Document

Table of Contents

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_______________________________________
FORM 10-Q
_______________________________________
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2018
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission File Number: 001-38311
_______________________________________
Denali Therapeutics Inc.
(Exact name of registrant as specified in its charter)
_______________________________________
Delaware
 
46-3872213
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
151 Oyster Point Blvd., 2nd Floor
South San Francisco, CA, 94080
(Address of principal executive offices and zip code)
(650) 866-8548
(Registrant’s telephone number, including area code)
_______________________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
¨
Accelerated filer
¨
 
 
 
 
Non-accelerated filer
x  (Do not check if a smaller reporting company)
Smaller reporting company
¨
 
 
 
 
 
 
Emerging growth company
x 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. x
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x
The number of outstanding shares of the registrant’s common stock as of August 2, 2018 was 94,807,111. 
 




TABLE OF CONTENTS


 
Page
 
 
 
Item 1.
 
 
 
 
Item 2.
Item 3.
Item 4.
 
 
 
 
 
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.
 


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Table of Contents

PART I. FINANCIAL INFORMATION
ITEM 1.
FINANCIAL STATEMENTS

Denali Therapeutics Inc.
Condensed Consolidated Balance Sheets
(Unaudited)
(In thousands, except share amounts)
 
June 30, 2018
 
December 31, 2017
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
33,088

 
$
218,375

Short-term marketable securities
339,503

 
187,851

Prepaid expenses and other current assets
4,827

 
3,381

Total current assets
377,418

 
409,607

Long-term marketable securities
178,703

 
60,750

Property and equipment, net
13,323

 
14,923

Other non-current assets
2,611

 
1,441

Total assets
$
572,055

 
$
486,721

Liabilities and stockholders' equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
9,176

 
$
2,716

Accrued liabilities
5,537

 
5,364

Accrued compensation
2,751

 
5,166

Contract liability
8,715

 

Deferred rent
4,782

 
855

Other current liabilities
47

 
63

Total current liabilities
31,008

 
14,164

Contract liability, less current portion
49,590

 

Deferred rent, less current portion
1,029

 
6,294

Other non-current liabilities
156

 
467

Total liabilities
81,783

 
20,925

Commitments and contingencies (Note 7)


 

Stockholders' equity:
 
 
 
Convertible preferred stock, $0.01 par value; 40,000,000 shares authorized as of June 30, 2018 and December 31, 2017; 0 shares issued and outstanding as of June 30, 2018 and December 31, 2017

 

Common stock, $0.01 par value; 400,000,000 shares authorized as of June 30, 2018 and December 31, 2017; 93,321,745 shares and 87,480,362 shares issued and outstanding as of June 30, 2018 and December 31, 2017, respectively
1,259

 
1,201

Additional paid-in capital
760,605

 
656,660

Accumulated other comprehensive loss
(1,493
)
 
(368
)
Accumulated deficit
(270,099
)
 
(191,697
)
Total stockholders' equity
490,272

 
465,796

Total liabilities and stockholders’ equity
$
572,055

 
$
486,721

See accompanying notes to unaudited condensed consolidated financial statements.

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Denali Therapeutics Inc.
Condensed Consolidated Statements of Operations and Comprehensive Loss
(Unaudited)
(In thousands, except share and per share amounts)
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
Collaboration revenue
$
1,648

 
$

 
$
2,289

 
$

Operating expenses:
 
 
 
 
 
 
 
Research and development
52,134

 
19,004

 
72,953

 
37,474

General and administrative
6,896

 
3,564

 
12,466

 
6,838

Total operating expenses
59,030

 
22,568

 
85,419

 
44,312

Loss from operations
(57,382
)
 
(22,568
)
 
(83,130
)
 
(44,312
)
Interest and other income, net
2,658

 
434

 
4,728

 
858

Net loss
(54,724
)
 
(22,134
)
 
(78,402
)
 
(43,454
)
Other comprehensive income (loss):
 
 
 
 
 
 
 
Net unrealized gain (loss) on marketable securities, net of tax
(206
)
 
18

 
(1,125
)
 
(4
)
Comprehensive loss
$
(54,930
)
 
$
(22,116
)
 
$
(79,527
)
 
$
(43,458
)
Net loss per share, basic and diluted
$
(0.59
)
 
$
(2.29
)
 
$
(0.86
)
 
$
(4.65
)
Weighted average number of shares outstanding, basic and diluted
92,899,524

 
9,670,449

 
91,239,274

 
9,346,051

See accompanying notes to unaudited condensed consolidated financial statements.
 


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Denali Therapeutics Inc.
Condensed Consolidated Statements of Cash Flows
(Unaudited)
(In thousands)
 
Six Months Ended June 30,
 
2018
 
2017
Operating activities
 
 
 
Net loss
$
(78,402
)
 
$
(43,454
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
Depreciation
2,709

 
1,497

Stock–based compensation expense
7,635

 
1,824

Net amortization of premiums and discounts on marketable securities
(1,092
)
 
685

Gain on disposal of property and equipment
(36
)
 

Changes in operating assets and liabilities:
 
 
 
Prepaid expenses and other assets
(1,718
)
 
1,266

Accounts payable
7,094

 
(446
)
Accrued and other current liabilities
(1,403
)
 
2,423

Deferred rent
(1,339
)
 

Contract liability
58,305

 

Other non-current liabilities

 
(173
)
Net cash used in operating activities
(8,247
)
 
(36,378
)
Investing activities
 
 
 
Purchase of marketable securities
(361,686
)
 
(28,156
)
Purchase of property and equipment
(1,109
)
 
(1,437
)
Maturities and sales of marketable securities
92,049

 
67,050

Net cash (used in) provided by investing activities
(270,746
)
 
37,457

Financing activities
 
 
 
Payments of issuance costs related to issuance for common stock
(1,342
)
 

Payments of issuance costs related to issuance for preferred stock
(44
)
 

Issuance of common stock in connection with collaboration agreement
94,406

 

Proceeds from exercise of awards under equity incentive plans
1,651

 
375

Net cash provided by financing activities
94,671

 
375

Net (decrease) increase in cash, cash equivalents and restricted cash
(184,322
)
 
1,454

Cash, cash equivalents and restricted cash at beginning of period
218,910

 
40,388

Cash, cash equivalents and restricted cash at end of period
$
34,588

 
$
41,842

See accompanying notes to unaudited condensed consolidated financial statements.

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Denali Therapeutics Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1.
Significant Accounting Policies
Organization and Description of Business

Denali Therapeutics Inc. ("Denali" or the “Company”) is a biopharmaceutical company, incorporated in Delaware, that discovers and develops therapeutics to defeat neurodegenerative diseases. The Company is headquartered in South San Francisco, California.
Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and the instructions to Form 10-Q and Article 10 of SEC Regulation S-X for interim financial information.

These unaudited condensed consolidated financial statements and notes should be read in conjunction with the audited consolidated financial statements and notes thereto contained in the Annual Report on Form 10-K for the year ended December 31, 2017, as filed with the Securities and Exchange Commission on March 19, 2018 (the "2017 Annual Report on Form 10-K"). The condensed consolidated Balance Sheet as of December 31, 2017 was derived from the audited annual consolidated financial statements as of the period then ended. Certain information and footnote disclosures typically included in the Company's annual consolidated financial statements have been condensed or omitted. The accompanying unaudited condensed consolidated financial statements reflect all adjustments that, in the opinion of management, are necessary for a fair statement of the results of the interim periods presented. All such adjustments are of a normal recurring nature except for the impacts of adopting new accounting standards discussed below. These interim financial results are not necessarily indicative of results expected for the full fiscal year or for any subsequent interim period.

During the three and six months ended June 30, 2018, except as discussed below in the sections titled Derivatives and Hedging Activities, Revenue Recognition, and Recently Adopted Accounting Standards, there were no material changes to the Company's significant accounting and financial reporting policies from those reflected in the 2017 Annual Report on Form 10-K. For further information with regard to the Company’s Significant Accounting Policies, please refer to Note 1, "Significant Accounting Policies," to the Company’s Consolidated Financial Statements included in the 2017 Annual Report on Form 10-K.
Initial Public Offering

On December 7, 2017, the Company's Registration Statement on Form S-1 was declared effective by the SEC for Denali's initial public offering ("IPO") of common stock. In connection with the IPO, the Company sold an aggregate of 15,972,221 shares of common stock, including 2,083,333 shares sold pursuant to the underwriters’ full exercise of their option to purchase additional shares, at a price to the public of $18.00 per share. The aggregate net proceeds received by the Company from the offering, net of underwriting discounts and commissions and offering expenses, were $264.3 million. Upon the closing of the IPO, all then-outstanding shares of Company convertible preferred stock converted into 60,365,020 shares of common stock. The related carrying value of $378.6 million was reclassified to common stock and additional paid-in capital.

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Principles of Consolidation

These unaudited condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary. All intercompany balances and transactions have been eliminated on consolidation. For the Company and its subsidiary, the functional currency has been determined to be U.S. dollars. Monetary assets and liabilities denominated in foreign currency are remeasured at period-end exchange rates. Non-monetary assets and liabilities denominated in foreign currencies are remeasured at historical rates. Foreign currency transaction gains and losses resulting from remeasurement are recognized in interest and other income, net in the condensed consolidated statements of operations and comprehensive loss.
Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires the Company to make certain estimates, judgments and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements, as well as the reported amounts of expenses during the reporting period. Actual results could differ from those estimates, and such differences could be material to the condensed consolidated financial position and statements of operations and comprehensive loss.
Concentration of Credit Risk and Other Risks and Uncertainties

Financial instruments that potentially subject the Company to significant concentrations of credit risk consist primarily of cash, cash equivalents, marketable securities and forward foreign currency exchange contracts. Substantially all of the Company’s cash and cash equivalents are deposited in accounts with financial institutions that management believes are of high credit quality. Such deposits have and will continue to exceed federally insured limits. The Company maintains its cash with accredited financial institutions and accordingly, such funds are subject to minimal credit risk. The Company has not experienced any losses on its cash deposits.

The Company’s investment policy limits investments to certain types of securities issued by the U.S. government, its agencies and institutions with investment-grade credit ratings and places restrictions on maturities and concentration by type and issuer. The Company is exposed to credit risk in the event of a default by the financial institutions holding its cash, cash equivalents and marketable securities and issuers of marketable securities to the extent recorded on the consolidated balance sheets. As of June 30, 2018 and December 31, 2017, the Company had no off-balance sheet concentrations of credit risk.

The Company is exposed to counterparty credit risk on all of its derivative financial instruments. The Company has established and maintains strict counterparty credit guidelines and enters into hedges only with financial institutions that are investment grade or better to minimize the Company’s exposure to potential defaults. The Company does not require collateral to be pledged under these agreements.

The Company is subject to a number of risks similar to other early-stage biopharmaceutical companies, including, but not limited to, the need to obtain adequate additional funding, possible failure of current or future preclinical testing or clinical trials, its reliance on third parties to conduct its clinical trials, the need to obtain regulatory and marketing approvals for its product candidates, competitors developing new technological innovations, the need to successfully commercialize and gain market acceptance of the Company’s product candidates, its right to develop and commercialize its product candidates pursuant to the terms and conditions of the licenses granted to the Company, protection of proprietary technology, the ability to make milestone, royalty or other payments due under any license or collaboration agreements, and the need to secure and maintain adequate manufacturing arrangements with third parties. If the Company does not successfully commercialize or partner any of its product candidates, it will be unable to generate product revenue or achieve profitability.

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Segments

The Company has one operating segment. The Company’s chief operating decision maker, its Chief Executive Officer, manages the Company’s operations on a consolidated basis for the purposes of allocating resources.
Restricted Cash

The Company’s restricted cash consists of the letter of credit for the Company’s headquarters building lease, and is included within other non-current assets on the accompanying condensed consolidated balance sheets.
Derivatives and Hedging Activities

The Company accounts for its derivative instruments as either assets or liabilities on the condensed consolidated balance sheet and measures them at fair value. Derivatives are adjusted to fair value through Interest and other income, net in the condensed consolidated statements of operations and comprehensive loss.
Revenue Recognition

License and Collaboration Revenues

The Company analyzes its collaboration arrangements to assess whether they are within the scope of ASC 808, Collaborative Arrangements (“ASC 808”) to determine whether such arrangements involve joint operating activities performed by parties that are both active participants in the activities and exposed to significant risks and rewards dependent on the commercial success of such activities.  This assessment is performed throughout the life of the arrangement based on changes in the responsibilities of all parties in the arrangement.  For collaboration arrangements within the scope of ASC 808 that contain multiple elements, the Company first determines which elements of the collaboration are deemed to be within the scope of ASC 808 and those that are more reflective of a vendor-customer relationship and, therefore, within the scope of Topic 606. For elements of collaboration arrangements that are accounted for pursuant to ASC 808, an appropriate recognition method is determined and applied consistently, generally by analogy to Topic 606. The accounting treatment pursuant to Topic 606 is outlined below.  

The terms of licensing and collaboration agreements entered into typically include payment of one or more of the following: non-refundable, up-front license fees; development, regulatory and commercial milestone payments; payments for manufacturing supply services; and royalties on net sales of licensed products. Each of these payments results in license, collaboration and other revenues, except for revenues from royalties on net sales of licensed products, which are classified as royalty revenues. The core principle of Topic 606 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration that is expected to be received in exchange for those goods or services.

In determining the appropriate amount of revenue to be recognized as the Company fulfills its obligations under each of its agreements, the Company performs the following steps: (i) identification of the promised goods or services in the contract; (ii) determination of whether the promised goods or services are performance obligations including whether they are distinct in the context of the contract; (iii) measurement of the transaction price, including the constraint on variable consideration; (iv) allocation of the transaction price to the performance obligations based on estimated selling prices; and (v) recognition of revenue when (or as) the Company satisfies each performance obligation.


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Amounts received prior to satisfying the revenue recognition criteria are recorded as contract liabilities in the Company’s consolidated balance sheets. If the related performance obligation is expected to be satisfied within the next twelve months this will be classified in current liabilities. Amounts recognized as revenue prior to receipt are recorded as contract assets in the Company's consolidated balance sheets. If the Company expects to have an unconditional right to receive the consideration in the next twelve months, this will be classified in current assets. A net contract asset or liability is presented for each contract with a customer.

At contract inception, the Company assesses the goods or services promised in a contract with a customer and identifies those distinct goods and services that represent a performance obligation. A promised good or service may not be identified as a performance obligation if it is immaterial in the context of the contract with the customer, if it is not separately identifiable from other promises in the contract (either because it is not capable of being separated or because it is not separable in the context of the contract), or if the performance obligation does not provide the customer with a material right.

The Company considers the terms of the contract and its customary business practices to determine the transaction price. The transaction price is the amount of consideration to which the Company expects to be entitled in exchange for transferring promised goods or services to a customer. The consideration promised in a contract with a customer may include fixed amounts, variable amounts, or both. Variable consideration will only be included in the transaction price when it is not considered constrained, which is when it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur.

If it is determined that multiple performance obligations exist, the transaction price is allocated at the inception of the agreement to all identified performance obligations based on the relative standalone selling prices. The relative selling price for each deliverable is estimated using objective evidence if it is available. If objective evidence is not available, the Company uses its best estimate of the selling price for the deliverable.

Revenue is recognized when, or as, the Company satisfies a performance obligation by transferring a promised good or service to a customer. An asset is transferred when, or as, the customer obtains control of that asset, which for a service is considered to be as the services are received and used. The Company recognizes revenue over time by measuring the progress toward complete satisfaction of the relevant performance obligation using an appropriate input or output method based on the nature of the good or service promised to the customer.

After contract inception, the transaction price is reassessed at every period end and updated for changes such as resolution of uncertain events. Any change in the transaction price is allocated to the performance obligations on the same basis as at contract inception.

Management may be required to exercise considerable judgment in estimating revenue to be recognized. Judgment is required in identifying performance obligations, estimating the transaction price, estimating the stand-alone selling prices of identified performance obligations, which may include forecasted revenues, development timelines, reimbursement rates for personnel costs, discount rates and probabilities of technical and regulatory success, and estimating the progress towards satisfaction of performance obligations.
Net Loss per Share

Basic net loss per share is calculated by dividing the net loss by the weighted-average number of shares of common stock outstanding during the period, without consideration for common stock equivalents. Diluted net loss per share is the same as basic net loss per share, since the effects of potentially dilutive securities are antidilutive given the net loss for each period presented.

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Recently Issued Accounting Pronouncements

In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update ("ASU") No. 2016-02, Leases (Topic 842), which supersedes the guidance in former ASC 840, Leases. The FASB issued further updates to this guidance in July 2018 through ASU 2018-10, Codification Improvements to Topic 842, Leases and ASU 2018-11, Leases (Topic 842): Targeted Improvements. The new standard requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase by the lessee. This classification will determine whether lease expense is recognized based on an effective interest method or on a straight-line basis over the term of the lease. A lessee is also required to record a right-of-use asset and a lease liability for all leases with a term of greater than 12 months regardless of their classification. Leases with a term of 12 months or less will be accounted for similar to existing guidance for operating leases today. The standard is effective for interim and annual periods beginning after December 15, 2018, with early adoption permitted, and is required to be adopted using a modified retrospective approach. The Company plans to adopt this standard on January 1, 2019. ASU 2016-02 is expected to impact the Company’s consolidated financial statements as the Company has certain operating lease arrangements for which the Company is the lessee. Management is currently evaluating the impact the adoption of ASU 2016-02 will have on the Company’s financial position and results of operations. Management expects that the adoption of this standard will result in the recognition of an asset for the right to use a leased facility on the Company’s balance sheet, as well as the recognition of a liability for the lease payments remaining on the lease. While the balance sheet presentation is expected to change, management does not expect a material change to the condensed consolidated statements of operations and comprehensive loss or cash flows.

In June 2018, the FASB issued ASU No. 2018-07, Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting. ASU 2018-07 is intended to reduce the cost and complexity and to improve financial reporting for nonemployee share-based payments. ASU 2018-07 expands the scope of Topic 718, Compensation-Stock Compensation (which currently only includes share-based payments to employees) to include share-based payments issued to nonemployees for goods or services. Consequently, the accounting for share-based payments to nonemployees and employees will be substantially aligned. ASU 2018-07 supersedes Subtopic 505-50, Equity-Based Payments to Non-Employees. ASU 2018-07 is effective for the Company for fiscal years beginning after December 15, 2018, including interim periods within that fiscal year and early adoption is permitted. The Company is currently assessing the impact of this standard on its consolidated financial statements.
Recently Adopted Accounting Pronouncements

In May 2014, the FASB issued ASU No. 2014–09, Revenue from Contracts with Customers (Topic 606), which amends the existing accounting standards for revenue recognition. The FASB issued further updates to this guidance through ASU 2016-12 Narrow-Scope Improvements and Practical Expedients, ASU 2016-10 Identifying Performance Obligations and Licensing and ASU 2016-08 Principal Versus Agent Considerations (Reporting Revenue Gross Versus Net). The new standard is based on principles that govern the recognition of revenue at an amount to which an entity expects to be entitled when products are transferred to customers. This standard was adopted on January 1, 2018 using a full retrospective application. There was no impact to the consolidated financial statements upon adoption of ASU 2014-09 as the Company had not recognized any revenue through December 31, 2017.

In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash. The purpose of ASU 2016-18 is to clarify the guidance for and presentation of restricted cash in the statement of cash flows. The amendment requires beginning-of-period and end-of-period total amounts shown on the statement of cash flows to include cash and cash equivalents as well as restricted cash and restricted cash equivalents. This standard was adopted on January 1, 2018. Accordingly, the condensed consolidated statements of cash flows and Note 3 " Cash and Marketable Securities" have been updated to reconcile cash, cash equivalents and restricted cash for all periods presented.


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In May 2017, the FASB issued ASU No. 2017-09, Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting, which clarifies when to account for a change to the terms or conditions of a share-based payment award as a modification. Under the new guidance, modification accounting is required only if the fair value, the vesting conditions, or the classification of the award (as equity or liability) changes as a result of the change in terms or conditions. This standard was adopted as of January 1, 2018 and will be applied prospectively to any award modified after the adoption date.
2.
Fair Value Measurements

Assets and liabilities measured at fair value at each balance sheet date are as follows (in thousands):
 
June 30, 2018
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
Money market funds
$
16,547

 
$

 
$

 
$
16,547

Short-term marketable securities:
 
 
 
 
 
 
 
U.S. government treasuries
172,809

 

 

 
172,809

U.S. government agency securities

 
110,958

 

 
110,958

Corporate debt securities

 
45,052

 

 
45,052

Commercial paper

 
10,684

 

 
10,684

Long-term marketable securities:
 
 
 
 
 
 
 
U.S. government treasuries
89,825

 

 

 
89,825

U.S. government agency securities

 
26,617

 

 
26,617

Corporate debt securities

 
62,261

 

 
62,261

Total
$
279,181

 
$
255,572

 
$

 
$
534,753

Liabilities:
 
 
 
 
 
 
 
Foreign currency derivative contracts
$

 
$
32

 
$

 
$
32

Total
$

 
$
32

 
$

 
$
32


 
December 31, 2017
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
Money market funds
$
212,868

 
$

 
$

 
$
212,868

Short-term marketable securities:
 
 
 
 
 
 
 
U.S. government treasuries
42,587

 

 

 
42,587

U.S. government agency securities

 
106,139

 

 
106,139

Corporate debt securities

 
39,125

 

 
39,125

Long-term marketable securities:
 
 
 
 
 
 
 
U.S. government treasuries
39,848

 

 

 
39,848

U.S. government agency securities

 
19,911

 

 
19,911

Corporate debt securities

 
991

 

 
991

Total
$
295,303

 
$
166,166

 
$

 
$
461,469

The carrying amounts of accounts payable and accrued liabilities approximate their fair values due to their short-term maturities.
The Company’s Level 2 securities are valued using third-party pricing sources. The pricing services utilize industry standard valuation models, including both income and market-based approaches, for which all significant inputs are observable, either directly or indirectly.

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There were no transfers of assets or liabilities between the fair value measurement levels during the three and six months ended June 30, 2018 or 2017.
3.
Cash and Marketable Securities
Cash, cash equivalents and restricted cash

A reconciliation of cash, cash equivalents, and restricted cash reported within the condensed consolidated balance sheets to the amount reported within the condensed consolidated statements of cash flows is shown in the table below (in thousands):
 
June 30, 2018
 
December 31, 2017
 
June 30, 2017
Cash and cash equivalents
$
33,088

 
$
218,375

 
$
41,307

Restricted cash included within prepaid expenses and other current assets

 
84

 
84

Restricted cash included within other non-current assets
1,500

 
451

 
451

Total cash, cash equivalents, and restricted cash
$
34,588

 
$
218,910

 
$
41,842

Marketable Securities

All marketable securities were considered available-for-sale at June 30, 2018 and December 31, 2017. The amortized cost, gross unrealized holding gains or losses, and fair value of the Company’s marketable securities by major security type at each balance sheet date are summarized in the tables below (in thousands):
 
June 30, 2018
 
Amortized Cost
 
Unrealized Holding Gains
 
Unrealized Holding Losses
 
Aggregate Fair Value
Short-term marketable securities:
 
 
 
 
 
 
 
U.S. government treasuries
$
173,095

 
$

 
$
(286
)
 
$
172,809

U.S. government agency securities
111,188

 

 
(230
)
 
110,958

Corporate debt securities
45,214

 

 
(162
)
 
45,052

Commercial paper
10,684

 

 

 
10,684

Total short-term marketable securities
340,181

 

 
(678
)
 
339,503

Long-term marketable securities:
 
 
 
 
 
 
 
U.S. government treasuries
90,145

 

 
(320
)
 
89,825

U.S. government agency securities
26,781

 

 
(164
)
 
26,617

Corporate debt securities
62,592

 

 
(331
)
 
62,261

Total long-term marketable securities
179,518

 

 
(815
)
 
178,703

Total
$
519,699

 
$

 
$
(1,493
)
 
$
518,206



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December 31, 2017
 
Amortized Cost
 
Unrealized Holding Gains
 
Unrealized Holding Losses
 
Aggregate Fair Value
Short-term marketable securities:
 
 
 
 
 
 
 
U.S. government treasuries
$
42,614

 
$

 
$
(27
)
 
$
42,587

U.S. government agency securities
106,368

 

 
(229
)
 
106,139

Corporate debt securities
39,197

 

 
(72
)
 
39,125

Total short-term marketable securities
188,179

 

 
(328
)
 
187,851

Long-term marketable securities:
 
 
 
 
 
 
 
U.S. government treasuries
39,868

 

 
(20
)
 
39,848

U.S. government agency securities
19,931

 

 
(20
)
 
19,911

Corporate debt securities
991

 

 

 
991

Total long-term marketable securities
60,790

 

 
(40
)
 
60,750

Total
$
248,969

 
$

 
$
(368
)
 
$
248,601


As of June 30, 2018 and December 31, 2017, certain of the Company’s marketable securities were in an unrealized loss position. The Company determined that it had the ability and intent to hold all marketable securities that have been in a continuous loss position until maturity or recovery, thus there has been no recognition of any other-than-temporary impairment for the three and six months ended June 30, 2018 and 2017. All marketable securities with unrealized losses as of each balance sheet date have been in a loss position for less than twelve months or the loss is not material.

All of the Company’s marketable securities have an effective maturity of less than two years.
4.
Derivative Financial Instruments
Foreign Currency Exchange Rate Exposure

The Company uses forward foreign currency exchange contracts to hedge certain operational exposures resulting from potential changes in foreign currency exchange rates. Such exposures result from portions of the Company’s forecasted cash flows being denominated in currencies other than the U.S. dollar, primarily the Euro and British Pound. The derivative instruments the Company uses to hedge this exposure are not designated as cash flow hedges, and as a result, changes in their fair value are recorded in Interest and other income, net, on the Company's condensed consolidated statements of operations and comprehensive loss.

The fair values of forward foreign currency exchange contracts are estimated using current exchange rates and interest rates and take into consideration the current creditworthiness of the counterparties. Information regarding the specific instruments used by the Company to hedge its exposure to foreign currency exchange rate fluctuations is provided below. The Company did not have foreign currency exchange contracts prior to June 2018.

The following table summarizes the Company’s forward foreign currency exchange contracts outstanding as of June 30, 2018 (notional amounts in thousands):
Foreign Exchange Contracts
 
Number of Contracts
 
Aggregate Notional Amount in Foreign Currency
 
Maturity
Euros
 
10

 
2,123

 
Jul. 2018 - May 2019
British Pounds
 
8

 
1,113

 
Nov. 2018 - Jun. 2019
Swiss Francs
 
8

 
813

 
Aug. 2018 - Apr. 2019
Total
 
26

 
 
 
 

The maximum length of time over which the Company is hedging its exposure to changes in exchange rates is June 2019.

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The derivative liability balance of $31,952 is recorded in Other current liabilities on the condensed consolidated balance sheet as of June 30, 2018, and the net loss associated with the Company's derivative instruments of $31,952 is recognized in Interest and other income, net on the condensed consolidated statement of operations and comprehensive loss for the three and six months ended June 30, 2018.
5.
Acquisition
 
In August 2016, the Company entered into a License and Collaboration Agreement (“F-star Collaboration Agreement”) with F-star Gamma Limited (“F-star Gamma”), F-star Biotechnologische Forschungs-Und Entwicklungsges M.B.H ("F-star GmbH") and F-star Biotechnology Limited ("F-Star Ltd") (collectively, “F-star”) to leverage F-star’s modular antibody technology and the Company’s expertise in the development of therapies for neurodegenerative diseases. In connection with the entry into the F-star Collaboration Agreement, the Company also purchased an option for an upfront option fee of $0.5 million (the “buy-out-option”), to acquire all of the outstanding shares of F-star Gamma pursuant to a pre-negotiated buy-out option agreement (the “Option Agreement”).

On May 30, 2018, the Company exercised such buy-out option and entered into a Share Purchase Agreement (the “Purchase Agreement”) with the shareholders of F-star Gamma and Shareholder Representative Services LLC, pursuant to which the Company acquired all of the outstanding shares of F-star Gamma (the “Acquisition”).

As a result of the Acquisition, F-star Gamma has become a wholly-owned subsidiary of the Company and the Company has changed the entity’s name to Denali BBB Holding Limited. In addition, the Company became a direct licensee of certain intellectual property of F-star Ltd (by way of the Company’s assumption of F-star Gamma’s license agreement with F-star Ltd, dated August 24, 2016, (the “F-star Gamma License”)). The Company has made initial exercise payments under the Purchase Agreement and the F-star Gamma License in the aggregate, of $18.0 million, less the estimated net liabilities of F-star Gamma, which is approximately $0.2 million. In addition, the Company is required to make future contingent payments, to F-star Ltd and the former shareholders of F-star Gamma, up to a maximum amount of $447.0 million in the aggregate upon the achievement of certain defined preclinical, clinical, regulatory and commercial milestones. The amount of the contingent payments varies based on whether F-star delivers an Fcab (constant Fc-domains with antigen-binding activity) that meets pre-defined criteria and whether the Fcab has been identified solely by the Company or solely by F-star or jointly by the Company and F-star.

Under the terms of the original F-star Collaboration Agreement, the Company could nominate up to three Fcab targets (“Accepted Fcab Targets”) within the first three years of the date of the F-star Collaboration Agreement. Upon entering into the F-star Collaboration Agreement, the Company had selected transferrin receptor (“TfR”) as the first Accepted Fcab Target and paid F-star Gamma an upfront fee of $5.5 million, which included selection of the first Accepted Fcab Target. In May 2018, the Company exercised its right to nominate two additional Fcab Targets and identified a second Accepted fcab Target. The Company is obligated to make a one-time payment for the two additional Accepted Fcab Targets of, in the aggregate, $6.0 million and has extended the time period for its selection of the third Accepted Fcab Target until approximately the fourth anniversary of the date of the original F-Star Collaboration Agreement.

The Company is also responsible for certain research costs incurred by F-star Ltd in conducting activities under each agreed development plan, for up to 24 months. These research costs for the agreed TfR development plan will be up to $2.1 million.
 

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The Company concluded that the assets acquired and liabilities assumed upon the exercise of the Option Agreement did not meet the accounting definition of a business, and as such, the acquisition was accounted for as an asset purchase. The Company recorded the upfront purchase price less estimated net liabilities acquired of $17.8 million in research and development expense in the accompanying condensed consolidated statement of operations and comprehensive loss in the three and six months ended June 30, 2018 since it represented consideration for in-process research and development with no future alternative use. The upfront option fee of $0.5 million previously included within other non-current assets was also included in research and development expense during the three and six months ended June 30, 2018.

As this transaction was accounted for as an asset purchase rather than a business combination, no amounts were recognized on the acquisition date relating to the contingent consideration. Contingent consideration will be recognized in research and development expense as incurred.

The Company recognized $0.2 million and $0.5 million of research and development expense related to the funding of F-star Gamma research costs during the three and six months ended June 30, 2018, respectively, and $0.2 million and $0.5 million during the three and six months ended June 30, 2017, respectively.
6.
License and Collaboration Agreements
Takeda

On January 3, 2018, the Company entered into a Collaboration and Option Agreement ("Takeda Collaboration Agreement") with Takeda Pharmaceutical Company Limited ("Takeda"), pursuant to which the Company granted Takeda an option in respect of three programs to develop and commercialize, jointly with the Company, certain biologic products that are enabled by Denali's BBB delivery technology and intended for the treatment of neurodegenerative disorders. The three programs are Denali’s ATV:BACE1/Tau and ATV: TREM2 programs, as well as a third identified discovery stage program. The Takeda Collaboration Agreement became effective on February 12, 2018 when the requirements of the Hart-Scott-Rodino Antitrust Improvements Act of 1976 were satisfied.

Under the Takeda Collaboration Agreement and unless otherwise agreed jointly between both parties, Denali will be responsible, at its cost, for conducting activities relating to pre-IND development of biologic products directed to the three identified targets and enabled by its BBB delivery technology targeting transferrin receptor during the applicable research period. The period through which the option can be exercised continues for each target until the first biologic product directed to the relevant target is IND-ready or about five years after selection of the target, whichever is earlier.

The Takeda Collaboration Agreement provided that Takeda pay a $40.0 million upfront payment, and up to an aggregate of $25.0 million with respect to each program directed to a target and based upon the achievement of certain preclinical milestone events, up to $75.0 million in total. The upfront payment of $40.0 million was received in February 2018, as well as the first preclinical milestone payment of $5.0 million related to one of the programs.

If Takeda exercises its option with respect to a particular target, then Takeda will have the right to develop and commercialize, jointly with the Company, a specified number of biologic products enabled by its BBB delivery technology that were developed during the research period and which are directed to the relevant target, and the Company will grant to Takeda a co-exclusive license under the intellectual property the Company controls related to those biologic products.

Takeda is obligated to pay Denali a $5.0 million option fee for each target for which Takeda exercises its option, up to $15.0 million in total.


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In addition, Takeda may be obligated to pay Denali up to an aggregate of $707.5 million upon achievement of certain clinical and regulatory milestone events if Takeda exercises its option for all three collaboration programs. Takeda may also be obligated to pay Denali up to $75.0 million per biologic product upon achievement of a certain sales-based milestone, or an aggregate of $225.0 million if one biologic product from each program achieves the milestone.

If Takeda exercises its option for a particular target, Denali and Takeda will share equally the development and commercialization costs, and, if applicable, the profits, for each collaboration program. However, for each collaboration program, the Company may elect not to continue sharing development and commercialization costs, or Takeda may elect to terminate Denali's cost-profit sharing rights and obligations if, following notice from Takeda and a cure period, the Company fails to satisfy its cost sharing obligations with respect to the relevant collaboration program. After such an election by the Company or termination by Takeda becomes effective, Denali will no longer be obligated to share in the development and commercialization costs for the relevant collaboration program, and will not share in any profits from that collaboration program. Instead the Company will be entitled to receive tiered royalties. The royalty rates will be in the low- to mid-teen percentages on net sales, or low- to high-teen percentages on net sales if certain co-funding thresholds have been met at the time of the Company's election to opt out of co-development or Takeda’s termination of Denali's cost-profit sharing rights and obligations, and, in each case, these royalty rates will be subject to certain reductions specified in the Takeda Collaboration Agreement. Takeda will pay these royalties for each biologic product included in the relevant collaboration program, on a country-by-country basis, until the latest of (i) the expiration of certain patents covering the relevant biologic product, (ii) the expiration of all regulatory exclusivity for that biologic product, and (iii) an agreed period of time after the first commercial sale of that biologic product in the applicable country, unless biosimilar competition in excess of a significant level specified in the Takeda Collaboration Agreement occurs earlier, in which case Takeda’s royalty obligations in the applicable country would terminate.

For each collaboration program for which costs and profits are shared with Takeda, Denali will lead the conduct of clinical activities for each indication through the first Phase 2 trial with a clinical outcomes-based efficacy endpoints, and Takeda will lead the conduct of all subsequent clinical activities for that indication. Further, Denali and Takeda will jointly commercialize biologic products included in the relevant collaboration program in the United States and China. Unless Denali has opted out of cost-sharing for two collaboration programs, it has the right to lead commercialization activities in the United States for one collaboration program and Takeda will lead commercialization activities in the United States for all collaboration programs for which Denali does not lead commercialization activities. Further, Takeda will lead commercialization activities in China and will solely conduct commercialization activities in all other countries. The Company has the right to lead all manufacturing activities for all collaboration programs for which the parties are sharing costs and profits.

Each party may terminate the Takeda Collaboration Agreement in its entirety, or with respect to a particular collaboration program, as applicable, if the other party remains in material breach of the Takeda Collaboration Agreement following a cure period to remedy the material breach. Takeda may terminate the Takeda Collaboration Agreement in its entirety or with respect to any particular collaboration program, for convenience and after giving a specified amount of prior notice, but Takeda may not do so for a certain period of time after the Effective Date of the Takeda Collaboration Agreement. Takeda may also terminate the Takeda Collaboration Agreement with respect to any collaboration program if the joint steering committee ("JSC") established under the Takeda Collaboration Agreement unanimously agrees that a material safety event has occurred with respect to the applicable collaboration program. Denali may terminate the Takeda Collaboration Agreement with respect to a particular collaboration program if Takeda fails to conduct material development and commercial activities for a specified period of time with respect to a collaboration program, unless Takeda cures such failure within a certain period of time. Denali and Takeda may each terminate the Takeda Collaboration Agreement in its entirety if the other party is declared insolvent or in similar financial distress or if, subject to a specified cure period, the other party challenges any patents licensed to it under the Takeda Collaboration Agreement.


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Pursuant to the terms of the Takeda Collaboration Agreement, the Company entered into a common stock purchase agreement (the "Stock Purchase Agreement") with Takeda on January 3, 2018, pursuant to which Takeda purchased 4,214,559 shares of Denali’s common stock (the "Shares") for an aggregate purchase price of $110.0 million. The sale of the Shares closed on February 23, 2018. The fair market value of the common stock sold to Takeda was $94.4 million, based on the closing stock price of $22.40 on the date of issuance, resulting in a $15.6 million premium paid to the Company above the fair value of the Company's common stock which was credited to contract liability in our condensed consolidated balance sheet. 

The Company believes that the Takeda Collaboration Agreement is a collaboration arrangement as defined in ASC 808, Collaborative Agreements. Further, during the research period, the Company believes that the arrangement is a contract with a customer as defined in ASC 606, Revenue From Contracts With Customers. The Takeda Collaboration Agreement and the Stock Purchase Agreement are being accounted for as one arrangement because they were entered into at the same time with interrelated financial terms. 

The Company identified performance obligations during the research period consisting of the license, the development options, and JSC participation together with the research services for each collaboration program. The license rights, JSC involvement, option and research services are considered to be a single performance obligation for each program since the research services are highly interrelated with the option and JSC involvement and will significantly modify the license. The performance obligations under each of the three programs are separate since the activities and risks under the programs are distinct.

The Company has determined that all other goods or services which are contingent upon Takeda exercising its option for each program are not considered performance obligations at the inception of the arrangement.

The transaction price at inception included fixed consideration consisting of the upfront fee of $40.0 million, the $15.6 million premium on the sale of common stock, and the first preclinical milestone payment of $5.0 million. It also included variable consideration of $26.0 million relating to future milestones that are not constrained. The amount of variable consideration was estimated using the most likely amount method. The remaining $44.0 million of preclinical milestones were considered constrained at the inception of the arrangement since the Company could not conclude it is probable that a significant reversal in the amount recognized will not occur. Additionally, cost and profit sharing income, and the development and commercial milestones as outlined above, have not been considered given Takeda has not exercised its options for the development and commercial phases for each program. There was no change in the transaction price from inception through June 30, 2018. This will be reassessed at each reporting period.

The transaction price has been ascribed in its entirety to the three performance obligations identified in the research term of the Takeda Collaboration Agreement.

Revenue is recognized when, or as, the Company satisfies its performance obligations by transferring the promised services to Takeda. Revenue will be recognized over time using the input method, based on costs incurred to perform the research services, since the level of costs incurred over time is thought to best reflect the transfer of services to Takeda.

A contract liability of $58.3 million is recorded on the balance sheet at June 30, 2018, which relates to the three performance obligations identified, with such amounts to be recognized over the period of the pre-IND research services, which is expected to be several years.

Revenue recognized relating to future milestone payments of approximately $0.8 million, for which the Company concluded that it is probable that a significant reversal in the amount recognized will not occur, is presented net of contract liability on the balance sheet.


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Significant changes in the net contract liability balance during the period are as follows (in thousands):
 
 
Contract liability
Balance at January 1, 2018
 
$

Increases due to cash received, excluding amounts recognized as revenue during the period
 
59,149

Decreases due to revenue recognized in the period for which cash has not been received
 
(844
)
Balance at June 30, 2018
 
$
58,305


There are no receivables or net contract assets as of June 30, 2018 associated with this arrangement.

In assessing this arrangement, management was required to exercise considerable judgment in estimating revenue to be recognized. Management applied judgment in determining the separate performance obligations in the research period, estimating variable consideration, and estimating total future costs when using the input method.
Genentech

In June 2016, the Company entered into an Exclusive License Agreement with Genentech, Inc. (“Genentech”). The agreement gives the Company access to Genentech’s LRRK2 small molecule program for Parkinson’s disease. Under the agreement, Genentech granted the Company (i) an exclusive, worldwide, sublicenseable license under Genentech’s rights to certain patents and patent applications directed to small molecule compounds which bind to and inhibit LRRK2 and (ii) a non-exclusive, worldwide, sublicenseable license to certain related know-how, in each case, to develop and commercialize certain compounds and licensed products incorporating any such compound. The Company is obligated to use commercially reasonable efforts during the first three years of the agreement to research, develop and commercialize at least one licensed product.

As consideration, the Company paid an upfront fee of $8.5 million and a technology transfer fee of $1.5 million, both of which were recognized as research and development expense for the year ended December 31, 2016.

The Company may owe Genentech milestone payments upon the achievement of certain development, regulatory, and commercial milestones, up to a maximum of $315.0 million in the aggregate, as well as royalties on net sales of licensed products ranging from low to high single-digit percentages, with the exact royalty rate dependent on various factors, including (i) whether the compound incorporated in the relevant licensed product is a Genentech-provided compound or a compound acquired or developed by the Company, (ii) the date a compound was first discovered, derived or optimized by the Company, (iii) the existence of patent rights covering the relevant licensed product in the relevant country, (iv) the existence of orphan drug exclusivity covering a licensed product that is a Genentech-provided compound and (v) the level of annual net sales of the relevant licensed product. The Company also has the right to credit a certain amount of third-party royalty and milestone payments against royalty and milestone payments owed to Genentech, up to a maximum reduction of fifty percent. The Company’s royalty payment obligations will expire on a country-by-country and licensed product-by-licensed product basis upon the later of (a) ten years after the first commercial sale of such licensed product in such country and (b) the expiration of the last valid claim of a licensed patent covering such licensed product in such country.


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Table of Contents

Genentech may terminate the agreement if the Company challenges any of the patent rights licensed to the Company by Genentech, or if the Company materially breaches the agreement, subject to specified notice and cure provisions, or enters into bankruptcy or insolvency proceedings. If Genentech terminates the agreement for the Company’s material breach, bankruptcy or insolvency after the Company has made a milestone payment to Genentech, then the Company is obligated to grant to Genentech an exclusive right of first negotiation with respect to certain of the Company’s patents, know-how and regulatory filings directed to Genentech-provided compounds. The Company does not have the right to terminate the agreement without cause, but may terminate the agreement for Genentech’s material breach, subject to specified notice and cure provisions.

Unless earlier terminated, the agreement with Genentech will continue in effect until all of the Company’s royalty and milestone payment obligations to Genentech expire. Following expiration of the agreement, the Company will retain the licenses under the intellectual property Genentech licensed to the Company on a non-exclusive, royalty-free basis.

The first clinical milestone of $2.5 million became due in June 2017 upon first patient dosing in the Phase 1 clinical trial for DNL201. The full amount was recorded as research and development expense in the three and six months ended June 30, 2017.
7.
Commitments and Contingencies
Lease Obligations

In September 2015, the Company entered into a non-cancelable operating lease for its corporate headquarters comprising 38,109 of rentable square feet in a building in South San Francisco (the "Headquarters Lease"). The Headquarters Lease commenced on August 1, 2016 with a lease term of eight years. The Headquarters Lease provides for monthly base rent amounts escalating over the term of the lease. In addition, the Headquarters Lease provided a tenant improvement allowance (“TIA”) of up to $7.4 million, of which $1.9 million was to be repaid to the landlord in the form of additional monthly rent with interest applied. This additional monthly rent commenced in November 2016 when the entire TIA was utilized, and resulted in an increase of base rent of $0.4 million per year over the eight-year lease term.

On May 2, 2018, the Company entered into an amendment to the Headquarters Lease (the "Headquarters Lease Amendment") to relocate and expand its headquarters to 148,020 rentable square feet in a to-be-constructed building located in South San Francisco, California (the "New Premises"). The Headquarters Lease Amendment has a contractual term of ten years from the legal commencement date, which is the later of February 1, 2019 or the date that the premises are ready for occupancy. The Company has an option to extend the lease term for a period of ten years by giving the landlord written notice of the election to exercise the option at least nine months, but not more than twelve months, prior to the expiration of the Headquarters Lease Amendment lease term.

Under the terms of the Headquarters Lease, the Company was required to pay a security deposit of $0.5 million, which was increased to $1.5 million under the Headquarters Lease Amendment. This is recorded as other non-current assets in the accompanying condensed consolidated balance sheets.

The Headquarters Lease Amendment provides for monthly base rent amounts escalating over the term of the lease. In addition, the Headquarters Lease Amendment provides a TIA of up to $25.9 million, of which $4.4 million, if utilized, would be repaid to the landlord in the form of additional monthly rent with interest applied. The Company will also be required to pay its share of operating expenses for the New Premises.


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Table of Contents

The total $7.4 million TIA under the Headquarters Lease was recorded as leasehold improvements and deferred rent liability on the condensed consolidated balance sheet under the Headquarters Lease. The Company is amortizing the deferred rent liability as a reduction of rent expense and the leasehold improvement through an increase of depreciation expense of leasehold improvements ratably over the remaining period of expected use.

The Company recognizes rent expense on a straight-line basis over the non-cancelable lease term and records the difference between cash rent payments and the recognition of rent expense as a deferred rent liability. Where leases contain escalation clauses, rent abatements, and/or concessions such as rent holidays and landlord or tenant incentives or allowances, the Company applies them in the determination of straight-line rent expense over the lease term. The Company records tenant improvement allowances as deferred rent and associated expenditures as leasehold improvements that are being amortized over the shorter of their estimated useful life or the term of the lease. The Company does not assume renewals in its determination of the lease term unless the renewals are deemed by management to be reasonably assured at lease inception.

As of June 30, 2018, the future minimum lease payments under the Headquarters Lease and subsequently the Headquarters Lease Amendment are as follows (in thousands):
Year Ended December 31:
 
 
2018 (six months)
 
$
1,309

2019
 
4,941

2020
 
9,097

2021
 
9,716

2022
 
10,056

2023 and later
 
71,289

 
 
$
106,408


Rent expense excluding amortization of leasehold improvements was $0.6 million and $1.3 million for the three and six months ended June 30, 2018, and $0.6 million and $1.2 million for the three and six months ended June 30, 2017, respectively.
Indemnification

In the ordinary course of business, the Company may provide indemnifications of varying scope and terms to vendors, lessors, business partners, board members, officers, and other parties with respect to certain matters, including, but not limited to, losses arising out of breach of such agreements, services to be provided by the Company, negligence or willful misconduct of the Company, violations of law by the Company, or from intellectual property infringement claims made by third parties. In addition, the Company has entered into indemnification agreements with directors and certain 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. No demands have been made upon the Company to provide indemnification under such agreements, and thus, there are no claims that the Company is aware of that could have a material effect on the Company’s balance sheet, statements of comprehensive loss, or statements of cash flows.

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Table of Contents

Commitments

Effective September 2017, the Company entered into a Development and Manufacturing Services Agreement as amended (“DMSA”) with Lonza Sales AG (“Lonza”) for the development and manufacture of biologic products. Under the DMSA, the Company will execute purchase orders based on project plans authorizing Lonza to provide development and manufacturing services with respect to certain of the Company's antibody and enzyme products, and will pay for the services provided and batches delivered in accordance with the DMSA and project plan. Unless earlier terminated, the Lonza agreement will expire on September 6, 2022. As of June 30, 2018, the Company had purchase orders for biological product development and manufacturing costs totaling $0.7 million and $11.4 million, for the First and Second DMSA Amendments, respectively. The activities under both the First Amendment and the Second Amendment commenced in January 2018 and are expected to be completed in May 2019 and April 2024, respectively. During the three and six months ended June 30, 2018, the Company incurred costs of $1.1 million and $1.2 million, and made payments of $0.6 million and $0.7 million, respectively, for the development and manufacturing services rendered under the agreement. As of June 30, 2018, the Company had total non-refundable purchase commitments of $6.3 million under the DMSA.
8.
Stock-Based Awards
2017 Equity Incentive Plan

In December 2017, the Company adopted the 2017 Equity Incentive Plan (the “2017 Plan”), which initially reserved 6,379,238 shares for the issuance of stock options, restricted stock and other stock awards, to employees, non-employee directors, and consultants under terms and provisions established by the Board of Directors and approved by the stockholders. Awards granted under the 2017 Plan expire no later than ten years from the date of grant. For stock options, the option price shall not be less than 100% of the estimated fair value on the day of grant. Options granted typically vest over a four-year period but may be granted with different vesting terms.
2015 Stock Incentive Plan

 In May 2015, the Company adopted the 2015 Stock Incentive Plan (the “2015 Plan”), which as amended, reserved 8,325,000 shares for the issuance of stock options, restricted stock and other stock awards, to employees, non-employee directors, and consultants under terms and provisions established by the Board of Directors and approved by the stockholders. Awards granted under the 2015 Plan expire no later than ten years from the date of grant. For stock options, the option price shall not be less than 100% of the estimated fair value on the day of grant. For all stock options granted between August 2015 and February 2016 with an exercise price of $0.68, a deemed fair value of $1.20 per share was used in calculating stock-based compensation expense, which was determined using management hindsight. Options granted typically vest over a four-year period but may be granted with different vesting terms.

Upon adoption of the 2017 Plan, no new awards or grants are permitted under the 2015 Plan, and the 169,238 shares that were then unissued and available for future award under the 2015 Plan became available under the 2017 Plan. The 2015 Plan will continue to govern restricted stock awards and option awards previously granted thereunder.

As of June 30, 2018, there were 3,237,032 shares available for the Company to grant under the 2017 Plan.

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Stock Option Activity

The following table summarizes option award activity under the 2017 Plan and the 2015 Plan: 
 
Number of 
Options
 
Weighted-
Average
 
Exercise Price
 
Weighted-
Average
 
remaining 
contractual 
life (years)
 
Aggregate 
Intrinsic 
Value (in thousands)
Balance at December 31, 2017
6,689,479

 
$
4.08

 
8.37
 
$
77,317

Options granted
2,964,234

 
21.68

 
 
 
 
Options exercised
(291,557
)
 
2.17

 
 
 
 
Options forfeited
(188,768
)
 
9.56

 
 
 
 
Balance at June 30, 2018
9,173,388

 
$
9.72

 
8.52
 
$
50,761

Options vested and expected to vest at June 30, 2018
7,428,656

 
$
11.84

 
8.84
 
$
25,340

Options exercisable at June 30, 2018
1,559,981

 
$
3.58

 
8.05
 
$
18,207


Aggregate intrinsic value represents the difference between the Company’s estimated fair value of its common stock and the exercise price of outstanding options. The total intrinsic value of options exercised was $3.5 million and $4.7 million for the three and six months ended June 30, 2018, and $0.5 million and $2.3 million for the three and six months ended June 30, 2017, respectively. During the three and six months ended June 30, 2018, the weighted-average grant-date fair value of the vested options was $2.83 and $2.87 per share, respectively. During the three and six months ended June 30, 2017, the weighted-average grant-date fair value of the vested options was $1.29 and $1.16 per share, respectively. The weighted-average grant date fair value of all options granted during the three and six months ended June 30, 2018 was $13.37 and $15.90 per share, respectively. The weighted-average grant date fair value of all options granted during the three and six months ended June 30, 2017 was $4.84 and $4.13 per share, respectively.
Stock Options Granted to Employees with Service-Based Vesting

The estimated fair value of stock options granted to employees were calculated using the Black-Scholes option-pricing model using the following assumptions:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
Expected term (in years)
5.50 - 6.08
 
6.08
 
5.50 - 6.08
 
6.08
Volatility
80.0% - 85.6%
 
88.1% - 89.8%
 
80.0% - 87.4%
 
89.8% - 91.3%
Risk-free interest rate
2.7% - 2.9%
 
1.9%
 
2.6% - 2.9%
 
1.9% - 2.3%
Dividend yield
 
 
 

Expected Term: The expected term represents the period that the options granted are expected to be outstanding and is determined using the simplified method (based on the mid-point between the vesting date and the end of the contractual term).

Expected Volatility: The Company uses an average historical stock price volatility of comparable public companies within the biotechnology and pharmaceutical industry that were deemed to be representative of future stock price trends as the Company does not have sufficient trading history for its common stock. The Company will continue to apply this process until a sufficient amount of historical information regarding the volatility of its own stock price becomes available.

Risk-Free Interest Rate: The Company based the risk-free interest rate over the expected term of the options based on the constant maturity rate of U.S. Treasury securities with similar maturities as of the date of the grant.


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Expected Dividend: The Company has not paid and does not anticipate paying any dividends in the near future. Therefore, the expected dividend yield was zero.
Early Exercise of Stock Options

The Company permits early exercise of certain stock options prior to vesting by certain directors and officers. Any shares issued pursuant to unvested options are restricted and subject to repurchase by the Company until the conditions for vesting are met. The amounts paid for shares purchased under an early exercise of stock options and subject to repurchase by the Company are reported in stockholders’ equity once those shares vest. Upon termination of employment of an option holder, the Company has the right to repurchase, at the original purchase price, any unvested restricted shares.

A total of $31,875 and $0.3 million was reclassified from other non-current liabilities to stockholders' equity during the three and six months ended June 30, 2018, respectively, related to vesting of early exercised options. A total of $31,874 and $0.2 million was reclassified from other non-current liabilities to stockholders' equity during the three and six months ended June 30, 2017, respectively, related to vesting of early exercised options. Unvested early exercised options of $0.3 million and $0.5 million remained in other non-current liabilities as of June 30, 2018 and December 31, 2017, respectively.
Performance and Market Contingent Stock Options Granted to Employees

In August and November 2015, the Board of Directors granted performance- and market- contingent options to purchase 1,619,738 shares and 125,000 shares of the Company's common stock, respectively, to members of the senior management team. These awards have an exercise price of $0.68 per share.

These awards have two separate market triggers for vesting based upon either (i) the successful achievement of stepped target closing prices on a national securities exchange for 90 consecutive trading days later than 180 days after the Company’s initial public offering for its common stock, or (ii) stepped target prices for a change in control transaction. By definition, the market condition in these awards can only be achieved after the performance condition of a liquidity event has been achieved. As such, the requisite service period is based on the estimated period over which the market condition can be achieved. When a performance goal is deemed to be probable of achievement, time-based vesting and recognition of stock-based compensation expense commences. In the event any the milestones are not achieved by the specified timelines, such award will terminate and no longer be exercisable with respect to that portion of the shares. The maximum potential expense associated with the performance- and market- contingent awards is $6.2 million ($5.8 million and $0.4 million of general and administrative and research and development expense, respectively) if all of the performance and market conditions are achieved as stated in the option agreement.

The Company uses a lattice model with a Monte Carlo simulation to value stock options with performance and market conditions. This valuation methodology utilizes the estimated fair value of the Company’s common stock on grant date and several key assumptions, including expected volatility of the Company’s stock price based on comparable public companies, risk-free rates of return and expected dividend yield.
Stock Options Granted to Non-Employees with Service-Based Vesting Valuation Assumptions

Stock-based compensation related to stock options granted to non-employees is recognized as the stock options are earned. The estimated fair value of the stock options granted is calculated at each reporting date using the Black-Scholes option-pricing model with the following assumptions:

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Three Months Ended June 30,
 
Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
Expected term (in years)
7.14 - 9.61
 
8.01 - 9.21
 
7.14 - 9.86
 
8.01 - 9.45
Volatility
89.4% - 99.7%
 
91.4% - 96.0%
 
88.9% - 103.1%
 
91.4% - 98.0%
Risk-free interest rate
2.8%
 
2.3% - 2.4%
 
2.7% - 2.8%
 
2.3% - 2.4%
Dividend yield
 
 
 
Restricted Stock Activity

The following table summarizes restricted stock activity:
 
Shares
 
Weighted-Average Fair Value at Date of Grant per Share
Unvested at December 31, 2017
2,293,788

 
$
0.18

Granted

 

Vested
(1,125,791
)
 
0.18

Forfeited

 

Unvested at June 30, 2018
1,167,997

 
$
0.18

Vested and expected to vest – June 30, 2018
1,167,997

 
$
0.18


At June 30, 2018, there was $0.2 million of total unrecognized compensation cost related to unvested restricted stock, all which is expected to be recognized over a remaining weighted-average vesting period of 0.7 years.
Employee Stock Purchase Plan

In December 2017, the Company adopted the 2017 Employee Stock Purchase Plan (the “2017 ESPP”), which initially reserved 1,000,000 shares of the Company's common stock for employee purchases under terms and provisions established by the Board of Directors. Under the 2017 ESPP, employees may purchase common stock through payroll deductions at a price equal to 85% of the lower of the fair market value of common stock on the first trading day of each offering period or on the exercise date. The 2017 ESPP provides for consecutive, overlapping 12-month offering periods. The offering periods are scheduled to start on the first trading day on or after May 31 or November 30 of each year, except for the first offering period which commenced on December 8, 2017, the first trading day after the effective date of the Company’s registration statement. Contributions under the 2017 ESPP are limited to a maximum of 15% of an employee's eligible compensation.

The estimated fair value of stock purchase rights granted under the ESPP were calculated using the Black-Scholes option-pricing model using the following assumptions:
 
Three and Six Months Ended June 30,
 
2018
Expected term (in years)
0.5 -1.0
Volatility
63.2% - 63.7%
Risk-free interest rate
2.1%
Dividend yield

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Stock-Based Compensation Expense

The Company’s results of operations include expenses relating to employee and non-employee stock option and restricted stock awards, as follows (in thousands):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
Research and development
$
2,586

 
$
709

 
$
4,272

 
$
1,222

General and administrative
2,124

 
350

 
3,363

 
602

Total
$
4,710

 
$
1,059

 
$
7,635

 
$
1,824


As of June 30, 2018 and December 31, 2017, total unamortized stock-based compensation expense related to unvested stock-based awards that are expected to vest was $56.6 million and $17.7 million, respectively. The weighted-average periods over which such stock-based compensation expense will be recognized are approximately 3.3 and 3.2 years, respectively.
 
The Company recorded stock-based compensation expense for options issued to non-employees of $0.1 million and $0.4 million for the three and six months ended June 30, 2018, respectively, and $0.2 million and $0.3 million for the three and six months ended June 30, 2017, respectively.
9.
Net Loss and Net Loss Per Share

The following table sets forth the computation of the basic and diluted net loss per share (in thousands, except share and per share data): 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
Numerator:
 
 
 
 
 
 
 
Net loss
$
(54,724
)
 
$
(22,134
)
 
$
(78,402
)
 
$
(43,454
)
Denominator:
 
 
 
 
 
 
 
Weighted average common shares outstanding
92,899,524

 
9,670,449

 
91,239,274

 
9,346,051

Net loss per share, basic and diluted
$
(0.59
)
 
$
(2.29
)
 
$
(0.86
)
 
$
(4.65
)

Since the Company was in a loss position for all periods presented, basic net loss per share is the same as diluted net loss per share for all periods as the inclusion of all potential shares of common stock outstanding would have been anti-dilutive. Potentially dilutive securities that were not included in the diluted per share calculations because they would be anti-dilutive were as follows:
 
Three and Six Months Ended June 30,
 
2018
 
2017
Series A-1 convertible preferred stock

 
46,114,423

Series A-2 convertible preferred stock

 
4,361,527

Series B-1 convertible preferred stock

 
8,124,365

Options issued and outstanding and ESPP shares issuable and outstanding
9,264,644

 
5,954,099

Restricted shares subject to future vesting
1,167,997

 
3,108,201

Early exercised common stock subject to future vesting
229,172

 
463,544

Shares to be issued under Incro acquisition agreement

 
81,164

Total
10,661,813

 
68,207,323



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ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read together with our financial statements and the other financial information appearing elsewhere in this Quarterly Report on Form 10-Q. These statements generally relate to future events or to our future financial performance and involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. The following discussion and analysis contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Our actual results and the timing of events may differ materially from those discussed in our forward-looking statements as a result of various factors, including those discussed below and those discussed in the section entitled “Risk Factors” included in this Quarterly Report on Form 10-Q.

Forward-looking statements include, but are not limited to, statements about:

the success, cost and timing of our development activities, preclinical studies and clinical trials, including the enrollment in such trials, and in particular the development of our blood-brain barrier (“BBB”) platform technology, core programs and biomarkers;

the extent to which any dosing limitations that we have been subject to, and/or may be subject to in the future, may affect the success of our product candidates;

the impact of preclinical findings on our ability to achieve exposures of our product candidates that allow us to explore a robust pharmacodynamic range of these candidates in humans;

the expected potential benefits and potential revenue resulting from strategic collaborations with third parties and our ability to attract collaborators with development, regulatory and commercialization expertise;

the timing or likelihood of regulatory filings and approvals;

our ability to obtain and maintain regulatory approval of our product candidates, and any related restrictions, limitations and/or warnings in the label of any approved product candidate;

the scope of protection we are able to establish and maintain for intellectual property rights covering our product candidates and technology;

the terms and conditions of licenses granted to us and our ability to license and/or acquire additional intellectual property relating to our product candidates and BBB platform technology;

our ability to obtain funding for our operations, including funding necessary to develop and commercialize our current and potential future product candidates;

our plans and ability to establish sales, marketing and distribution infrastructure to commercialize any product candidates for which we obtain approval;

future agreements with third parties in connection with the commercialization of our product candidates;

the size and growth potential of the markets for our product candidates, if approved for commercial use, and our ability to serve those markets;

the rate and degree of market acceptance of our product candidates;


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existing regulations and regulatory developments in the United States and foreign countries;

potential claims relating to our intellectual property and third-party intellectual property;

our ability to contract with third-party suppliers and manufacturers and their ability to perform adequately;

our potential plans and ability to develop our own manufacturing facilities;

the pricing and reimbursement of our product candidates, if approved and commercialized;

the success of competing products or platform technologies that are or may become available;

our ability to attract and retain key managerial, scientific and medical personnel;

the accuracy of our estimates regarding expenses, future revenue, capital requirements and needs for additional financing;

our ability to enhance operational, financial and information management systems;

our financial performance; and

our expectations regarding the period during which we qualify as an emerging growth company under the JOBS Act.

These forward-looking statements are subject to a number of risks, uncertainties, and assumptions, including those described in “Risk Factors”. In some cases, you can identify these statements by terms such as “anticipate,” “believe,” “could,” “estimate,” “expects,” “intend,” “may,” “plan,” “potential,” “predict,” “project,” “should,” “will,” “would” or the negative of those terms, and similar expressions that convey uncertainty of future events or outcomes. These forward-looking statements reflect our beliefs and views with respect to future events and are based on estimates and assumptions as of the date of this Quarterly Report on Form 10-Q and are subject to risks and uncertainties. We discuss many of these risks in greater detail in the section entitled “Risk Factors” included in Part II, Item 1A and elsewhere in this report. Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time. It is not possible to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. Given these uncertainties, you should not place undue reliance on these forward-looking statements. We qualify all of the forward-looking statements in this Quarterly Report on Form 10-Q by these cautionary statements. Except as required by law, we assume no obligation to update these forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in any forward-looking statements, whether as a result of new information, future events or otherwise.
Overview

Our goal is to discover and develop therapeutics to defeat degeneration.

Our strategy is guided by three overarching principles:
 
Genetic Pathway Potential: We select our therapeutic targets and disease pathways based on genes that, when mutated, cause, or are major risk factors for, neurodegenerative diseases, which we refer to as degenogenes.

Engineering Brain Delivery: We engineer our product candidates to cross the BBB and act directly in the brain.


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Biomarker-Driven Development: We discover, develop and utilize biomarkers to select the right patient population and demonstrate target engagement, pathway engagement and impact on disease progression of our product candidates. 

Our total portfolio currently consists of thirteen programs. To prioritize the allocation of our resources, we designate certain programs as core programs and others as seed programs, and we currently have eight core programs and five seed programs. Our most advanced core programs are our leucine-rich repeat kinase 2 ("LRRK2") inhibitor program to address Parkinson’s disease and our receptor interacting serine/threonine protein kinase 1 ("RIPK1") inhibitor program to address Alzheimer’s disease and amyotrophic lateral sclerosis ("ALS"). The two most advanced product candidates in our LRRK2 program, DNL201 and DNL151, are potent, selective and brain-penetrant small molecule LRRK2 inhibitor product candidates for Parkinson’s disease. DNL201 is currently in a Phase 1 clinical trial in healthy volunteers in the United States, and DNL151 is currently in a Phase 1 clinical trial in healthy volunteers in the Netherlands. We recently announced that DNL201 meets all key objectives in the Phase 1 Healthy Volunteer Study, including achieving targeted levels of cerebrospinal fluid (CSF) exposure, robust target engagement as measured by two blood-based biomarkers of LRRK2 activity at doses that were safe and well tolerated, and effects on biomarkers of lysosomal function. As such, DNL201 will advance into a Phase 1b clinical study in Parkinson’s disease patients with and without the genetic LRRK2 mutation in 2018. The most advanced product candidate in our RIPK1 inhibitor program, DNL747, is a potent, selective and brain-penetrant small molecule RIPK1 inhibitor product candidate for ALS and Alzheimer’s disease is currently in a Phase 1 clinical trial in healthy volunteers in the Netherlands.

We have also developed proprietary BBB platform technology, our transport vehicle ("TV"), which is designed to effectively transport antibodies (antibody transport vehicle ("ATV")) and enzymes (enzyme transport vehicle ("ETV")) across the BBB. This technology is designed to engage specific BBB transport receptors, which are ubiquitously expressed in brain capillaries and facilitate transport of proteins into the brain. We are currently optimizing and broadening this platform technology. We plan to have multiple product candidates that utilize our ATV or ETV platforms enter clinical development in 2019 and 2020, including molecules targeting alpha-synuclein (“aSyn”); iduronate 2-sulfatase (“IDS”); triggering receptor expressed in myeloid cells 2 (“TREM2”); and a bispecific agent targeting both beta-secretase 1 (“BACE1”); and Tau.
 
To complement our internal capabilities, we have entered into arrangements with biopharmaceutical companies, numerous leading academic institutions and foundations to gain access to new product candidates, enable and accelerate the development of our existing programs and deepen our scientific understanding of certain areas of biology. We rely on third-party contract manufacturers to manufacture and supply our preclinical and clinical materials to be used during the development of our product candidates. We currently do not need commercial manufacturing capacity.

Since we commenced operations in May 2015, we have devoted substantially all of our resources to discovering, acquiring and developing product candidates, building our BBB platform technology and assembling our core capabilities in neurodegenerative disease pathways.

Key operational and financing milestones in 2018 to date include:

On January 3, 2018, we entered into the Takeda Collaboration Agreement pursuant to which we granted Takeda an option with respect to three of our programs to develop and commercialize, jointly with us, certain biologic products that are enabled by our BBB delivery technology and intended for the treatment of neurodegenerative disorders. Pursuant to this agreement, we received an upfront payment of $40.0 million in February 2018, as well as the first preclinical milestone payment of $5.0 million related to one of our programs. Further, under the associated common stock purchase agreement (the "Stock Purchase Agreement"), we received proceeds of $110.0 million for the sale of 4,214,559 shares of our common stock which were issued on February 23, 2018.


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On February 7, 2018, we submitted a CTA for DNL747, a RIPK1 inhibitor, to the Netherlands Health Authority, and we initiated a Phase 1 clinical trial of DNL747 in healthy volunteers in the Netherlands in March 2018.

On May 21, 2018, we exercised our right to nominate two additional Fcab (constant Fc-domains with antigen-binding activity) targets under the F-star Collaboration Agreement associated with our BBB platform technology, resulting in an obligation to make a one-time payment of $6.0 million within 90 days of the exercise date.

On May 30, 2018, we exercised our buy-out option to acquire all of the outstanding shares of F-star Gamma Limited, and subsequently changed the name of the entity to Denali BBB Holding Limited. We made initial exercise payments of, in the aggregate, $18.0 million, less the estimated net liabilities of F-star Gamma, which was approximately $0.2 million. In addition, we are required under the buy-out option agreement and the F-star Gamma License to make future contingent payments to F-star Ltd or the former shareholders of F-star Gamma, up to a maximum amount of $447.0 million in the aggregate, upon the achievement of certain defined preclinical, clinical, regulatory and commercial milestones.

During the second quarter of 2018, one of our pending patent applications directed to the composition of matter of DNL151, a LRRK2 inhibitor, issued in the United States.

During the second quarter of 2018 we achieved in vivo proof of concept for the ETV:IDS program in a mouse model of Hunter Syndrome.

On August 1, 2018, we announced positive results from the DNL201 Phase 1 Healthy Volunteer Study. DNL201 meets all key objectives in the Phase 1 Healthy Volunteer Study, including achieving targeted levels of CSF exposure and inhibition of LRRK2 activity at doses that were safe and well tolerated, robust target engagement as measured by two blood-based biomarkers of LRRK2 activity, and effects on biomarkers of lysosomal function. As such, DNL201 will advance to Phase 1b clinical study in Parkinson’s disease patients with and without the genetic LRRK2 mutation in 2018.

We do not have any products approved for sale and have not generated any product revenue since our inception. We have funded our operations primarily from the issuance and sale of convertible preferred stock, the proceeds from our IPO and cash proceeds from Takeda under the Takeda Collaboration Agreement.

We have incurred significant operating losses to date and expect to continue to incur operating losses for the foreseeable future. Our net losses were $54.7 million and $78.4 million for the three and six months ended June 30, 2018, and $22.1 million and $43.5 million for the three and six months ended June 30, 2017, respectively. As of June 30, 2018, we had an accumulated deficit of $270.1 million. We expect to continue to incur significant expenses and operating losses as we advance our LRRK2 and RIPK1 programs through clinical trials; broaden and improve our BBB platform technology; acquire, discover, validate and develop additional product candidates; obtain, maintain, protect and enforce our intellectual property portfolio; and hire additional personnel.
Components of Operating Results
Collaboration Revenue

To date, we have not generated any revenue from product sales and do not expect to generate any revenue from product sales for the foreseeable future. For the three and six months ended June 30, 2018, we recognized $1.6 million and $2.3 million, respectively, of collaboration revenue from the Takeda Collaboration Agreement.


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In the future, we will continue to recognize revenue from the Takeda Collaboration Agreement and may generate revenue from product sales or other collaboration agreements, strategic alliances and licensing arrangements. We expect that our revenue will fluctuate from quarter-to-quarter and year-to-year as a result of the timing and amount of license fees, milestones, reimbursement of costs incurred and other payments and product sales, to the extent any are successfully commercialized. If we fail to complete the development of our product candidates in a timely manner or obtain regulatory approval for them, our ability to generate future revenue, and our results of operations and financial position, would be materially adversely affected.
Operating Expenses

Research and Development

Research and development activities account for a significant portion of our operating expenses. We record research and development expenses as incurred. Research and development expenses incurred by us for the discovery and development of our product candidates and BBB platform technology include:
 
external research and development expenses, including:

expenses incurred under arrangements with third parties, such as contract research organizations ("CROs"), preclinical testing organizations, contract manufacturing organizations ("CMOs"), academic and non-profit institutions and consultants;

expenses to acquire technologies to be used in research and development that have not reached technological feasibility and have no alternative future use;

fees related to our license and collaboration agreements;

personnel related expenses, including salaries, benefits and non-cash stock-based compensation expense; and

other expenses, which include direct and allocated expenses for laboratory, facilities and other costs.

A portion of our research and development expenses are direct external expenses, which we track on a program-specific basis once a program has commenced a late-stage IND-enabling studies.
 
Program expenses include expenses associated with our most advanced product candidates and the discovery and development of backup or next-generation molecules. We also track external expenses associated with our BBB platform technology. All external costs associated with earlier stage programs, or that benefit the entire portfolio, are tracked as a group. We do not track personnel or other operating expenses incurred for our research and development programs on a program-specific basis. These expenses primarily relate to salaries and benefits, stock-based compensation, facility expenses including depreciation and lab consumables.

At this time, we cannot reasonably estimate or know the nature, timing and estimated costs of the efforts that will be necessary to complete the development of, and obtain regulatory approval for, any of our product candidates. We are also unable to predict when, if ever, material net cash inflows will commence from sales or licensing of our product candidates. This is due to the numerous risks and uncertainties associated with drug development, including the uncertainty of:
 
our ability to add and retain key research and development personnel;

our ability to establish an appropriate safety profile with IND-enabling toxicology studies;


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Table of Contents

our ability to successfully develop, obtain regulatory approval for, and then successfully commercialize, our product candidates;

our successful enrollment in and completion of clinical trials;

the costs associated with the development of any additional product candidates we identify in-house or acquire through collaborations;

our ability to discover, develop and utilize biomarkers to demonstrate target engagement, pathway engagement and the impact on disease progression of our molecules;

our ability to establish agreements with third-party manufacturers for clinical supply for our clinical trials and commercial manufacturing, if our product candidates are approved;

the terms and timing of any collaboration, license or other arrangement, including the terms and timing of any milestone payments thereunder;

our ability to obtain and maintain patent, trade secret and other intellectual property protection and regulatory exclusivity for our product candidates if and when approved;

our receipt of marketing approvals from applicable regulatory authorities;

our ability to commercialize products, if and when approved, whether alone or in collaboration with others; and

the continued acceptable safety profiles of the product candidates following approval.

A change in any of these variables with respect to the development of any of our product candidates would significantly change the costs, timing and viability associated with the development of that product candidate. We expect our research and development expenses to increase at least over the next several years as we continue to implement our business strategy, advance our current programs, expand our research and development efforts, seek regulatory approvals for any product candidates that successfully complete clinical trials, access and develop additional product candidates and incur expenses associated with hiring additional personnel to support our research and development efforts. In addition, product candidates in later stages of clinical development generally incur higher development costs than those in earlier stages of clinical development, primarily due to the increased size and duration of later-stage clinical trials.

General and Administrative

General and administrative expenses include personnel related expenses, such as salaries, benefits, travel and non-cash stock-based compensation expense, expenses for outside professional services and allocated expenses. Outside professional services consist of legal, accounting and audit services and other consulting fees. Allocated expenses consist of rent expenses related to our office and research and development facility not otherwise included in research and development expenses.
We expect to incur additional expenses as a result of operating as a public company, including expenses related to compliance with the rules and regulations of the SEC and those of any national securities exchange on which our securities are traded, additional insurance expenses, investor relations activities and other administrative and professional services. We also expect to increase our administrative headcount as we advance our product candidates through clinical development, which will also likely require us to increase our general and administrative expenses.

Interest and Other Income, Net

Interest and other income, net, consists primarily of interest income and investment income earned on our cash, cash equivalents, and marketable securities as well as unrealized gains and losses on foreign currency hedges.

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Results of Operations
Comparison of the three and six months ended June 30, 2018 and 2017

The following tables set forth the significant components of our results of operations (in thousands):
 
Three Months Ended June 30,
 
Change
 
2018
 
2017
 
$
 
%
 
Collaboration revenue
$
1,648

 
$

 
$
1,648

 
*

%
Operating expenses:
 
 
 
 
 
 
 
 
Research and development
52,134

 
19,004

 
33,130

 
174

 
General and administrative
6,896

 
3,564

 
3,332

 
93

 
Total operating expenses
59,030

 
22,568

 
36,462

 
162

 
Loss from operations
(57,382
)
 
(22,568
)
 
(34,814
)
 
154

 
Interest and other income, net
2,658

 
434

 
2,224

 
512

 
Net loss
$
(54,724
)
 
$
(22,134
)
 
$
(32,590
)
 
147

%
__________________________________________________
* Percentage is not meaningful.

 
Six Months Ended June 30,
 
Change
 
2018
 
2017
 
$
 
%
 
Collaboration revenue
$
2,289

 
$

 
$
2,289

 
*

%
Operating expenses:
 
 
 
 
 
 
 
 
Research and development
72,953

 
37,474

 
35,479

 
95

 
General and administrative
12,466

 
6,838

 
5,628

 
82

 
Total operating expenses
85,419

 
44,312

 
41,107

 
93

 
Loss from operations
(83,130
)
 
(44,312
)
 
(38,818
)
 
88

 
Interest and other income, net
4,728

 
858

 
3,870

 
451

 
Net loss
$
(78,402
)
 
$
(43,454
)
 
$
(34,948
)
 
80

%
_________________________________________________
* Percentage is not meaningful.

Collaboration Revenue. Collaboration Revenue was $1.6 million and $2.3 million for the three and six months ended June 30, 2018, with no revenue recognized for the three and six months ended June 30, 2017, respectively. The increase was due to revenue recognized under our Takeda Collaboration Agreement.

Research and development expenses. Research and development expenses were $52.1 million and $73.0 million for the three and six months ended June 30, 2018 compared to $19.0 million and $37.5 million for the three and six months ended June 30, 2017, respectively.


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The following table summarizes our research and development expenses by program and category (in thousands):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
LRRK2 program external expenses (1)
$
3,039

 
$
5,887

 
$
6,247

 
$
9,749

RIPK1 program external expenses
3,094

 
1,280

 
4,947

 
3,755

BBB platform external expenses (2)
27,546

 
864

 
28,197

 
1,634

Other external research and development expenses
4,696

 
2,084

 
8,246

 
4,904

Personnel related expenses (3)
9,358

 
5,520

 
17,098

 
10,897

Other unallocated research and development expenses
4,401

 
3,369

 
8,218

 
6,535

Total research and development expenses
$
52,134

 
$
19,004

 
$
72,953

 
$
37,474

__________________________________________________
(1)
The amounts for the three and six months ended June 30, 2017 include a milestone payment of $2.5 million under the license agreement with Genentech.
(2)
The amounts for the three and six months ended June 30, 2018 include the upfront purchase price less estimated net liabilities acquired of $17.8 million, and transaction costs of $1.9 million in relation to our acquisition of F-star Gamma Limited, and the $6.0 million one-time payment made to F-star Ltd to nominate two additional Fcab targets under the Collaboration Agreement.
(3)
Personnel related expenses include stock-based compensation expense of $2.6 million and $4.3 million for the three and six months ended June 30, 2018, respectively, and $0.7 million and $1.2 million for the three and six months ended June 30, 2017, respectively, reflecting an increase of $1.9 million and $3.1 million, respectively.

The increase in total research and development expenses of $33.1 million for the three months ended June 30, 2018 compared to the three months ended June 30, 2017 was primarily attributable to a $26.7 million increase in BBB platform external expenses, the majority of which related to expense associated with the nomination of two additional Fcab targets in the F-star Collaboration Agreement, and the acquisition of F-star Gamma Limited, and a $3.8 million increase in personnel related expenses, consisting of a $2.0 million increase in salaries and related expenses attributable to an increase in our research and development headcount, and a $1.9 million increase in stock-based compensation expense attributable to new options granted at higher valuations subsequent to the IPO and an increase in our research and development headcount. Further, there was a $2.6 million increase in other external research and development expenses, which reflects our increased investment in growing and developing our pipeline, an increase of $1.8 million in RIPK1 program external expenses primarily due to the expenses related to the Phase 1 clinical trial for DNL 747, which commenced in March 2018, and an increase in other unallocated research and development expenses of $1.0 million, which was primarily due to an increase in lab consumable expenses of $0.6 million and an increase in facilities related expenses of $0.4 million, both of which are attributable to increases in research and development headcount.

These increases were partially offset by a $2.8 million decrease in LRRK2 program external expenses, primarily due to the milestone payment of $2.5 million under the license agreement with Genentech included in the three months ended June 30, 2017.


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The increase in total research and development expenses of $35.5 million for the six months ended June 30, 2018 compared to the six months ended June 30, 2017 was primarily attributable to a $26.6 million increase in BBB platform external expenses, the majority of which related to expense associated with the nomination of two additional Fcab targets in the F-star Collaboration Agreement, and the acquisition of F-star Gamma Limited, and a $6.2 million increase in personnel related expenses, consisting of a $3.2 million increase in salaries and related expenses attributable to an increase in our research and development headcount, and a $3.1 million increase in stock-based compensation expense attributable to new options granted at higher valuations subsequent to the IPO, and an increase in our research and development headcount. Further, there was a $3.3 million increase in other external research and development expenses, which reflects our increased investment in growing and developing our pipeline, an increase of $1.2 million in RIPK1 program external expenses primarily due to the expenses related to the Phase 1 clinical trial for DNL 747 which commenced in March 2018, and an increase in other unallocated research and development expenses of $1.7 million, which was primarily due to an increase in lab consumable expenses of $0.9 million and an increase in facilities related expenses of $0.7 million, both of which are attributable to increases in research and development headcount.

These increases were partially offset by a $3.5 million decrease in LRRK2 program external expenses, primarily due to the milestone payment of $2.5 million under the license agreement with Genentech included in the six months ended June 30, 2017.

General and administrative expenses. General and administrative expenses were $6.9 million for the three months ended June 30, 2018 compared to $3.6 million for the three months ended June 30, 2017, including stock-based compensation expense of $2.1 million and $0.4 million in the three months ended June 30, 2018 and 2017, respectively. The increase of $3.3 million was primarily attributable to the $1.8 million increase in stock-based compensation expense mainly due to new options granted at higher valuations subsequent to the IPO and an increase in our general and administrative headcount, a $0.2 million increase in legal expenses and other professional services to support our ongoing operations as a public company, and a $0.6 million increase in other personnel related expenses due to an increase in our general and administrative headcount.

General and administrative expenses were $12.5 million for the six months ended June 30, 2018 compared to $6.8 million for the six months ended June 30, 2017, including stock-based compensation expense of $3.4 million and $0.6 million in the six months ended June 30, 2018 and 2017, respectively. The increase of approximately $5.6 million was primarily attributable to the $2.8 million increase in stock-based compensation expense mainly due to new options granted at higher valuations subsequent to the IPO and an increase in our general and administrative headcount, a $0.8 million increase in legal expenses and other professional services to support our ongoing operations as a public company, and a $1.1 million increase in other personnel related expenses due to an increase in our general and administrative headcount.

Interest and other income, net. Interest and other income, net was $2.7 million for the three months ended June 30, 2018 compared to $0.4 million for the three months ended June 30, 2017. The increase of $2.2 million reflects that the marketable securities balances were higher in 2018 than in 2017, and increased interest rates on marketable securities in our portfolio for the three months ended June 30, 2018.

Interest and other income, net was $4.7 million for the six months ended June 30, 2018 compared to $0.9 million for the six months ended June 30, 2017. The increase of $3.9 million reflects that the marketable securities balances were higher in 2018 than in 2017, and that there were increased interest rates on marketable securities in our portfolio for the six months ended June 30, 2018.

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Liquidity and Capital Resources
Sources of Liquidity

We have funded our operations primarily from the issuance and sale of convertible preferred stock, the proceeds from our IPO and cash proceeds under our Takeda Collaboration Agreement. In December 2017, we completed our IPO pursuant to which we issued 15,972,221 shares of our common stock, including 2,083,333 shares sold pursuant the underwriters' full exercise of their option to purchase additional shares, at a price of $18.00 per share. We received $264.3 million from our IPO, net of underwriting discounts and commissions, and offering expenses incurred by us.

Pursuant to the Takeda Collaboration Agreement, we received a $40.0 million upfront payment and a $5.0 million preclinical milestone in February 2018. Further, under the associated Stock Purchase Agreement we received a further $110.0 million in February 2018 in exchange for 4,214,559 shares of common stock issued.

As of June 30, 2018, we had cash, cash equivalents and marketable securities in the amount of $551.3 million.
Future Funding Requirements

To date, we have not generated any product revenue. We do not expect to generate any product revenue unless and until we obtain regulatory approval of and commercialize any of our product candidates, and we do not know when, or if, either will occur.

We expect to continue to incur substantial additional losses for the foreseeable future as we expand our research and development activities and continue the development of, and seek regulatory approvals for, our product candidates, and begin to commercialize any approved products. Further, we expect general and administrative expenses to increase as we will now incur additional costs associated with operating as a public company. We are subject to all of the risks typically related to the development of new product candidates, and we may encounter unforeseen expenses, difficulties, complications, delays and other unknown factors that may adversely affect our business. We anticipate that we will need substantial additional funding in connection with our continuing operations.

Until we can generate a sufficient amount of revenue from the commercialization of our product candidates or from our Takeda Collaboration Agreement, or future agreements with other third parties, if ever, we expect to finance our future cash needs through public or private equity or debt financings. Additional capital may not be available on reasonable terms, if at all. If we are unable to raise additional capital in sufficient amounts or on terms acceptable to us, we may have to significantly delay, scale back or discontinue the development or commercialization of one or more of our product candidates. If we raise additional funds through the issuance of additional debt or equity securities, it could result in dilution to our existing stockholders, increased fixed payment obligations and the existence of securities with rights that may be senior to those of our common stock. If we incur indebtedness, we could become subject to covenants that would restrict our operations and potentially impair our competitiveness, such as limitations on our ability to incur additional debt, limitations on our ability to acquire, sell or license intellectual property rights and other operating restrictions that could adversely impact our ability to conduct our business. Additionally, any future collaborations we enter into with third parties may provide capital in the near term but limit our potential cash flow and revenue in the future. Any of the foregoing could significantly harm our business, financial condition and prospects.

Since our inception, we have incurred significant losses and negative cash flows from operations. We have an accumulated deficit of $270.1 million through June 30, 2018. We expect to incur substantial additional losses in the future as we conduct and expand our research and development activities. We believe that our existing cash, cash equivalents and marketable securities will be sufficient to enable us to fund our projected operations through at least the next 12 months. We have based this estimate on assumptions that may prove to be wrong, and we could utilize our available capital resources sooner than we currently expect. Our future funding requirements will depend on many factors, including:


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the timing and progress of preclinical and clinical development activities;

the number and scope of preclinical and clinical programs we decide to pursue;

the progress of the development efforts of third parties with whom we have entered into license and collaboration agreements;

our ability to maintain our current research and development programs and to establish new research and development, license or collaboration arrangements;

our ability and success in securing manufacturing relationships with third parties or, in the future, in establishing and operating a manufacturing facility;

the costs involved in prosecuting, defending and enforcing patent claims and other intellectual property claims;

the cost and timing of regulatory approvals;

our efforts to enhance operational, financial and information management systems and hire additional personnel, including personnel to support development of our product candidates; and

the costs and ongoing investments to in-license and/or acquire additional technologies.

A change in the outcome of any of these or other variables with respect to the development of any of our product candidates could significantly change the costs and timing associated with the development of that product candidate. Furthermore, our operating plans may change in the future, and we may need additional funds to meet operational needs and capital requirements associated with such operating plans.
Cash Flows

The following table sets forth a summary of the primary sources and uses of cash for each of the periods presented below (in thousands):
 
Six Months Ended June 30,
 
2018
 
2017
Net cash used in operating activities
$
(8,247
)
 
$
(36,378
)
Net cash (used in) provided by investing activities
(270,746
)
 
37,457

Net cash provided by financing activities
94,671

 
375

Net (decrease) increase in cash, cash equivalents and restricted cash
$
(184,322
)
 
$
1,454

Net Cash Used In Operating Activities

During the six months ended June 30, 2018, cash used in operating activities was $8.2 million, which consisted of a net loss of $78.4 million, adjusted by non-cash expenses of $9.2 million and cash provided by changes in our operating assets and liabilities of $62.3 million. The non-cash expenses consisted primarily of stock-based compensation expense of $7.6 million and depreciation expense of $2.7 million partially offset by net amortization of premiums and discounts on marketable securities of $1.1 million. The change in our operating assets and liabilities was primarily due to an increase of $58.3 million in a contract liability related to the Takeda Collaboration Agreement, an increase in accounts payable of $7.1 million due primarily to the liability for the one-time payment of $6.0 million to F-star Ltd in connection with the exercise of our right to nominate two additional Fcab targets under the F-star Collaboration Agreement, partially offset by a decrease of $1.3 million in deferred rent due to accelerated amortization of leasehold improvements for the existing Headquarters Lease due to the Headquarters Lease Amendment, and a decrease of $1.4 million in accrued and other current liabilities, primarily attributable to the payout of the employee bonuses during the first quarter of 2018 which were accrued in December 2017.


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During the six months ended June 30, 2017, cash used in operating activities was $36.4 million, which consisted of a net loss of $43.5 million, adjusted by non-cash expenses of $4.0 million and cash provided by changes in our operating assets and liabilities of $3.1 million. The non-cash charges consisted primarily of stock-based compensation expense of $1.8 million and depreciation expense of $1.5 million. The change in our operating assets and liabilities was primarily due to an increase of $2.4 million in accrued and other current liabilities and a decrease of $1.3 million in prepaid expenses and other current assets.
Net Cash (Used In) Provided By Investing Activities

During the six months ended June 30, 2018, cash used in investing activities was $270.7 million, which consisted of $361.7 million of purchases of marketable securities and $1.1 million of capital expenditures to purchase property and equipment, partially offset by $92.0 million in proceeds from the maturity of marketable securities.

During the six months ended June 30, 2017, cash provided by investing activities was $37.5 million, which consisted of $67.1 million in proceeds from the maturity of marketable securities, partially offset by $28.2 million of purchases of marketable securities and $1.4 million of capital expenditures to purchase property and equipment.
Net Cash Provided By Financing Activities

During the six months ended June 30, 2018, cash provided by financing activities was $94.7 million, which consisted of the $94.4 million market value of the 4,214,559 shares of common stock issued to Takeda in February 2018 under the Stock Purchase Agreement, and $1.7 million of proceeds from the exercise of common stock options and issuance of ESPP shares. These amounts were partially offset by $1.4 million for payments of issuance costs related to the issuance of common and preferred stock.
During the six months ended June 30, 2017, cash provided by financing activities was $0.4 million, which represents the proceeds from the exercise of common stock options.
Off-Balance Sheet Arrangements

We have not entered into any off-balance sheet arrangements. Prior to our acquisition of all of the outstanding shares of F-star Gamma, our F-star Collaboration Agreement represented a variable interest in a variable interest entity, or VIE, F-star Gamma. However, we did not consolidate F-star Gamma in our consolidated financial statements because we had determined that we were not considered to be its primary beneficiary.
Contractual Obligations and Commitments

Effective September 2017, we entered into a Development and Manufacturing Services Agreement, as amended (the "DMSA"), with Lonza Sales AG ("Lonza") for the development and manufacture of biologic products. Under the DMSA, we will execute purchase orders based on project plans authorizing Lonza to provide development and manufacturing services with respect to certain of our antibody and enzyme products, and will pay for the services provided and batches delivered in accordance with the DMSA and project plan. Unless earlier terminated, the Lonza agreement will expire on September 6, 2022. As of June 30, 2018, we had purchase orders for biological product development and manufacturing costs totaling $0.7 million and $11.4 million, for the First and Second DMSA Amendments, respectively. The activities under both the First Amendment and the Second Amendment commenced in January 2018 and are expected to be completed in May 2019 and April 2024, respectively. During the three and six months ended June 30, 2018, we incurred costs of $1.1 million and $1.2 million, and made payments of $0.6 million and $0.7 million, respectively, for the development and manufacturing services rendered under the agreement. As of June 30, 2018, we had total non-refundable purchase commitments of $6.3 million under the DMSA.

On May 2, 2018, we entered into an amendment to our Headquarters Lease (the "Headquarters Lease Amendment") to relocate and expand our headquarters to 148,020 rentable square feet in a to-be-

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constructed building in South San Francisco, California (the "New Premises"). The Headquarters Lease Amendment has a contractual term of ten years from the legal commencement date, which is the later of February 1, 2019 or the date that the premises are ready for occupancy. We have an option to extend the lease term for a period of ten years by giving the landlord written notice of the election to exercise the option at least nine months, but not more than twelve months, prior to the expiration of the Headquarters Lease Amendment lease term.

Under the terms of the Headquarters Lease Amendment, we were required to increase the security deposit of $0.5 million to $1.5 million. The Headquarters Lease Amendment provides for monthly base rent amounts escalating over the term of the lease. In addition, the Headquarters Lease Amendment provides a tenant improvement allowance ("TIA") of up to $25.9 million, of which $4.4 million, if utilized, would be repaid to the landlord in the form of additional monthly rent with interest applied. We will also be required to pay our share of operating expenses for the New Premises.

Other than those detailed above, there have been no other material changes from the contractual obligations and commitments previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2017, as filed with the SEC on March 19, 2018.
Critical Accounting Policies and Significant Judgments and Estimates

This discussion and analysis of our financial condition and results of operations is based on our condensed consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States. The preparation of these condensed consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements, as well as the reported revenues recognized and expenses incurred during the reporting periods. Our estimates are based on our historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Other than the addition of the revenue recognition policy included below, there have been no material changes to our critical accounting policies and estimates during the six months ended June 30, 2018 from those described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our 2017 Annual Report on Form 10-K for the year ended December 31, 2017, as filed with the SEC on March 19, 2018.
Revenue Recognition

License and Collaboration Revenues

We analyze our collaboration arrangements to assess whether they are within the scope of ASC 808, Collaborative Arrangements (“ASC 808”) to determine whether such arrangements involve joint operating activities performed by parties that are both active participants in the activities and exposed to significant risks and rewards dependent on the commercial success of such activities.  This assessment is performed throughout the life of the arrangement based on changes in the responsibilities of all parties in the arrangement.  For collaboration arrangements within the scope of ASC 808 that contain multiple elements, we first determine which elements of the collaboration are deemed to be within the scope of ASC 808 and those that are more reflective of a vendor-customer relationship and, therefore, within the scope of Topic 606. For elements of collaboration arrangements that are accounted for pursuant to ASC 808, an appropriate recognition method is determined and applied consistently, generally by analogy to Topic 606. The accounting treatment pursuant to Topic 606 is outlined below.  


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The terms of licensing and collaboration agreements entered into typically include payment of one or more of the following: non-refundable, up-front license fees; development, regulatory and commercial milestone payments; payments for manufacturing supply services; and royalties on net sales of licensed products. Each of these payments results in license, collaboration and other revenues, except for revenues from royalties on net sales of licensed products, which are classified as royalty revenues. The core principle of Topic 606 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration that is expected to be received in exchange for those goods or services.

In determining the appropriate amount of revenue to be recognized as we fulfill our obligations under each of our agreements, we perform the following steps: (i) identify the promised goods or services in the contract; (ii) determine whether the promised goods or services are performance obligations including whether they are distinct in the context of the contract; (iii) measure the transaction price, including the constraint on variable consideration; (iv) allocate the transaction price to the performance obligations based on estimated selling prices; and (v) recognize revenue when (or as) we satisfy each performance obligation.

We record amounts received prior to satisfying the revenue recognition criteria as contract liabilities in our consolidated balance sheets. If the related performance obligation is expected to be satisfied within the next twelve months this will be classified in current liabilities. Amounts recognized as revenue prior to receipt are recorded as contract assets in our consolidated balance sheets. If we expect to have an unconditional right to receive the consideration in the next twelve months this will be classified in current assets. We present a net contract asset or liability for each contract with a customer.

At contract inception, we assess the goods or services promised in a contract with a customer and identify those distinct goods and services that represent a performance obligation. A promised good or service may not be identified as a performance obligation if it is immaterial in the context of the contract with the customer, if it is not separately identifiable from other promises in the contract (either because it is not capable of being separated or because it is not separable in the context of the contract), or if the performance obligation does not provide the customer with a material right.

We consider the terms of the contract and our customary business practices to determine the transaction price. The transaction price is the amount of consideration to which we expect to be entitled in exchange for transferring promised goods or services to a customer. The consideration promised in a contract with a customer may include fixed amounts, variable amounts, or both. Variable consideration will only be included in the transaction price when it is not considered constrained, which is when it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur.

If it is determined that multiple performance obligations exist, at the inception of the agreement we will allocate the transaction price to all identified performance obligations based on the relative standalone selling prices. We estimate the relative selling price for each deliverable using objective evidence if it is available. If objective evidence is not available, we use our best estimate of the selling price for the deliverable.

Revenue is recognized when, or as, we satisfy a performance obligation by transferring a promised good or service to a customer. An asset is transferred when, or as, the customer obtains control of that asset, which for a service is considered to be as the services are received and used. We recognize revenue over time by measuring the progress toward complete satisfaction of the relevant performance obligation using an appropriate input or output method based on the nature of the good or service promised to the customer.

After contract inception, we reassess the transaction price at every period end, and update for changes such as resolution of uncertain events. Any change in the transaction price is allocated to the performance obligations on the same basis as at contract inception.


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We may be required to exercise considerable judgment in estimating revenue to be recognized. Judgment is required in identifying performance obligations, estimating the transaction price, estimating the stand-alone selling prices of identified performance obligations, which may include forecasted revenues, development timelines, reimbursement rates for personnel costs, discount rates and probabilities of technical and regulatory success, and estimating the progress towards satisfaction of performance obligations.
Recent Accounting Pronouncements

Except as described in Note 1 to the condensed consolidated financial statements under the heading “Recently Issued Accounting Pronouncements”, there have been no new accounting pronouncements or changes to accounting pronouncements during the six months ended June 30, 2018, as compared to the recent accounting pronouncements described in our 2017 Annual Report on Form 10-K for the year ended December 31, 2017, as filed with the SEC on March 19, 2018, that are of significance or potential significance to us.

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ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to market risks in the ordinary course of our business, primarily related to interest rate and foreign currency sensitivities.
Interest Rate Sensitivity

We are exposed to market risk related to changes in interest rates. We had cash, cash equivalents and marketable securities of $551.3 million as of June 30, 2018, which consisted primarily of money market funds and marketable securities, largely composed of investment grade, short to intermediate term fixed income securities.

The primary objective of our investment activities is to preserve capital to fund our operations. We also seek to maximize income from our investments without assuming significant risk. To achieve our objectives, we maintain a portfolio of investments in a variety of securities of high credit quality and short-term duration, according to our board-approved investment charter. Our investments are subject to interest rate risk and could fall in value if market interest rates increase. A hypothetical 10% relative change in interest rates during any of the periods presented would not have had a material impact on our condensed consolidated financial statements.
Foreign Currency Sensitivity

The majority of our transactions occur in U.S. dollars. However, we do have certain transactions that are denominated in currencies other than the U.S. dollar, primarily British Pounds, Swiss Francs and the Euro, and we therefore are subject to foreign exchange risk. The fluctuation in the value of the U.S. dollar against other currencies affects the reported amounts of expenses, assets and liabilities associated with a limited number of preclinical and clinical activities.

To partially mitigate the impact of changes in currency exchange rates on cash flows from our foreign currency denominated operating expenses, we enter into forward foreign currency exchange contracts. Generally, the market risks of these contracts are offset by the corresponding gains and losses on the transactions being hedged.

We do not use derivative financial instruments for speculative trading purposes, nor do we hedge foreign currency exchange rate exposure in a manner that entirely offsets the effects of changes in foreign currency exchange rates. The counterparties to these forward foreign currency exchange contracts are creditworthy multinational commercial banks, which minimizes the risk of counterparty nonperformance. We regularly review our hedging program and may, as part of this review, make changes to the program.

As of June 30, 2018, we had open forward foreign currency exchange contracts with notional amounts of $4.8 million. A hypothetical 10% strengthening in foreign currency exchange rates compared with the U.S. dollar relative to exchange rates at June 30, 2018 would have resulted in a reduction in the value received over the remaining life of these contracts of approximately $0.5 million and, if realized, would negatively affect earnings during the remaining life of the contracts. This analysis does not consider the impact of the hypothetical changes in foreign currency rates would have on the forecasted transactions that these foreign currency sensitive instruments were designated to offset.

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ITEM 4.
CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures

As of June 30, 2018, management, with the participation of our Chief Executive Officer and Chief Financial Officer, performed an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act. Our disclosure controls and procedures are designed to ensure that information required to be disclosed in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including the Chief Executive Officer and the Chief Financial Officer, to allow timely decisions regarding required disclosures.

Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objective and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of June 30, 2018, the design and operation of our disclosure controls and procedures were effective at a reasonable assurance level.
Changes in Internal Control over Financial Reporting

There was no change in our internal control over financial reporting identified in connection with the evaluation required by Rule 13a-15(d) and 15d-15(d) of the Exchange Act that occurred during the quarter ended June 30, 2018 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 1.
LEGAL PROCEEDINGS

From time to time, we may become involved in litigation or other legal proceedings. We are not currently a party to any litigation or legal proceedings that, in the opinion of our management, are likely to have a material adverse effect on our business. Regardless of outcome, litigation can have an adverse impact on us because of defense and settlement costs, diversion of management resources and other factors.
ITEM 1A.
RISK FACTORS

Investing in our common stock involves a high degree of risk. You should carefully consider the risks described below, as well as the other information in this Quarterly Report on Form 10-Q, including our financial statements and the related notes and the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The occurrence of any of the events or developments described below could harm our business, financial condition, results of operations and growth prospects. In such an event, the market price of our common stock could decline and you may lose all or part of your investment. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business operations and the market price of our common stock. The risk factors set forth below are substantially the same as the risk factors included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 19, 2018.


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Risks Related to Our Business, Financial Condition and Capital Requirements
We are in the early stages of clinical drug development and have a very limited operating history and no products approved for commercial sale, which may make it difficult to evaluate our current business and predict our future success and viability.

We are an early clinical-stage biopharmaceutical company with a limited operating history, focused on developing therapeutics for neurodegenerative diseases, including Alzheimer’s disease, Parkinson’s disease and amyotrophic lateral sclerosis ("ALS"). We commenced operations in May 2015, have no products approved for commercial sale and have not generated any product revenue. Drug development is a highly uncertain undertaking and involves a substantial degree of risk. We have recently initiated clinical trials for our LRRK2 and RIPK1 core programs and have not initiated clinical trials for any of our other current product candidates. To date, we have not initiated or completed a pivotal clinical trial, obtained marketing approval for any product candidates, manufactured a commercial scale product, or arranged for a third party to do so on our behalf, or conducted sales and marketing activities necessary for successful product commercialization. Our short operating history as a company makes any assessment of our future success and viability subject to significant uncertainty. We will encounter risks and difficulties frequently experienced by early-stage biopharmaceutical companies in rapidly evolving fields, and we have not yet demonstrated an ability to successfully overcome such risks and difficulties. If we do not address these risks and difficulties successfully, our business will suffer.
We have incurred significant net losses in each period since our inception and anticipate that we will continue to incur net losses for the foreseeable future.

We have incurred net losses in each reporting period since our inception, including net losses of $54.7 million and $78.4 million for the three and six months ended June 30, 2018, and $22.1 million and $43.5 million for the three and six months ended June 30, 2017, respectively. As of June 30, 2018, we had an accumulated deficit of $270.1 million.

We have invested significant financial resources in research and development activities, including for our preclinical and clinical product candidates and our BBB platform technology. We do not expect to generate revenue from product sales for several years, if at all. The amount of our future net losses will depend, in part, on the level of our future expenditures and our ability to generate revenue. Moreover, our net losses may fluctuate significantly from quarter to quarter and year to year, such that a period-to-period comparison of our results of operations may not be a good indication of our future performance.

We expect to continue to incur significant expenses and increasingly higher operating losses for the foreseeable future. We anticipate that our expenses will increase substantially if and as we:
 
continue our research and discovery activities;

progress our current and any future product candidates through preclinical and clinical development;

initiate and conduct additional preclinical, clinical or other studies for our product candidates;

work with our contract manufacturers to scale up the manufacturing processes for our product candidates or, in the future, establish and operate a manufacturing facility;

change or add additional contract manufacturers or suppliers;

seek regulatory approvals and marketing authorizations for our product candidates;

establish sales, marketing and distribution infrastructure to commercialize any products for which we obtain approval;


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acquire or in-license product candidates, intellectual property and technologies;

make milestone, royalty or other payments due under any license or collaboration agreements;

obtain, maintain, protect and enforce our intellectual property portfolio, including intellectual property obtained through license agreements;

attract, hire and retain qualified personnel;

provide additional internal infrastructure to support our continued research and development operations and any planned commercialization efforts in the future;

experience any delays or encounter other issues related to our operations;

meet the requirements and demands of being a public company; and

defend against any product liability claims or other lawsuits related to our products.

Our prior losses and expected future losses have had and will continue to have an adverse effect on our stockholders’ equity and working capital. In any particular quarter or quarters, our operating results could be below the expectations of securities analysts or investors, which could cause our stock price to decline.
Drug development is a highly uncertain undertaking and involves a substantial degree of risk. We have never generated any revenue from product sales, and we may never generate product revenue or be profitable.

We have no products approved for commercial sale and have not generated any revenue from product sales. We do not anticipate generating any revenue from product sales until after we have successfully completed clinical development and received regulatory approval for the commercial sale of a product candidate, if ever.

Our ability to generate revenue and achieve profitability depends significantly on many factors, including:
 
successfully completing research and preclinical and clinical development of our product candidates;
 
obtaining regulatory approvals and marketing authorizations for product candidates for which we successfully complete clinical development and clinical trials;
 
developing a sustainable and scalable manufacturing process for our product candidates, including those that utilize our BBB platform technology, as well as establishing and maintaining commercially viable supply relationships with third parties that can provide adequate products and services to support clinical activities and commercial demand of our product candidates;

identifying, assessing, acquiring and/or developing new product candidates;

negotiating favorable terms in any collaboration, licensing or other arrangements into which we may enter;

launching and successfully commercializing product candidates for which we obtain regulatory and marketing approval, either by collaborating with a partner or, if launched independently, by establishing a sales, marketing and distribution infrastructure;

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obtaining and maintaining an adequate price for our product candidates, both in the United States and in foreign countries where our products are commercialized;

obtaining adequate reimbursement for our product candidates from payors;

obtaining market acceptance of our product candidates as viable treatment options;

addressing any competing technological and market developments;

maintaining, protecting, expanding and enforcing our portfolio of intellectual property rights, including patents, trade secrets and know-how; and

attracting, hiring and retaining qualified personnel.

Because of the numerous risks and uncertainties associated with drug development, we are unable to predict the timing or amount of our expenses, or when we will be able to generate any meaningful revenue or achieve or maintain profitability, if ever. In addition, our expenses could increase beyond our current expectations if we are required by the U.S. Food and Drug Administration, or FDA, or foreign regulatory agencies, to perform studies in addition to those that we currently anticipate, or if there are any delays in any of our or our future collaborators’ clinical trials or the development of any of our product candidates. Even if one or more of our product candidates is approved for commercial sale, we anticipate incurring significant costs associated with commercializing any approved product candidate and ongoing compliance efforts.
Even if we are able to generate revenue from the sale of any approved products, we may not become profitable and may need to obtain additional funding to continue operations. Revenue from the sale of any product candidate for which regulatory approval is obtained will be dependent, in part, upon the size of the markets in the territories for which we gain regulatory approval, the accepted price for the product, the ability to get reimbursement at any price and whether we own the commercial rights for that territory. If the number of addressable patients is not as significant as we anticipate, the indication approved by regulatory authorities is narrower than we expect, or the reasonably accepted population for treatment is narrowed by competition, physician choice or treatment guidelines, we may not generate significant revenue from sales of such products, even if approved. Even if we do achieve profitability, we may not be able to sustain or increase profitability on a quarterly or annual basis.
Our failure to become and remain profitable would decrease the value of our company and could impair our ability to raise capital, expand our business, maintain our research and development efforts, diversify our pipeline of product candidates or continue our operations and cause a decline in the value of our common stock, all or any of which may adversely affect our viability.
If we fail to obtain additional financing, we may be unable to complete the development and, if approved, commercialization of our product candidates.

Our operations have required substantial amounts of cash since inception. To date, we have financed our operations primarily through the issuance and sale of convertible preferred stock, the proceeds from our IPO and cash proceeds under our Takeda Collaboration Agreement. We are currently advancing three product candidates, DNL201, DNL151 and DNL747, through clinical development and have several other product candidates in preclinical development, as well as early-stage research projects. Developing our product candidates is expensive, and we expect to continue to spend substantial amounts as we fund our early-stage research projects, continue preclinical development of our seed programs and, in particular, advance our core programs through preclinical development and clinical trials. Even if we are successful in developing our product candidates, obtaining regulatory approvals and launching and commercializing any product candidate will require substantial additional funding.


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As of June 30, 2018, we had $551.3 million in cash, cash equivalents and marketable securities. We believe that our existing cash, cash equivalents and marketable securities will be sufficient to fund our projected operations through at least the next 12 months. Our estimate as to how long we expect our existing cash, cash equivalents and marketable securities to be available to fund our operations is based on assumptions that may be proved inaccurate, and we could use our available capital resources sooner than we currently expect. In addition, changing circumstances may cause us to increase our spending significantly faster than we currently anticipate, and we may need to spend more money than currently expected because of circumstances beyond our control. We may need to raise additional funds sooner than we anticipate if we choose to expand more rapidly than we presently anticipate.

We will require additional capital for the further development and, if approved, commercialization of our product candidates. Additional capital may not be available when we need it, on terms acceptable to us or at all. We have no committed source of additional capital. If adequate capital is not available to us on a timely basis, we may be required to significantly delay, scale back or discontinue our research and development programs or the commercialization of any product candidates, if approved, or be unable to continue or expand our operations or otherwise capitalize on our business opportunities, as desired, which could materially affect our business, financial condition and results of operations and cause the price of our common stock to decline.
Due to the significant resources required for the development of our programs, and depending on our ability to access capital, we must prioritize development of certain product candidates. Moreover, we may expend our limited resources on programs that do not yield a successful product candidate and fail to capitalize on product candidates or indications that may be more profitable or for which there is a greater likelihood of success.

Our current total portfolio consists of thirteen programs. We designate certain programs as core programs and others as seed programs. Together, these programs require significant capital investment. We currently have eight core programs and five seed programs which are at various stages of research, discovery, preclinical and early clinical development. We seek to maintain a process of prioritization and resource allocation to maintain an optimal balance between aggressively advancing lead programs and ensuring replenishment of our portfolio. We regularly review the designation of each program as core or seed, and terminate those programs which do not meet our development criteria, which we have done with nine programs in the past two years.

Due to the significant resources required for the development of our programs, we must focus our programs on specific diseases and disease pathways and decide which product candidates to pursue and advance and the amount of resources to allocate to each. Our decisions concerning the allocation of research, development, collaboration, management and financial resources toward particular product candidates or therapeutic areas may not lead to the development of any viable commercial product and may divert resources away from better opportunities. Similarly, our potential decisions to delay, terminate or collaborate with third parties in respect of certain programs may subsequently also prove to be suboptimal and could cause us to miss valuable opportunities. If we make incorrect determinations regarding the viability or market potential of any of our programs or product candidates or misread trends in the biopharmaceutical industry, in particular for neurodegenerative diseases, our business, financial condition and results of operations could be materially adversely affected. As a result, we may fail to capitalize on viable commercial products or profitable market opportunities, be required to forego or delay pursuit of opportunities with other product candidates or other diseases and disease pathways that may later prove to have greater commercial potential than those we choose to pursue, or relinquish valuable rights to such product candidates through collaboration, licensing or other royalty arrangements in cases in which it would have been advantageous for us to invest additional resources to retain sole development and commercialization rights.


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Risks Related to the Discovery, Development and Commercialization of Our Product Candidates
Research and development of biopharmaceutical products is inherently risky. We are heavily dependent on the successful development of our BBB platform technology and the product candidates currently in our core programs, which are in the early stages of preclinical and clinical development. We cannot give any assurance that any of our product candidates will receive regulatory, including marketing, approval, which is necessary before they can be commercialized.

We are at an early stage of development of the product candidates currently in our programs and are further developing our BBB platform technology. To date, we have invested substantially all of our efforts and financial resources to identify, acquire intellectual property for, and develop our BBB platform technology and our programs, including conducting preclinical studies and early-stage clinical trials in our core programs, and providing general and administrative support for these operations. Our future success is dependent on our ability to successfully develop, obtain regulatory approval for, and then successfully commercialize our product candidates, and we may fail to do so for many reasons, including the following:
 
our product candidates may not successfully complete preclinical studies or clinical trials;

our drug delivery platform technology designed to deliver large molecule therapeutics across the BBB may not be clinically viable;

a product candidate may on further study be shown to have harmful side effects or other characteristics that indicate it is unlikely to be effective or otherwise does not meet applicable regulatory criteria;

our competitors may develop therapeutics that render our product candidates obsolete or less attractive;

our competitors may develop platform technologies to deliver large molecule therapeutics across the BBB that render our platform technology obsolete or less attractive;

the product candidates and BBB platform technology that we develop may not be sufficiently covered by intellectual property for which we hold exclusive rights;

the product candidates and BBB platform technology that we develop may be covered by third parties’ patents or other intellectual property or exclusive rights;

the market for a product candidate may change so that the continued development of that product candidate is no longer reasonable or commercially attractive;

a product candidate may not be capable of being produced in commercial quantities at an acceptable cost, or at all;

if a product candidate obtains regulatory approval, we may be unable to establish sales and marketing capabilities, or successfully market such approved product candidate, to gain market acceptance; and

a product candidate may not be accepted as safe and effective by patients, the medical community or third-party payors, if applicable.

If any of these events occur, we may be forced to abandon our development efforts for a program or programs, which would have a material adverse effect on our business and could potentially cause us to cease operations.

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We may not be successful in our efforts to further develop our BBB platform technology and current product candidates. We are not permitted to market or promote any of our product candidates before we receive regulatory approval from the FDA or comparable foreign regulatory authorities, and we may never receive such regulatory approval for any of our product candidates. Each of our product candidates is in the early stages of development and will require significant additional clinical development, management of preclinical, clinical, and manufacturing activities, regulatory approval, adequate manufacturing supply, a commercial organization, and significant marketing efforts before we generate any revenue from product sales, if at all.

We have never completed a clinical development program. In the past two years, we have discontinued the development of three programs prior to completion of preclinical development because we did not believe they met our criteria for potential clinical success. We currently have one product candidate, DNL201, in a Phase 1 clinical trial in healthy volunteers in the United States, and two product candidates, DNL151 and DNL747, in Phase 1 clinical trials in healthy volunteers in the Netherlands. DNL201 will advance into a Phase 1b clinical study in Parkinson’s disease patients with and without the genetic LRRK2 mutation in 2018. None of our product candidates have advanced into late-stage development or a pivotal clinical trial and it may be years before any such trial is initiated, if at all. Further, we cannot be certain that any of our product candidates will be successful in clinical trials. For instance, in 2016, we initiated a Phase 1 clinical trial in a former RIPK1 inhibitor product candidate, DNL104, which we subsequently discontinued based on liver test abnormalities in some clinical trial healthy volunteer participants. We may in the future advance product candidates into clinical trials and terminate such trials prior to their completion.

If any of our product candidates successfully complete clinical trials, we generally plan to seek regulatory approval to market our product candidates in the United States, the European Union, or EU, and in additional foreign countries where we believe there is a viable commercial opportunity. We have never commenced, compiled or submitted an application seeking regulatory approval to market any product candidate. We may never receive regulatory approval to market any product candidates even if such product candidates successfully complete clinical trials, which would adversely affect our viability. To obtain regulatory approval in countries outside the United States, we must comply with numerous and varying regulatory requirements of such other countries regarding safety, efficacy, chemistry, manufacturing and controls, clinical trials, commercial sales, pricing, and distribution of our product candidates. We may also rely on our collaborators or partners to conduct the required activities to support an application for regulatory approval, and to seek approval, for one or more of our product candidates. We cannot be sure that our collaborators or partners will conduct these activities or do so within the timeframe we desire. Even if we (or our collaborators or partners) are successful in obtaining approval in one jurisdiction, we cannot ensure that we will obtain approval in any other jurisdictions. If we are unable to obtain approval for our product candidates in multiple jurisdictions, our revenue and results of operations could be negatively affected.

Even if we receive regulatory approval to market any of our product candidates, whether for the treatment of neurodegenerative diseases or other diseases, we cannot assure you that any such product candidate will be successfully commercialized, widely accepted in the marketplace or more effective than other commercially available alternatives.

Investment in biopharmaceutical product development involves significant risk that any product candidate will fail to demonstrate adequate efficacy or an acceptable safety profile, gain regulatory approval, and become commercially viable. We cannot provide any assurance that we will be able to successfully advance any of our product candidates through the development process or, if approved, successfully commercialize any of our product candidates.
We may not be successful in our efforts to continue to create a pipeline of product candidates or to develop commercially successful products. If we fail to successfully identify and develop additional product candidates, our commercial opportunity may be limited.

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One of our strategies is to identify and pursue clinical development of additional product candidates. We currently have five seed programs, all of which are in the research, discovery and preclinical stages of development. Identifying, developing, obtaining regulatory approval and commercializing additional product candidates for the treatment of neurodegenerative diseases will require substantial additional funding and is prone to the risks of failure inherent in drug development. We cannot provide you any assurance that we will be able to successfully identify or acquire additional product candidates, advance any of these additional product candidates through the development process, successfully commercialize any such additional product candidates, if approved, or assemble sufficient resources to identify, acquire, develop or, if approved, commercialize additional product candidates. If we are unable to successfully identify, acquire, develop and commercialize additional product candidates, our commercial opportunity may be limited.
We have concentrated our research and development efforts on the treatment of neurodegenerative diseases, a field that has seen limited success in drug development. Further, our product candidates are based on new approaches and novel technology, which makes it difficult to predict the time and cost of product candidate development and subsequently obtaining regulatory approval.

We have focused our research and development efforts on addressing neurodegenerative diseases. Collectively, efforts by biopharmaceutical companies in the field of neurodegenerative diseases have seen limited successes in drug development. There are few effective therapeutic options available for patients with Alzheimer’s disease, Parkinson’s disease, ALS and other neurodegenerative diseases. Our future success is highly dependent on the successful development of our BBB platform technology and our product candidates for treating neurodegenerative diseases. Developing and, if approved, commercializing our product candidates for treatment of neurodegenerative diseases subjects us to a number of challenges, including engineering product candidates to cross the BBB to enable optimal concentration of the therapeutic in the brain and obtaining regulatory approval from the FDA and other regulatory authorities who have only a limited set of precedents to rely on.

Our approach to the treatment of neurodegenerative diseases aims to identify and select targets with a genetic link to neurodegenerative diseases, identify and develop molecules that engage the intended target, identify and develop biomarkers, which are biological molecules found in blood, other bodily fluids or tissues that are signs of a normal or abnormal process or of a condition or disease, to select the right patient population and demonstrate target engagement, pathway engagement and impact on disease progression of our molecules, and engineer our molecules to cross the BBB and act directly in the brain. This strategy may not prove to be successful. We may not be able to discover, develop and utilize biomarkers to demonstrate target engagement, pathway engagement and the impact on disease progression of our molecules. We cannot be sure that our approach will yield satisfactory therapeutic products that are safe and effective, scalable, or profitable. Moreover, public perception of drug safety issues, including adoption of new therapeutics or novel approaches to treatment, may adversely influence the willingness of subjects to participate in clinical trials, or if approved, of physicians to subscribe to novel treatments.
We may encounter substantial delays in our clinical trials, or may not be able to conduct or complete our clinical trials on the timelines we expect, if at all.

Clinical testing is expensive, time consuming, and subject to uncertainty. We cannot guarantee that any clinical trials will be conducted as planned or completed on schedule, if at all. We cannot be sure that submission of an investigational new drug application, or IND, or a clinical trial application, or CTA, will result in the FDA or European Medicines Agency, or EMA, as applicable, allowing clinical trials to begin in a timely manner, if at all. Moreover, even if these trials begin, issues may arise that could suspend or terminate such clinical trials. A failure of one or more clinical trials can occur at any stage of testing, and our future clinical trials may not be successful. Events that may prevent successful or timely initiation or completion of clinical trials include:
 

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inability to generate sufficient preclinical, toxicology, or other in vivo or in vitro data to support the initiation or continuation of clinical trials;

delays in confirming target engagement, patient selection or other relevant biomarkers to be utilized in preclinical and clinical product candidate development;

delays in reaching a consensus with regulatory agencies on study design;

delays in reaching agreement on acceptable terms with prospective CROs and clinical trial sites, the terms of which can be subject to extensive negotiation and may vary significantly among different CROs and clinical trial sites;

delays in identifying, recruiting and training suitable clinical investigators;

delays in obtaining required Institutional Review Board, or IRB, approval at each clinical trial site;

imposition of a temporary or permanent clinical hold by regulatory agencies for a number of reasons, including after review of an IND or amendment, CTA or amendment, or equivalent application or amendment; as a result of a new safety finding that presents unreasonable risk to clinical trial participants; a negative finding from an inspection of our clinical trial operations or study sites; developments on trials conducted by competitors for related technology that raises FDA or EMA concerns about risk to patients of the technology broadly; or if the FDA or EMA finds that the investigational protocol or plan is clearly deficient to meet its stated objectives;

delays in identifying, recruiting and enrolling suitable patients to participate in our clinical trials, and delays caused by patients withdrawing from clinical trials or failing to return for post-treatment follow-up;

difficulty collaborating with patient groups and investigators;

failure by our CROs, other third parties, or us to adhere to clinical trial requirements;

failure to perform in accordance with the FDA’s or any other regulatory authority’s current good clinical practices ("cGCPs") requirements, or applicable EMA or other regulatory guidelines in other countries;

occurrence of adverse events associated with the product candidate that are viewed to outweigh its potential benefits;

changes in regulatory requirements and guidance that require amending or submitting new clinical protocols;

changes in the standard of care on which a clinical development plan was based, which may require new or additional trials;

the cost of clinical trials of our product candidates being greater than we anticipate;

clinical trials of our product candidates producing negative or inconclusive results, which may result in our deciding, or regulators requiring us, to conduct additional clinical trials or abandon product development programs;

transfer of manufacturing processes from our academic collaborators to larger-scale facilities operated by a CMO or by us, and delays or failure by our CMOs or us to make any necessary changes to such manufacturing process; and


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delays in manufacturing, testing, releasing, validating, or importing/exporting sufficient stable quantities of our product candidates for use in clinical trials or the inability to do any of the foregoing.

Any inability to successfully initiate or complete clinical trials could result in additional costs to us or impair our ability to generate revenue. In addition, if we make manufacturing or formulation changes to our product candidates, we may be required to or we may elect to conduct additional studies to bridge our modified product candidates to earlier versions. Clinical trial delays could also shorten any periods during which our products have patent protection and may allow our competitors to bring products to market before we do, which could impair our ability to successfully commercialize our product candidates and may harm our business and results of operations.

We could also encounter delays if a clinical trial is suspended or terminated by us, by the data safety monitoring board for such trial or by the FDA, EMA or any other regulatory authority, or if the IRBs of the institutions in which such trials are being conducted suspend or terminate the participation of their clinical investigators and sites subject to their review. Such authorities may suspend or terminate a clinical trial due to a number of factors, including failure to conduct the clinical trial in accordance with regulatory requirements or our clinical protocols, inspection of the clinical trial operations or trial site by the FDA, EMA or other regulatory authorities resulting in the imposition of a clinical hold, unforeseen safety issues or adverse side effects, failure to demonstrate a benefit from using a product candidate, changes in governmental regulations or administrative actions or lack of adequate funding to continue the clinical trial.

Our most advanced product candidate, DNL201, is currently in a Phase 1 clinical trial in healthy volunteers, and will advance to a Phase 1b clinical study in Parkinson’s disease patients with and without the genetic LRRK2 mutation in 2018. This program was previously subject to a partial clinical hold due to preclinical toxicity data. The partial clinical hold was removed in December 2017 based on additional clinical and preclinical data provided to the FDA. Our second most advanced product candidate, DNL151, is currently in a Phase 1 clinical trial in healthy volunteers. Our third most advanced product candidate, DNL747, is currently in a Phase 1 clinical trial in healthy volunteers. In the nonclinical safety studies for DNL201, DNL151, and DNL747, toxicities were observed at high doses in rat and/or cynomolgus monkey above doses and exposures that will be tested in the clinic. We cannot assure you that DNL201, DNL151, DNL747 or our other product candidates will not be subject to new, partial or full clinical holds in the future.

We may in the future advance product candidates into clinical trials and terminate such trials prior to their completion, such as we did for DNL104, which could adversely affect our business.

Delays in the completion of any clinical trial of our product candidates will increase our costs, slow down our product candidate development and approval process and delay or potentially jeopardize our ability to commence product sales and generate revenue. In addition, many of the factors that cause, or lead to, a delay in the commencement or completion of clinical trials may also ultimately lead to the denial of regulatory approval of our product candidates.
We may encounter difficulties enrolling patients in our clinical trials, and our clinical development activities could thereby be delayed or otherwise adversely affected.

The timely completion of clinical trials in accordance with their protocols depends, among other things, on our ability to enroll a sufficient number of patients who remain in the trial until its conclusion. We may experience difficulties in patient enrollment in our clinical trials for a variety of reasons, including:
 
the size and nature of the patient population;


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the patient eligibility criteria defined in the protocol, including biomarker-driven identification and/or certain highly-specific criteria related to stage of disease progression, which may limit the patient populations eligible for our clinical trials to a greater extent than competing clinical trials for the same indication that do not have biomarker-driven patient eligibility criteria;

the size of the study population required for analysis of the trial’s primary endpoints;

the proximity of patients to a trial site;

the design of the trial;

our ability to recruit clinical trial investigators with the appropriate competencies and experience;

competing clinical trials for similar therapies or targeting patient populations meeting our patient eligibility criteria;

clinicians’ and patients’ perceptions as to the potential advantages and side effects of the product candidate being studied in relation to other available therapies and product candidates;

our ability to obtain and maintain patient consents; and

the risk that patients enrolled in clinical trials will not complete such trials, for any reason.
Our clinical trials may fail to demonstrate substantial evidence of the safety and efficacy of our product candidates, which would prevent, delay or limit the scope of regulatory approval and commercialization.

Before obtaining regulatory approvals for the commercial sale of any of our product candidates, we must demonstrate through lengthy, complex and expensive preclinical studies and clinical trials that our product candidates are both safe and effective for use in each target indication. For those product candidates that are subject to regulation as biological drug products, we will need to demonstrate that they are safe, pure, and potent for use in their target indications. Each product candidate must demonstrate an adequate risk versus benefit profile in its intended patient population and for its intended use.

Clinical testing is expensive and can take many years to complete, and its outcome is inherently uncertain. Failure can occur at any time during the clinical trial process. The results of preclinical studies of our product candidates may not be predictive of the results of early-stage or later-stage clinical trials, and results of early clinical trials of our product candidates may not be predictive of the results of later-stage clinical trials. The results of clinical trials in one set of patients or disease indications may not be predictive of those obtained in another. In some instances, there can be significant variability in safety or efficacy results between different clinical trials of the same product candidate due to numerous factors, including changes in trial procedures set forth in protocols, differences in the size and type of the patient populations, changes in and adherence to the dosing regimen and other clinical trial protocols and the rate of dropout among clinical trial participants. Product candidates in later stages of clinical trials may fail to show the desired safety and efficacy profile despite having progressed through preclinical studies and initial clinical trials. A number of companies in the biopharmaceutical industry have suffered significant setbacks in advanced clinical trials due to lack of efficacy or unacceptable safety issues, notwithstanding promising results in earlier trials. This is particularly true in neurodegenerative diseases, where failure rates historically have been higher than in many other disease areas. Most product candidates that begin clinical trials are never approved by regulatory authorities for commercialization.


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We have limited experience in designing clinical trials and may be unable to design and execute a clinical trial to support marketing approval. We cannot be certain that our current clinical trials or any other future clinical trials will be successful. Additionally, any safety concerns observed in any one of our clinical trials in our targeted indications could limit the prospects for regulatory approval of our product candidates in those and other indications, which could have a material adverse effect on our business, financial condition and results of operations.

In addition, even if such clinical trials are successfully completed, we cannot guarantee that the FDA or foreign regulatory authorities will interpret the results as we do, and more trials could be required before we submit our product candidates for approval. To the extent that the results of the trials are not satisfactory to the FDA or foreign regulatory authorities for support of a marketing application, we may be required to expend significant resources, which may not be available to us, to conduct additional trials in support of potential approval of our product candidates. Even if regulatory approval is secured for any of our product candidates, the terms of such approval may limit the scope and use of our product candidate, which may also limit its commercial potential.
We face significant competition in an environment of rapid technological and scientific change, and there is a possibility that our competitors may achieve regulatory approval before us or develop therapies that are safer, more advanced or more effective than ours, which may negatively impact our ability to successfully market or commercialize any product candidates we may develop and ultimately harm our financial condition.

The development and commercialization of new drug products is highly competitive. Moreover, the neurodegenerative field is characterized by strong and increasing competition, and a strong emphasis on intellectual property. We may face competition with respect to any product candidates that we seek to develop or commercialize in the future from major pharmaceutical companies, specialty pharmaceutical companies, and biotechnology companies worldwide. Potential competitors also include academic institutions, government agencies, and other public and private research organizations that conduct research, seek patent protection, and establish collaborative arrangements for research, development, manufacturing, and commercialization.

There are a number of large pharmaceutical and biotechnology companies that are currently pursuing the development of products for the treatment of the neurodegenerative disease indications for which we have research programs, including Alzheimer’s disease, Parkinson’s disease and ALS. Companies that we are aware are developing therapeutics in the neurodegenerative disease area include large companies with significant financial resources, such as AbbVie, AstraZeneca, Biogen, Celgene, Eli Lilly, GlaxoSmithKline, Johnson & Johnson, Novartis, Roche, Sanofi and Takeda. In addition to competition from other companies targeting neurodegenerative indications, any products we may develop may also face competition from other types of therapies, such as gene-editing therapies.


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Many of our current or potential competitors, either alone or with their strategic partners, have significantly greater financial resources and expertise in research and development, manufacturing, preclinical testing, conducting clinical trials, obtaining regulatory approvals, and marketing approved products than we do. Mergers and acquisitions in the pharmaceutical and biotechnology industries may result in even more resources being concentrated among a smaller number of our competitors. Smaller or early-stage companies may also prove to be significant competitors, particularly through collaborative arrangements with large and established companies. These competitors also compete with us in recruiting and retaining qualified scientific and management personnel and establishing clinical trial sites and patient registration for clinical trials, as well as in acquiring technologies complementary to, or necessary for, our programs. Our commercial opportunity could be reduced or eliminated if our competitors develop and commercialize products that are safer, more effective, have fewer or less severe side effects, are more convenient, or are less expensive than any products that we may develop. Furthermore, currently approved products could be discovered to have application for treatment of neurodegenerative disease indications, which could give such products significant regulatory and market timing advantages over any of our product candidates. Our competitors also may obtain FDA, EMA or other regulatory approval for their products more rapidly than we may obtain approval for ours and may obtain orphan product exclusivity from the FDA for indications our product candidates are targeting, which could result in our competitors establishing a strong market position before we are able to enter the market. Additionally, products or technologies developed by our competitors may render our potential product candidates uneconomical or obsolete, and we may not be successful in marketing any product candidates we may develop against competitors.

In addition, we could face litigation or other proceedings with respect to the scope, ownership, validity and/or enforceability of our patents relating to our competitors’ products and our competitors may allege that our products infringe, misappropriate or otherwise violate their intellectual property. The availability of our competitors’ products could limit the demand, and the price we are able to charge, for any products that we may develop and commercialize. See “Risks Related to Our Intellectual Property.”
The manufacture of our product candidates, particularly those that utilize our BBB platform technology, is complex and we may encounter difficulties in production. If we or any of our third-party manufacturers encounter such difficulties, or fail to meet rigorously enforced regulatory standards, our ability to provide supply of our product candidates for clinical trials or our products for patients, if approved, could be delayed or stopped, or we may be unable to maintain a commercially viable cost structure.

The processes involved in manufacturing our drug and biological product candidates, particularly those that utilize our BBB platform technology, are complex, expensive, highly-regulated and subject to multiple risks. Additionally, the manufacture of biologics involves complex processes, including developing cells or cell systems to produce the biologic, growing large quantities of such cells, and harvesting and purifying the biologic produced by them. As a result, the cost to manufacture a biologic is generally far higher than traditional small molecule chemical compounds, and the biologics manufacturing process is less reliable and is difficult to reproduce. Manufacturing biologics is highly susceptible to product loss due to contamination, equipment failure, improper installation or operation of equipment, vendor or operator error, inconsistency in yields, variability in product characteristics and difficulties in scaling the production process. Even minor deviations from normal manufacturing processes could result in reduced production yields, product defects and other supply disruptions. Further, as product candidates are developed through preclinical studies to late-stage clinical trials towards approval and commercialization, it is common that various aspects of the development program, such as manufacturing methods, are altered along the way in an effort to optimize processes and results. Such changes carry the risk that they will not achieve these intended objectives, and any of these changes could cause our product candidates to perform differently and affect the results of planned clinical trials or other future clinical trials.


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In order to conduct clinical trials of our product candidates, or supply commercial products, if approved, we will need to manufacture them in small and large quantities. Our manufacturing partners may be unable to successfully increase the manufacturing capacity for any of our product candidates in a timely or cost-effective manner, or at all. In addition, quality issues may arise during scale-up activities. If our manufacturing partners are unable to successfully scale up the manufacture of our product candidates in sufficient quality and quantity, the development, testing and clinical trials of that product candidate may be delayed or become infeasible, and regulatory approval or commercial launch of any resulting product may be delayed or not obtained, which could significantly harm our business. The same risks would apply to our internal manufacturing facilities, should we in the future decide to build internal manufacturing capacity. In addition, building internal manufacturing capacity would carry significant risks in terms of being able to plan, design and execute on a complex project to build manufacturing facilities in a timely and cost-efficient manner.

In addition, the manufacturing process for any products that we may develop is subject to FDA, EMA and foreign regulatory authority approval processes, and continuous oversight, and we will need to contract with manufacturers who can meet all applicable FDA, EMA and foreign regulatory authority requirements, including complying with current good manufacturing practices ("cGMPs"), on an ongoing basis. If we or our third-party manufacturers are unable to reliably produce products to specifications acceptable to the FDA, EMA or other regulatory authorities, we may not obtain or maintain the approvals we need to commercialize such products. Even if we obtain regulatory approval for any of our product candidates, there is no assurance that either we or our CMOs will be able to manufacture the approved product to specifications acceptable to the FDA, EMA or other regulatory authorities, to produce it in sufficient quantities to meet the requirements for the potential launch of the product, or to meet potential future demand. Any of these challenges could delay completion of clinical trials, require bridging clinical trials or the repetition of one or more clinical trials, increase clinical trial costs, delay approval of our product candidate, impair commercialization efforts, increase our cost of goods, and have an adverse effect on our business, financial condition, results of operations and growth prospects.
If, in the future, we are unable to establish sales and marketing capabilities or enter into agreements with third parties to sell and market any product candidates we may develop, we may not be successful in commercializing those product candidates if and when they are approved.

We do not have a sales or marketing infrastructure and have no experience in the sale, marketing, or distribution of pharmaceutical products. To achieve commercial success for any approved product for which we retain sales and marketing responsibilities, we must either develop a sales and marketing organization or outsource these functions to third parties. In the future, we may choose to build a focused sales, marketing, and commercial support infrastructure to sell, or participate in sales activities with our collaborators for, some of our product candidates if and when they are approved.

There are risks involved with both establishing our own commercial capabilities and entering into arrangements with third parties to perform these services. For example, recruiting and training a sales force or reimbursement specialists is expensive and time consuming and could delay any product launch. If the commercial launch of a product candidate for which we recruit a sales force and establish marketing and other commercialization capabilities is delayed or does not occur for any reason, we would have prematurely or unnecessarily incurred these commercialization expenses. This may be costly, and our investment would be lost if we cannot retain or reposition our commercialization personnel.

Factors that may inhibit our efforts to commercialize any approved product on our own include:
 
our inability to recruit and retain adequate numbers of effective sales, marketing, reimbursement, customer service, medical affairs, and other support personnel;

the inability of sales personnel to obtain access to physicians or persuade adequate numbers of physicians to prescribe any future approved products;


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the inability of reimbursement professionals to negotiate arrangements for formulary access, reimbursement, and other acceptance by payors;

the inability to price our products at a sufficient price point to ensure an adequate and attractive level of profitability;

restricted or closed distribution channels that make it difficult to distrib