the common stock effected on August 1, 2017. Under U.S. GAAP, the Merger is treated as a “reverse merger” under the purchase method of accounting. For accounting purposes, Private Molecular is considered to have acquired Threshold. See Note 3, “Merger with Private Molecular”, for further details on the Merger and the U.S. GAAP accounting treatment.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. GAAP pursuant to the requirements of the Securities and Exchange Commission (“SEC”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. The unaudited interim condensed consolidated financial statements have been prepared on the same basis as the annual consolidated financial statements. In the opinion of management, all adjustments, consisting only of normal recurring adjustments necessary for the fair presentation of results for the periods presented, have been included. The results of operations of any interim period are not necessarily indicative of the results of operations for the full year or any other interim period.

The preparation of condensed consolidated financial statements requires management to make estimates and assumptions that affect the recorded amounts reported therein. A change in facts or circumstances surrounding the estimates could result in a change to estimates and impact future operating results.

The unaudited condensed consolidated financial statements and related disclosures have been prepared with the presumption that users of the interim unaudited condensed consolidated financial statements have read or have access to the audited consolidated financial statements for the preceding fiscal year. Accordingly, these unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto for the year ended December 31, 2017 included in the Company’s Annual Report on Form 10-K filed with the SEC on March 30, 2018.

The unaudited condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, and reflect the elimination of intercompany accounts and transactions.

Significant Accounting Policies

Except as detailed below, there have been no material changes to the Company’s significant accounting policies during the three and nine months ended September 30, 2018, as compared to the significant accounting policies disclosed in Note 1, Summary of significant accounting policies, to the consolidated financial statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.

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Revenue Recognition

Effective January 1, 2018, the Company adopted the Financial Accounting Standards Board’s (“FASB”) provisions of ASC 606, Revenue from Contracts with Customers (ASC 606), using the modified retrospective method for all contracts not completed as of the date of adoption. For contracts that were modified before the effective date, the Company reflected the aggregate effect of all modifications when identifying performance obligations and allocating transaction price in accordance with available practical expedients. The reported results for 2018 reflect the application of ASC 606 guidance, while the reported results for 2017 were prepared under the guidance of ASC 605,  Revenue Recognition , which is also referred to herein as “Previous Guidance.”

Under ASC 606, the Company recognizes revenue when its customer obtains control of promised goods or services, in an amount that reflects the consideration which the Company expects to receive in exchange for those goods or services. To determine revenue recognition for arrangements that are within the scope of ASC 606, the Company performs the following five steps: (i) identification of the promised goods or services in the contract; (ii) determination of whether the promised goods or services are performance obligations including whether they are distinct in the context of the contract; (iii) measurement of the transaction price, including the constraint on variable consideration; (iv) allocation of the transaction price to the performance obligations based on estimated selling prices; and (v) recognition of revenue when (or as) the Company satisfies each performance obligation. A performance obligation is a promise in a contract to transfer a distinct good or service to the customer.

The Company identifies the goods or services promised within each collaboration agreement and assesses whether each promised good or service is distinct for the purpose of identifying the performance obligations in the contract. This assessment involves subjective determinations and requires management to make judgments about the individual promised goods or services and whether such are separable from the other aspects of the contractual relationship. Promised goods and services are considered distinct provided that: (i) the customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer and (ii) the entity’s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract. In assessing whether a promised good or service is distinct, the Company considers factors such as the research, manufacturing and commercialization capabilities of the collaboration partner and the availability of the associated expertise in the general marketplace. If a promised good or service is not distinct, an entity is required to combine that promised good or service with other promised goods or services until it identifies a bundle of goods or services that is distinct.

The allocation of the transaction price to the performance obligations in proportion to their standalone selling prices is determined at contract inception. If the consideration promised in a contract includes a variable amount, the Company estimates the amount of consideration to which it will be entitled in exchange for transferring the promised goods or services to a customer. The Company determines the amount of variable consideration by using the expected value method or the most likely amount method. The Company includes the unconstrained amount of estimated variable consideration in the transaction price. The amount included in the transaction price is the amount for which it is probable that a significant reversal of cumulative revenue recognized will not occur. At the end of each subsequent reporting period, the Company re-evaluates the estimated variable consideration included in the transaction price and any related constraint, and if necessary, adjusts its estimate of the overall transaction price. Any such adjustments are recorded on a cumulative catch-up basis in the period of adjustment.

In determining the transaction price, the Company adjusts consideration for the effects of the time value of money if there is a significant benefit of financing. The Company assessed its collaboration agreements and concluded that no significant financing components were present.

If an arrangement contains customer options that allow the customer to acquire additional goods or services, including an exclusive license to the Company’s intellectual property, the goods and services underlying the customer options are evaluated to determine whether they are deemed to represent a material right. In determining whether the customer option has a material right, the Company assesses whether there is an option to acquire additional goods or services at a discount. If the customer option is determined not to represent a material right, the option is not considered to be performance obligations at the outset of the arrangement. If the customer option is determined to represent a material right, the material right is recognized as a separate performance obligation at the outset of the arrangement. The Company allocates the transaction price to material rights based on the relative standalone selling price, which is determined based on the identified discount and the probability that the customer will exercise the option. Amounts allocated to a material right are not recognized as revenue until the option is exercised.

The Company recognizes as revenue the amount of the transaction price that is allocated to the respective performance obligation as each performance obligation is satisfied over time, based on the use of an input method. Performance obligations may include research and development services to be performed by the Company on behalf of the collaboration partner. Revenue is recognized on research and development efforts as the services are performed and presented on a gross basis, since the Company is the principal.

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Under collaboration agreements, the timing of revenue recognition and contract billings may differ, and result in contract assets and contract liabilities. Contract assets represen t revenues recognized in excess of amounts billed under collaboration agreements and are transferred to accounts receivable when billed or billing rights become unconditional. Contract liabilities represent billings in excess of revenues recognized under c ollaboration agreements. 

Refer to Note 4 ,” Research and Development Agreements” , for further details about the impact of the adoption of ASC 606.

Concentration of Credit Risk and Other Risks and Uncertainties

Financial instruments that potentially subject the Company to concentrations of risk consist principally of cash and cash equivalents, investments, long term debt and accounts receivable.

The Company’s cash and cash equivalents are with two major financial institutions in the United States.

The Company performs an ongoing credit evaluation of its strategic partners’ financial conditions and generally does not require collateral to secure accounts receivable from its strategic partners. The Company’s exposure to credit risk associated with non-payment will be affected principally by conditions or occurrences within Takeda Pharmaceutical Company Ltd. (“Takeda”). Approximately 28% and 35% of total revenues for the three and nine months ended September 30, 2018, respectively, were derived from Takeda. There was $31.2 million in accounts receivable due from Takeda at September 30, 2018, which was received in October 2018. See also Note 4, “Research and Development Agreements”, regarding the collaboration agreements with Takeda.

Drug candidates developed by the Company may require approvals or clearances from the U.S. Food and Drug Administration (“FDA”) or international regulatory agencies prior to commercial sales. There can be no assurance that the Company’s drug candidates will receive any of the required approvals or clearances. If the Company were to be denied approval or clearance or any such approval or clearance were to be delayed, it would have a material adverse impact on the Company.

Recently Issued Accounting Pronouncements

Effective January 1, 2018, the Company adopted ASC 606, which provides principles for recognizing revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the Company expects to be entitled in exchange for those goods or services. The Company adopted ASC 606 on a modified retrospective basis through a cumulative adjustment to equity.  The impact of the adoption of the standard to prior period amounts is discussed below in Note 4, “ Research and Development Agreements” .

In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842).” ASU 2016-02 requires management to record right-to-use asset and lease liability on the statement of financial position for operating leases. ASU 2016-02 is effective for annual and interim reporting periods beginning on or after December 15, 2018 and the modified retrospective approach is required. The Company is in the process of evaluating the impact the adoption of this standard would have on its consolidated financial statements and disclosures and expects the new standard to significantly increase the reported assets and liabilities on its consolidated balance sheets.

In December 2017, the SEC issued Staff Accounting Bulletin (“SAB”) 118 to address the application of GAAP in situations in which a registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the Tax Cuts and Jobs Act (the “Tax Act”), which was signed into law on December 22, 2017. In March 2018, the FASB issued ASU No. 2018-05, “Income Taxes (Topic 740): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118 (SEC Update)”, which amended ASC 740 to incorporate the requirements of SAB 118. There were no changes in the provisional amounts recorded by the Company at December 31, 2017 related to the Tax Act.  The Company continues to evaluate the impact of the Tax Act.

In June 2018, the FASB issued ASU No. 2018-07, “Stock-based Compensation: Improvements to Nonemployee Share-based Payment Accounting”, which amends the existing accounting standards for share-based payments to nonemployees. This ASU aligns much of the guidance on measuring and classifying nonemployee awards with that of awards to employees. Under the new guidance, the measurement of nonemployee equity awards is fixed on the grant date. This ASU becomes effective in the first quarter of fiscal year 2019 and early adoption is permitted. Entities will apply the ASU by recognizing a cumulative-effect adjustment to retained earnings as of the beginning of the annual period of adoption. We are currently evaluating the impact that ASU 2018-07 will have on our condensed consolidated financial statements.

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NOTE 2 — NET LO SS PER COMMON SHARE

Basic net loss per common share is computed by dividing net loss by the weighted-average number of common shares outstanding during the period. Diluted net loss per share is computed by giving effect to all potential dilutive common shares, including outstanding options and warrants.   The following is the calculation of basic and diluted net loss per share (in thousands, except share and per share data ):

The following outstanding warrants and options were excluded from the computation of diluted net loss per share for the periods presented because including them would have had an antidilutive effect (in thousands):

NOTE 3 — MERGER WITH PRIVATE MOLECULAR

On August 1, 2017, the Company, formerly known as Threshold, completed the Merger with Private Molecular, in accordance with the terms of the Merger Agreement . Immediately upon completion of the Merger, the former stockholders of Private Molecular held a majority of the voting interest of the combined company.

Also on August 1, 2017, in connection with, and prior to the completion of, the Merger, Threshold effected a   Reverse Stock Split and changed its name from “Threshold Pharmaceuticals, Inc.” to “Molecular Templates, Inc.” Under the terms of the Merger, at the effective time of the Merger, the Company issued shares of its common stock to Private Molecular stockholders, at an exchange ratio of 7.7844 shares of common stock (the “Exchange Ratio”), after taking into account the Reverse Stock Split, in exchange for each share of Private Molecular common stock outstanding immediately prior to the Merger.   Immediately following the closing of the Merger on August 1, 2017, the former Threshold stockholders owned approximately 34.4% of the aggregate number of shares of common stock of the Company and the former Private Molecular stockholders owned approximately 65.6% of the shares of common stock of the Company, subject to adjustments in accordance with the Merger Agreement.

All Private Molecular stock options granted under the Private Molecular stock option plan (whether or not then exercisable) outstanding prior to the effective time of the Merger were exchanged for options to purchase the Company’s common stock. All outstanding and unexercised Private Molecular stock options assumed by the Company may be exercised solely for shares of the Company’s common stock. The number of shares of the Company’s common stock subject to each Private Molecular stock option assumed by the Company was determined by multiplying (a) the number of shares of Private Molecular common stock that were subject to such Private Molecular stock option, as in effect immediately prior to the effective time of the merger by (b) the Exchange Ratio and dividing by 11 (to account for the Reverse Stock Split); rounding the resulting number down to the nearest whole number of shares of the Company’s common stock. The per share exercise price for the Company’s common stock issuable upon exercise of each Private Molecular stock option assumed by the Company was determined by dividing (a) the per share exercise price of Private Molecular common stock subject to such Private Molecular stock option, as in effect immediately prior to the effective time of the Merger, by (b) the Exchange Ratio, and multiplying by 11 (to account for the Reverse Stock Split); rounding the resulting exercise price up to the nearest whole cent. The exchange of the Private Molecular stock options for the Company’s stock options was treated as a modification of the awards.

Threshold equity awards issued and outstanding at the time of the Merger remained issued and outstanding. However, for accounting purposes, Threshold equity awards will be assumed to have been exchanged for equity awards of Private Molecular, the accounting acquirer. As of August 1, 2017, Threshold had outstanding stock options to purchase 963,681 shares of common stock, of which stock options to purchase 963,681 shares were vested and exercisable at a weighted average exercise price of $33.62 per share, after giving effect to the Reverse Stock Split.

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Allocation of Purchase Consideration

Pursuant to business combination accounting, the Company applied the acquisition method, which requires the assets acquired and liabilities assumed be recorded at fair value with limited exceptions.

The purchase price for Threshold on August 1, 2017, the closing date of the Merger, was calculated as follows (in thousands, except per share amounts):

Under the acquisition method of accounting, the total purchase price was allocated to tangible and identifiable intangible assets acquired and liabilities assumed of Threshold on the basis of their estimated fair values as of the transaction closing date on August 1, 2017.

The following table summarizes the allocation of the purchase consideration to the assets acquired and liabilities assumed based on their fair values as of August 1, 2017 (in thousands):

The Company believes that the historical values of the Company’s current assets and current liabilities approximate fair value based on the short-term nature of such items. The allocation of the purchase price is dependent on the valuation of the fair value of assets acquired and liabilities assumed. The Company does not expect any further revisions to the allocation of the purchase price.

In-Process Research and Development

The Company used the risk adjusted discounted cash flow method to value the in-process research and development intangible asset.  Under the valuation method, the present value of future cash flows expected to be generated from the in-process research and development of the acquired product candidate, evofosfamide, was determined using a discount rate of 12%, and identified projected cash flows from evofosfamide were risk adjusted to take into consideration the probabilities of moving through the various clinical stages.  

Transaction Costs

Transaction costs associated with the Merger of approximately $2.0 million were included in general and administrative expense in 2017.

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Threshold Promissory Note

On March 24, 2017, the Company received $2.0 million from Threshold in the form of a promissory note at an interest rate of 1.0% per annum. The Company received an additional $2.0 million on June 1, 2017. The note was settled as part of the Merger.

Share Based Awards

The exchange of Private Molecular stock options for options to purchase Threshold common stock, as renamed Molecular, was accounted for as a modification of the awards because the legal exchange of the awards is considered a modification of Private Molecular stock options.  The modification of the stock options did not result in any incremental compensation expense as the modification did not increase the fair value of the stock options.

Additionally, pursuant to the terms of the Merger Agreement, participants in Threshold’s 2014 Equity Incentive Plan received accelerated vesting for all or a portion of their pre-Merger awards granted under such plan, as well as a modification of the exercise period. The Company recorded $1.2 million in stock-based compensation associated with the transaction.

Impact of Adoption of ASC 606

Effective January 1, 2018, the Company adopted ASC 606, which provides principles for recognizing revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the Company expects to be entitled in exchange for those goods or services. The Company adopted ASC 606 on a modified retrospective basis through a cumulative adjustment to stockholders’ equity.

The cumulative effect of applying the new guidance of ASC 606 to all contracts with customers that were not completed as of January 1, 2018 was recorded as an adjustment to accumulated deficit as of the adoption date. As a result of applying the modified retrospective method to adopt the new revenue guidance, the following adjustments were made to accounts on the Condensed Consolidated Balance Sheet as of January 1, 2018 (in thousands):

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The impact of adoption on the Company’s Condensed Consolidated Statement of Operations and Comprehensive Loss for the three months ended September 30, 2018 was as follows (in thousands):

The impact of adoption on the Company’s Condensed Consolidated Statement of Operations and Comprehensive Loss for the nine months ended September 30, 2018 was as follows (in thousands):

The impact of adoption on the Company’s Condensed Consolidated Statement of Cash Flows for the nine months ended September 30, 2018 was as follows (in thousands):

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The performance obligations are expected to be fulfilled, and revenue fully recognized, as services are rendered.   The aggregate amount of the contract price of the Company’s collaborative agreements allocated to performance obligations not yet satisfied is $33.6 million . During the three and nine months ended September 30, 2018, the Company recorded a c umulative catch-up adjustment to revenue of $180,000, respectively, related to a change in an estimate of the transaction price of the Takeda Individual Project Agreement.

As of September 30, 2018, the Company had receivables from customers of $31.4 million, and as of December 31, 2017, the Company had no receivables from customers.

Related Party Collaboration Agreement - Takeda Pharmaceuticals, Inc.

Takeda Collaboration Agreement

In October 2016, Private Molecular entered into a collaboration and option agreement (the “Takeda Collaboration Agreement”) with Millennium Pharmaceuticals, Inc., a wholly owned subsidiary of Takeda (“Takeda”), to discover and develop CD38-targeting engineered toxin bodies (“ETBs”), which includes MT-4019 for evaluation by Takeda. Under the terms of the Takeda Collaboration Agreement, Molecular is responsible for providing to Takeda (i) new ETBs generated using Takeda’s proprietary fully human antibodies targeting CD38 and (ii) MT-4019 for in vitro and in vivo pharmacological and anti-tumor efficacy evaluations. Private Molecular granted Takeda (1) a background intellectual property (“IP”) license during the term of the Takeda Collaboration Agreement, and (2) an exclusive option during the term of the Takeda Collaboration Agreement and for a period of thirty days thereafter, to negotiate and obtain an exclusive worldwide license to develop and commercialize any ETB that may result from this collaboration, including MT-4019.

The Company has received payments of $2.0 million in technology access fees and cost reimbursement associated with the Company’s performance obligations under the agreement.

The Company determined that the promised goods and services under the Takeda Collaboration Agreement were the background IP license, as well as the research and development services. The Company determined that there was one performance obligation, since the background IP and manufacturing were not distinct from the research and development services. Revenues are recognized over the period that the research and development services occur. The Company also concluded that, since the option for the exclusive license is deemed to be at fair value that the option does not provide the customer with a material right, and should be accounted for if and when the option is exercised. All research and development services were performed as of September 30, 2018.  

During the three months ended September 30, 2018 and 2017, the Company recorded research and development revenue from Takeda of $0 and $648,000, respectively, under the Takeda Collaboration Agreement. During the nine months ended September 30, 2018 and September 30, 2017, the Company recorded research and development revenue from Takeda of $92,000 and $1.9 million, respectively, under the Takeda Collaboration Agreement. This revenue is deemed to be revenue from a related party (as discussed further in Note 5 “Related Party Transactions”).

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Takeda Individual Project Agreement

In connection with the Takeda Collaboration Agreement, the Company entered into an Individual Project Agreement (the “Takeda Individual Project Agreement”) with Takeda in June 2018, that was subsequently amended in July 2018.  Under the Takeda Individual Project Agreement, the Company is responsible to perform certain research and development services relating to Chemistry, Manufacturing, and Controls (“CMC”) work for three potential lead ETBs targeting CD38 .  In consideration of these services, the Company will receive up to $2.2 million in compensation that includes an increase in transaction consideration of $1.1 million as a result of the amendment to the Takeda Individual Project Agreement in July 2018.   

During the three and nine months ended September 30, 2018, the Company recognized research and development revenue from Takeda of $1.2 million and $1.9 million, respectively, under the Takeda Individual Project Agreement. No revenue was recognized during the three and nine months ended September 30, 2017 since the agreement was not in place. As of September 30, 2018, $1.2 million was due from Takeda under the Development and License Agreement.

Takeda Development and License Agreement

On September 18, 2018, the Company entered into a Development and License Agreement with Takeda (“Takeda Development and License Agreement”) for the development and commercialization of products incorporating or comprised of one or more CD38 SLT-A fusion proteins (“Licensed Products”) for the treatment of patients with diseases such as multiple myeloma.

Pursuant the Takeda Development and License Agreement Takeda made an upfront payment of $30.0 million to the Company in October 2018.

The Takeda Development and License Agreement also provides for development costs to be shared equally between the Company and Takeda during the Early Stage Development Period. The Company has an option to opt into co-development after the Early Stage Development, that would make the Company eligible to potentially receive higher milestone payments and a higher royalty percentage.

In addition to the upfront fee, if the Company exercises its co-development option and funds its share of development costs, it is eligible to receive pre-clinical and clinical development milestone payments of up to $307.5 million, upon the achievement of certain development milestones and regulatory approvals; and sales milestone payments of up to $325.0 million, upon the achievement of certain sales milestone events. If the Company does not exercise its co-development option, it is eligible to receive development milestone payments of up to $162.5 million upon the achievement of certain development milestones and regulatory approvals; and sales milestone payments of up to $175.0 million upon the achievement of certain sales milestone events. The Company will also be entitled to receive tiered royalties, subject to certain reductions, as percentages of annual aggregate net sales, if any, of Licensed Products. The royalty percentages would range from low double-digits to low twenties if the Company exercises its option to co-develop, and from high-single digits to low teens if the Company does not exercise its option to co-develop.

The Company identified one performance obligation at the inception of the Takeda Development and License Agreement, the research and development services for the CD38 ETBs, including manufacturing. The Company determined that research, development and commercialization license and the participation in the committee meetings are not distinct from the research and development services and therefore those promised services were combined into one combined performance obligation.

The total transaction price of $29.3 million, consisting of the (1) $30.0 million upfront payment, (2) a $10.0 million development milestone payment that is deemed probable of being achieved, (3) minus $10.7 million in expected co-share payment payable to Takeda during Early Stage Development. The expected co-share payment is considered variable consideration, and the Company applied a constraint using the expected value method. Significant judgement was involved in determining transaction consideration, including the determination of the variable consideration, including the constraint on consideration.  

The Company determined that the initial $10.0 million potential development milestone payment under the Development and License Agreement is probable of being achieved. Therefore, this payment was included in the transaction consideration. As of September 30, 2018, the other potential development milestones and sales milestones are not currently deemed probable of being achieved, as they are dependent on factors outside the Company ’ s control.  Therefore, these future development milestones and sales-based milestone payments have been fully constrained and are not included in the transaction price as of September 30, 2018.

The Company recognizes revenue using a cost-based input measure. In applying the cost-based input method of revenue recognition, the Company used actual costs incurred relative to budgeted costs expected to be incurred for the combined performance obligation. These costs consist primarily of internal employee efforts and third-party contract costs. Revenue is recognized based on actual costs incurred as a percentage of total budgeted costs as the Company completes its performance obligation over the estimated service period.

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The Company recognized revenue of $ 253,000 during the three and nine months ended September 30, 2018, respectively, related to the Take da Development and License Agreement. During the three and nine months ended September 30, 2017, the Company recorded no research and development revenue under the Development Agreement, since the agreement was not in place . As of September 30, 2018, defer red revenue related to the performance obligation was $ 28.8 million. As of September 30, 2018, $30.0 million was due from Takeda under the Development and License Agreement, that the Company received in October 2018.

Takeda Multi-Target Agreement

In June 2017, Private Molecular entered into a Multi-Target Collaboration and License Agreement with Takeda (“Takeda Multi-Target Agreement”) in which Molecular agreed to collaborate with Takeda to identify and generate ETBs, against two targets designated by Takeda. Takeda designated certain targets of interest as the focus of the research. Each party granted to the other nonexclusive rights in its intellectual property for purposes of the conduct of the research, and Private Molecular agreed to work exclusively with Takeda with respect to the designated targets.

Under the Takeda Multi-Target Agreement, Takeda has an option during an option period to obtain an exclusive license under the Company’s intellectual property to develop, manufacture, commercialize and otherwise exploit ETBs against the designated targets. The option period for each target ends three months after the completion of the evaluation of such designated target. Under the Takeda Multi-Target Agreement, both parties have the right to terminate the agreement, with a specified notice period.

The Company received an upfront fee of $1.0 million and an additional $2.0 million following the designation of each of the two targets in December 2017. As of September 30, 2018, the Company has received $5.0 million from Takeda pursuant to the Takeda Multi-Target Agreement.

The Company may also receive an additional $25.0 million in aggregate through the exercise of the option to license ETBs. Additionally, the Company may also be entitled to receive clinical development milestone payments of up to approximately $397.0 million, for achievement of development milestones and regulatory approval of collaboration products under the Takeda Development Agreement. The Company may also be entitled to receive commercial milestone payments of up to $150.0 million, for achievement of pre-specified sales milestones related to net sales of all collaboration products under the Takeda Development Agreement. The Company is also entitled to tiered royalty payments of a mid-single to low-double digit percentage of net sales of any licensed ETBs, subject to certain reductions. Finally, the Company is entitled to receive up to $10.0 million in certain contingency fees.

The Takeda Multi-Target Agreement will expire on the expiration of the option period (within three months after the completion of the evaluation of each designated target) for the designated targets if Takeda does not exercise its options, or, following exercise of the option, on the later of the expiration of patent rights claiming the licensed ETB or ten years from first commercial sale of a licensed ETB. The Takeda Multi-Target Agreement may be sooner terminated by Takeda for convenience or upon a material change of control, or by either party for an uncured material breach of the agreement.

The Company evaluated the contract termination clause and concluded that it was a non-substantive termination provision. As such, an initial contract term was defined as the length of the termination notice period, with a deemed renewal option to continue the research and development services over the remainder of the contract term as a material right.

The Company determined that the promised goods and services under the Takeda Multi-Target Agreement were the background IP license, the research and development services, and manufacturing during the initial contract period; and a renewal option to continue the research and development services. The Company determined that there were two performance obligations; research and development services, and the renewal options. Since the background IP and manufacturing were not distinct from the research and development services, they were deemed to be one performance obligation. Transaction consideration was allocated to each of the performance obligation using an estimate of the standalone selling price, and revenues are recognized over the period that the research and development services occur. The Company also concluded that, since the option for the exclusive license is deemed to be at fair value that the option does not provide the customer with a material right, and should be accounted for if and when the option is exercised.

In connection with the execution of the Takeda Multi-Target Agreement, Takeda also entered into a stock purchase agreement with the Company (“Takeda Stock Purchase Agreement”), pursuant to which Takeda purchased approximately $20.0 million of shares of the Company’s common stock following the Merger. See Note 10, “Stockholders’ Equity” for further details. Since the Takeda Stock Purchase Agreement was dependent on contingent events, the Company determined that the transaction was constrained, and not a performance obligation under the Takeda Multi-Target Agreement. The Company accounted for the stock purchase agreement in August 2017, once the constraints were removed, and recorded the $20.0 million in equity upon the settlement of the stock purchase transaction.

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During the three and nine months ended September 30, 2018 , the Company recorded $ 415 ,000 and $ 755 ,000 , respectively, in research and development revenue under the Multi-Target Takeda Agreement. During the three and nine months ended September 30, 2017 , the Company recorded no research and devel opment revenue under the Multi-Target Takeda Agreement, since the agreement had not been entered into.

Other Collaboration Agreements

In September 2016, Private Molecular entered into a collaboration agreement with an undisclosed pharmaceutical company (“Other Collaboration Agreement”) to generate ETBs, for evaluation for consideration of $500,000. Under the terms of the Other Collaboration Agreement, Private Molecular was responsible for providing to the customer (i) new ETBs generated using the customer’s materials and (ii) ETB study molecules for testing and evaluation.  

The customer also exercised an option under the Other Collaboration Agreement in November 2017, for the manufacture of additional quantities of ETB molecules, for additional consideration of $250,000, upon delivery and acceptance of the additional materials.

The Company determined that at the inception of the agreement, the promised goods and services under the Other Collaboration Agreement were, the research and development services, and manufacturing. The Company determined that there was one performance obligation, since the manufacturing was not distinct from the research and development services. Revenues are recognized over the period that the research and development services occur using an input method to measure progress towards satisfaction of the performance obligation. The option for additional ETB molecules was determined to be at fair value and was accounted for once the option was exercised. All research and development services were performed as of September 30, 2018.

During the three months ended September 30, 2018 and 2017, the Company recorded $117,000 and zero in research and development revenue under the Other Collaboration Agreement, respectively. During the nine months ended September 30, 2018 and 2017, the Company recorded $196,000 and $500,000 in research and development revenue under the Other Collaboration Agreement, respectively.

Grant Agreements

The Company receives funds from a state grant funding program, which is a conditional cost reimbursement grant, and revenue is recognized as allowable costs are paid.

In November 2011, Private Molecular was awarded a $10.6 million product development grant from the Cancer Prevention Research Institute of Texas (“CPRIT”) for its CD20-targeting ETB MT-3724. To date, Private Molecular has received $9.5 million in grant funds.

On September 18, 2018, the Company entered into a Cancer Research Grant Contract (the “CPRIT Agreement”) with CPRIT, in connection with a grant of approximately $15.2 million awarded by CPRIT to the Company to fund research of a cancer therapy involving a CD38 targeting ETB . Pursuant to the CPRIT Agreement, the Company may also use such funds to develop a replacement CD38 targeting ETB, with or without a partner.

During the three months ended September 30, 2018 and 2017, the Company recorded $4.7 million and zero in grant revenue under these awards, respectively. During the nine months ended September 30, 2018 and 2017, the Company recorded $5.4 million and $167,000 in grant revenue under these awards, respectively. Amounts collected in excess of revenue recognized are recorded as deferred revenue.

NOTE 5 — RELATED PARTY TRANSACTIONS

Takeda Collaboration and Stock Purchase

In connection with and immediately following the transactions consummated pursuant to the Takeda Stock Purchase Agreement described in Note 4, “Research and Development Agreements”, Takeda became a related party. Refer to Note 4, “Research and Development Agreements” for more details about the Takeda Development and License Agreement, Takeda Collaboration Agreement, Takeda Individual Project Agreement, and the Takeda Multi-Target Agreement. Refer to Note 10, “Stockholders’ Equity”, for more detail about the Takeda Stock Purchase Agreement.

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Private Placement

Following the Private Placement described in Note 10, “Stockholders’ Equity” below, Longitude Venture Partner III, L.P. (“Longitude”) and CDK Associates, L.L.C. (“CDK”) became related parties, with Longitude and CDK beneficially owning 15.3% and 4.99% of the Company, respectively, following investments of $20.0 million and $7.0 million, respectively. The ownership of CDK is subject to a 4.99% ownership blocker, pursuant to which shares of the Company’s common stock may not be issued pursuant to the warrant held by CDK to the extent that the issuance of the common stock subject to such issuance would cause CDK to beneficially own more than 4.99% of the Company’s outstanding common stock. Scott Morenstein, a director of the Company is a Managing Director of Caxton Alternative Management LP, the investment manager of CDK. David Hirsch, a director of the Company, is a member of Longitude Capital Partners III, LLC, the general partner of Longitude. Furthermore, Kevin Lalande, a director of the Company is affiliated with Sante Health Ventures I, L.P. and Sante Heath Ventures Annex Fund, L.P., which are both stockholders of the Company and were investors in the Private Placement. Finally, Excel Venture Fund II, L.P., a stockholder of the Company beneficially owning greater than 5% of the Company, invested approximately $333,000 in the Private Placement.

Public Offering

Following the Public Offering described in Note 10, “Stockholders’ Equity” below, BVF Partners L.P. (“BVF”) became a related party, owning 7.6% of the Company, following investments of $15.3 million.

BVF is not affiliated with any director or executive officer of the Company. Longitude Venture Partners III, L.P. and CDK, current stockholders of the Company, purchased 365,000 and 545,454 shares of common stock, respectively, in the Public Offering at the public offering price.  Scott Morenstein, a director of the Company is a Managing Director of Caxton Alternative Management LP, the investment manager of CDK. David Hirsch, a director of the Company, is a member of Longitude Capital Partners III, LLC, the general partner of Longitude.

NOTE 6 —MARKETABLE SECURITIES AND FAIR VALUE MEASUREMENTS

The Company accounts for its marketable securities in accordance with ASC 820 “Fair Value Measurements and Disclosures.” ASC 820 defines fair value, establishes a framework for measuring fair value in U.S. GAAP, and expands disclosures about fair value measurements. ASC 820 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. ASC 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

Level 1 —Quoted prices in active markets for identical assets or liabilities.

Level 2 —Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3 —Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

The Company utilizes the market approach to measure fair value for its financial assets and liabilities. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities. For Level 2 securities that have market prices from multiples sources, a “consensus price” or a weighted average price for each of these securities can be derived from a distribution-curve-based algorithm which includes market prices obtained from a variety of industrial standard data providers (e.g. Bloomberg), security master files from large financial institutions, and other third-party sources. Level 2 securities with short maturities and infrequent secondary market trades are typically priced using mathematical calculations adjusted for observable inputs when available.

The following table sets forth the Company’s financial assets (cash equivalents and marketable securities) at fair value on a recurring basis as of September 30, 2018 and December 31, 2017 (in thousands):

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The Company invests in highly-liquid, investment-grade securities. The following is a summary of the Company’s available-for-sale securities at September 30, 2018 and December 31, 2017 (in thousands):

There were no realized gains or losses in the three and nine months ended September 30, 2018 and 2017, respectively.  

The following table sets forth the Company’s financial liabilities measured at fair value on a recurring basis as of the date indicated below:

The Company determined the fair value of the liability associated with its 2017 Warrants to purchase in aggregate 377,273 shares of outstanding common stock using a Black-Scholes Model. See detailed discussion in Note 10, “Stockholders’ Equity”.

As of September 30, 2018 and December 31, 2017 the fair value of the long-term debt, payable in installments through years ended 2022 and 2019, respectively, approximated its carrying value of $3.2 million and $3.5 million, respectively, because it is carried at a market observable interest rate, which are considered Level 2.

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Deferred revenue was comprised of the following:

NOTE 8 — BORROWING ARRANGEMENTS

SVB Growth Capital Loan

In April 2014, the Company entered into a loan and security agreement (the “Loan Agreement”) with Silicon Valley Bank (“SVB”) that was subsequently amended, to provide for (1) growth capital advances to the Company of up to $6.0 million over three tranches based on corporate milestones; (2) term loans of up to $6.0 million in the aggregate (the “Growth Capital Loan”); (3) warrants to purchase 48,874 shares of the Company’s common stock at an exercise price of $3.07 per share; and (4) a final fee of $375,000 due at the loan maturity date in addition to the principal and interest payments.  

The Company drew down $0.8 million and $2.3 million in May and June 2015, respectively, and issued warrants to purchase 14,254 and 17,310 shares of the Company’s common stock at an exercise price of $3.07 per share. The Company drew down $3.0 million in April 2016 and issued warrants to purchase 17,310 shares of the Company’s common stock at an exercise price of $3.07 per share. The warrants issued in the Loan Agreement became exercisable upon issuance and were converted into common stock upon the closing of the Merger.

As of December 31, 2017, the Company had received $6.0 million in the aggregate from the Growth Capital Loan. The Company was required to repay the outstanding principal in 30 equal installments beginning November 1, 2016 and was due in full on April 30, 2019. Interest accrued at a rate of 1.19% above prime, or 5.44% per annum, as of December 31, 2017.  Interest only payments were made monthly and beginning November 1, 2016, the Company paid the first of 30 consecutive equal monthly payments of principal plus interest.

The Company paid down the Growth Capital Loan on February 27, 2018, from the proceeds of the Perceptive Credit Facility, discussed below. Until the termination of the Growth Capital Loan on February 27, 2018, the Company paid $3.2 million in principal, $375,000 in a final fee, and $42,000 in interest during the nine months ended September 30, 2018 and $1.8 million in principal and $187,000 in interest in the nine months ended September 30, 2017.  

As of September 30, 2018 the Growth Capital Loan had been repaid, and the balance was zero. As of December 31, 2017, the Growth Capital Loan principal balance was 3.5 million.

Perceptive Credit Facility

On February 27, 2018, the Company entered into a term loan facility with Perceptive Credit Holdings II, LP (“Perceptive”) in the amount of $10.0 million (the “Perceptive Credit Facility”). The Perceptive Credit Facility consists of a $5.0 million term loan, which was drawn on the effective date of the Perceptive Credit Facility, and an additional $5.0 million term loan to be drawn six months following the effective date of the Perceptive Credit Facility (as discussed above). The Company used a portion of the proceeds from the Perceptive Credit Facility to pay off the existing debt facility with SVB. Borrowings under the Perceptive Credit Facility are secured by all of the property and assets of the Company. The principal on the facility accrues interest at an annual rate equal to a three-month LIBOR plus the Applicable Margin. The Applicable Margin is 11.00%. Upon the occurrence, and during the continuance, of an event of default, the Applicable Margin, defined above, will be increased by 4.00% per annum. The interest rate at September 30, 2018 was 13.3%. Payments for the first 24 months are interest only and are paid quarterly. After the second anniversary of the closing date of the Perceptive Credit Facility, principal payments of $200,000 are due each calendar quarter, with a final payment of $3.4 million due on February 27, 2022. This term loan facility matures on February 27, 2022 and includes both financial and non-financial covenants, including a minimum cash balance requirement. The Company is required to pay an exit fee of $100,000 on a pro rata basis on the maturity date or the earlier date of repayment of the term loans in full. The exit fee is being accreted to interest expense over the term of the Perceptive Credit Facility using the effective interest method.

For the three months ended September 30, 2018, the Company recorded $170,000 of interest expense and $65,000 of amortization of debt discount related to the Perceptive Credit Facility.  For the nine months ended September 30, 2018, the Company recorded $398,000 of interest expense and $146,000 of amortization of debt discount related to the Perceptive Credit Facility. For the three and nine months ended September 30, 2017, the Company did not incur any interest expense related to the Perceptive Credit Facility, since the facility was not in place at that time.

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In connection with t he Perceptive Credit Facility, on February 27, 2018 the Company issued Perceptive a warrant to purchase 190,000 shares of the Company’s common stock. The warrant is exercisable for a period of seven years from the date of issuance at an exercise price per share of $9.5792, subject to certain adjustments as specified in the Warrant. See Note 10 , “ Stockholders’ Equity ” for further discussion of the warrant. The fair value of the warrant of $1.5 million was recorded as a debt discount, which is being amortize d to interest expense over the term of the Perceptive Credit Facility using the effective interest method

As of September 30, 2018 and December 31, 2017 the Perceptive Credit Facility principal balance was $5.0 million and zero, respectively. As of September 30, 2018, the Company was in compliance with the non-financial covenants of the Perceptive Credit Facility.

Future required principal and final payments on the Perceptive Credit Facility were as follows as of September 30, 2018:

NOTE 9 — COMMITMENTS AND CONTINGENCIES

The Company is obligated under operating lease agreements covering the Company’s office facilities in Austin, Texas and Jersey City, New Jersey. Facilities expense under the operating leases was approximately $378,000 and $182,000 for the three months ended September 30, 2018 and 2017, respectively, and $1.0 million and $387,000 for the nine months ended September 30, 2018 and 2017, respectively.

Future minimum payments due under the operating lease agreements at September 30, 2018 were as follows (in thousands):

The Company leases laboratory equipment under non-cancelable capital lease agreements. As of September 30, 2018 and December 31, 2017, laboratory equipment under capital leases included in property and equipment totaled approximately $237,000 and $171,000, respectively, net of accumulated amortization of approximately $100,000 and $66,000, respectively. Future minimum capital lease payments consisted of the following at September 30, 2018 (in thousands):

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Contingencies

In the ordinary course of business, the Company may provide indemnifications of varying scope and terms to vendors, lessors, business partners and other parties with respect to certain matters, including, but not limited to, losses arising out of the Company’s breach of such agreements, services to be provided by or on behalf of the Company, or from intellectual property infringement claims made by third parties. In addition, the Company has entered into indemnification agreements with its directors and certain of its officers and employees that will require the Company, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as directors, officers or employees. The Company maintains director and officer insurance, which may cover certain liabilities arising from its obligation to indemnify its directors and certain of its officers and employees, and former officers and directors in certain circumstances. The Company maintains product liability insurance and comprehensive general liability insurance, which may cover certain liabilities arising from its indemnification obligations. It is not possible to determine the maximum potential amount of exposure under these indemnification obligations due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each particular indemnification obligation. Such indemnification obligations may not be subject to maximum loss clauses. Management is not currently aware of any matters that could have a material adverse effect on the financial position, results of operations or cash flows of the Company.

NOTE 10 — STOCKHOLDERS’ EQUITY

Private Placement

On August 1, 2017, the Company entered into the a securities purchase agreement with Longitude Venture Partners III, L.P. and certain other accredited investors (the “Longitude Securities Purchase Agreement”), pursuant to which the Company sold an aggregate of 5,793,063 units (the “Units”) accredited investors having an aggregate purchase price of $40.0 million, each such Unit consisting of (i) one (1) share (the “Shares”) of the Company’s common stock and (ii) a warrant (the “Private Placement Warrants”) to purchase 0.5 shares of the Company’s common stock (the “Private Placement”). The Private Placement was pursuant to equity commitment letter agreements entered into by and between the Company and investors in March and June 2017. The purchase price per Unit was $6.9048. The Warrants are exercisable for a period of seven years from the date of their issuance at a per-share exercise price of $6.8423 (which exercise price shall be payable in cash or through a cashless exercise mechanic), subject to certain adjustments as specified in the Warrants.  At September 30, 2018, there were warrants outstanding under the Longitude Securities Purchase Agreement to purchase 2,896,532 shares of common stock.  At the time of issuance and as of September 30, 2018, the warrants met the requirements for equity classification under ASC 815, “Derivatives and Hedging” (ASC 815), and the value of these warrants is included in additional paid-in capital on the balance sheet. The Private Placement Warrants are exercisable upon issuance and expire August 1, 2024. The Company will continue to evaluate equity classification on a quarterly basis.

In December 2015, the Company entered into an agreement (the “Wedbush Agreement”) with Wedbush Securities Inc. (“Wedbush”), which was subsequently amended in December of 2017, related to Wedbush’s services associated with the equity financing under the Longitude Securities Purchase Agreement. As part of the Wedbush Agreement, the Company issued to Wedbush warrants to purchase 57,930 shares of the Company’s common stock (the “Wedbush Warrants”). The Wedbush Warrants are exercisable for a period of seven years from the date of their issuance at a per-share exercise price of $6.8423 (which exercise price shall be payable in cash or through a cashless exercise mechanic), subject to certain adjustments as specified in the Wedbush Warrants.  At September 30, 2018, there were warrants outstanding under the Wedbush Agreement to purchase 57,930 shares of common stock. The warrants met the requirements for equity classification under ASC 815, and the value of these warrants is included in additional paid-in capital on the balance sheet. The Wedbush Warrants are exercisable upon issuance and expire December 1, 2024. The Company will continue to evaluate equity classification on a quarterly basis. 

Subsequent Private Placement

In connection with the execution of the Takeda Multi-Target Agreement, Threshold and Private Molecular entered into the Takeda Stock Purchase Agreement. Pursuant to the Takeda Stock Purchase Agreement, following the consummation of the Merger and the Private Placement, Takeda purchased 2,922,993 shares of the Company’s common stock, at a price per share of $6.84, for an aggregate purchase price of $20.0 million.

Public offering

On September 25, 2018, the Company closed its underwritten public offering (the “Public Offering”) of 9,430,000 shares of its common stock, which included the exercise in full by the underwriters of their option to purchase 1,230,000 additional shares of common stock, at a price to the public of  $5.50  per share. The net proceeds to the Company from the offering, after deducting the underwriting discounts and commissions and offering expenses payable by the Company, were approximately  $48.1 million .

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Common Stock Warrants

As of September 30, 2018, the Company had warrants outstanding to purchase 3,521,735 shares of the Company’s common stock.  The Company accounts for certain of its common stock warrants under guidance in ASC 480 that clarifies the determination of whether an instrument is classified as a liability or equity.  The following table summarizes the Company’s outstanding warrants as of September 30, 2018 and December 31, 2017 and the warrant activity during the nine months ended September 30, 2018:

On August 1, 2017, as part of the Merger, the Company assumed the warrant liability of the predecessor Threshold, related to warrants to purchase 377,273 shares of the Company’s common stock (“2017 Warrants”), with an exercise price of $39.82 per share. Refer to Note 3, “Merger with Private Molecular”, for further detail about the Merger.

Due to change in control provisions outside of the Company’s control in the 2017 Warrants, the guidance requires the Company’s outstanding warrants to be classified as liabilities and to be fair valued at each reporting period, with the changes in fair value recognized as change in fair value of warrant liabilities in the Company’s consolidated statements of operations and comprehensive loss.

The following table is a reconciliation of the 2017 Warrant liability measured at fair value using level 3 inputs (in thousands):

The fair value of the 2017 Warrants on September 30, 2018 and December 31, 2017 was determined using a Black-Scholes model with the following key level 3 inputs:

During the nine months ended September 30, 2018 the change in fair value of $916,000 of noncash income related to the 2017 Warrants was recorded as change in fair value of warrant liabilities in the Company’s consolidated statement of operations and comprehensive loss. Significant changes in the level 3 inputs of volatility, stock price and expected life, used in the fair value measurement of the 2017 Warrants in isolation could result in a material change in the fair value measurement.

On August 1, 2017, in conjunction with the Private Placement, the Company issued warrants to purchase 2,896,532 shares of the Company’s common stock with an exercise price of $6.84, the Private Placement Warrants as described above.  The Private Placement warrants are classified as equity and were valued at $16.3 million using the Black-Scholes model, and recorded in additional paid-in capital.  The Black-Scholes inputs used were:  expected dividend rate of 0%, expected volatility of 147%, risk free interest rate of 2.07%, and expected term of 7.0 years.

In December 2017, the Company issued warrants to purchase 57,930 shares of the Company’s common stock with an exercise price of $6.84, the Wedbush Warrants as described above.  The Wedbush Warrants are classified as equity and recorded in additional paid-in capital; and were valued at $0.4 million using the Black-Scholes model.  The Black-Scholes inputs used were:  expected dividend rate of 0%, expected volatility of 108%, risk free interest rate of 2.33%, and expected term of 7.0 years.  The Wedbush Warrants together with the Private Placement Warrants are combined as “2017 Private Placement Warrants” in the table above.

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On Februar y 28, 2018, i n connection with the Perceptive Credit Facility, the Company issued warrant s to purchase 190,000 shares of the Company’s common stock with an exercise price of $9.58 ( the “ 2018 Warrants ”) . The 2018 W arrants are exercisable for a period of seven years from the date of issuance, subject to certain adjustments as specified in the Warrants. The 2018 Warrants were classified as equity and recorded in additional paid-in capital; and were valued at $1.5 million using the Black-Scholes model.  The Black-Scholes inputs used were:  expected dividend rate of 0%, expected volatility of 105%, risk free interest rate of 2.83%, and expected term of 7.0 years.   See Note 8, “Borrowing Arrangements”, for further detail about the Perceptive Credit Facility.

NOTE 11 — STOCK-BASED COMPENSATION

The Company recognizes stock-based compensation in accordance with ASC 718, “Compensation—Stock Compensation.” Stock-based compensation expense, which consists of the compensation cost for employee stock options granted under the 2009 Stock Plan, as amended (the “2009 Stock Plan”), the Company’s 2014 Equity Incentive Plan, as amended (the “2014 Equity Incentive Plan”), the Company’s 2018 Equity Incentive Plan (the “2018 Equity Incentive Plan”) and the value of options issued to non-employees for services rendered, was allocated to research and development and general and administrative expenses in the unaudited consolidated statements of operations. Stock-based compensation for the three and nine months ended September 30, 2018 and 2017 were (in thousands):

Valuation Assumptions

The Company estimated the fair value of stock options granted using the Black-Scholes option-pricing formula and a single option award approach. This fair value is being amortized ratably over the requisite service periods of the awards, which is generally the vesting period. The fair value of employee stock options was estimated using the following weighted-average assumptions for the three and nine months ended September 30, 2018 and 2017:

To determine the expected term of the Company’s employee stock options granted, the Company utilized the simplified approach as defined by SEC Staff Accounting Bulletin No. 107, “Share-Based Payment” (“SAB 107”). To determine the risk-free interest rate, the Company utilized an average interest rate based on U.S. Treasury instruments with a term consistent with the expected term of the Company’s stock-based awards. To determine the expected stock price volatility for the Company’s stock-based awards, the Company utilized the historical volatility of the Company’s common stock. The fair value of all the Company’s stock-based awards assumes no dividends as the Company does not anticipate paying cash dividends on its common stock.

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Employee Stock-based Compensation Expense

As required by ASC 718, the Company recognized $1.2 million and $2.8 million of stock-based compensation expense related to stock options under the Company’s equity incentive plans for the three and nine months ended September 30, 2018, respectively, and $1.4 million and $1.4 million for the three and nine months ended September 30, 2017.  

As of September 30, 2018, the total unrecognized compensation cost related to unvested stock-based awards granted to employees under the Company’s equity incentive plans was approximately $14.2 million. This cost will be recorded as compensation expense on a ratable basis over the remaining weighted average requisite service period of approximately 3.1 years.

Equity Incentive Plans

The Company’s equity incentive plans include the 2009 Stock Plan, the 2014 Equity Incentive Plan and the 2018 Equity Incentive Plan. No additional shares will be issued under the 2009 Stock Plan and the 2014 Equity Incentive Plan.

The following table summarizes stock option activity under the Company’s equity incentive plans:

The total intrinsic value of stock options exercised during the three and nine months ended September 30, 2018, was $4,000 and $1.6 million, respectively, as determined at the date of the option exercise. Cash received from stock option exercises was $2,000 and $157,000 for the three and nine months ended September 30, 2018, respectively.  Cash received from stock options exercises was $14,000 and $14,000 for the three and nine months ended September 30, 2017.  The Company issues new shares of common stock upon exercise of options. In connection with these exercises, there was no tax benefit realized by the Company due to the Company’s current loss position.

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