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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 September 30, 2018

Or

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

Commission File Number 001-36562

LOXO ONCOLOGY, INC.

(Exact Name of Registrant as Specified in Its Charter)

Registrant’s telephone number, including area code: (203) 653-3880

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act: None

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 o

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x  No o

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.:

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.    o

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

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PART I

ITEM 1. FINANCIAL STATEMENTS

LOXO ONCOLOGY, INC.

Condensed Consolidated Balance Sheets

(in thousands, except share and per share amounts)

See accompanying notes to unaudited condensed consolidated financial statements.

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LOXO ONCOLOGY, INC.

Condensed Consolidated Statements of Operations

(unaudited)

(in thousands, except share and per share amounts)

See accompanying notes to unaudited condensed consolidated financial statements.

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LOXO ONCOLOGY, INC.

Condensed Consolidated Statements of Comprehensive Loss

(unaudited)

(in thousands)

See accompanying notes to unaudited condensed consolidated financial statements.

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LOXO ONCOLOGY, INC.

Condensed Consolidated Statement of Stockholders’ Equity

(unaudited)

For the period from January 1, 2018 to September 30, 2018

(in thousands except share and per share amounts)

See accompanying notes to unaudited condensed consolidated financial statements.

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LOXO ONCOLOGY, INC.

Condensed Consolidated Statements of Cash Flows

(unaudited)

(in thousands)

See accompanying notes to unaudited condensed consolidated financial statements.

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LOXO ONCOLOGY, INC.

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2018

1.                                      Organization and Description of the Business

Loxo Oncology, Inc. (the “Company”) was incorporated on May 9, 2013 in the State of Delaware. The Company is a biopharmaceutical company developing highly selective medicines for patients with genomically defined cancers. Its pipeline focuses on cancers that are uniquely dependent on single gene abnormalities, such that a single drug has the potential to treat the cancer with dramatic effect. The Company operates in one segment and has its principal office in Stamford, Connecticut.

2.                                      Summary of Significant Accounting Policies

Basis of Presentation

The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”) and include the results of operations of the Company and its wholly owned subsidiary. All intercompany accounts and transactions have been eliminated in consolidation. Any reference in these notes to applicable guidance is meant to refer to GAAP as found in the Accounting Standards Codification (“ASC”) and Accounting Standards Update (“ASU”) of the Financial Accounting Standards Board (“FASB”).

Unaudited Interim Financial Information

The accompanying balance sheet as of December 31, 2017, was derived from the Company’s audited financial statements included in Form 10-K filed with the Securities and Exchange Commission (“SEC”) on March 1, 2018. It is suggested that the interim unaudited condensed consolidated financial statements be read in conjunction with the annual financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K.

The accompanying balance sheet as of September 30, 2018, the statements of operations for the three and nine months ended September 30, 2018 and 2017, the statements of comprehensive loss for the three and nine months ended September 30, 2018 and 2017, the statement of stockholders’ equity for the period from January 1, 2018 to September 30, 2018 and the statements of cash flows for the nine months ended September 30, 2018 and 2017 are unaudited.

The interim unaudited condensed consolidated financial statements have been prepared on the same basis as the annual audited financial statements and, in the opinion of management, reflect all adjustments, which include only normal recurring adjustments, necessary for the fair presentation of the Company’s financial position as of September 30, 2018, the results of its operations for the three and nine months ended September 30, 2018 and 2017 and its cash flows for the nine months ended September 30, 2018 and 2017. Certain amounts from prior periods have been reclassified on the statements of cash flows to conform to the current period presentation as a result of the adoption of ASU 2016-18, as described further below. Additionally, operating results for the three and nine months ended September 30, 2018 are not necessarily indicative of the results that may be expected for any other interim period or for the year ending December 31, 2018.

The interim unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the SEC. Certain information and note disclosures normally included in annual financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to those rules and regulations, although the Company believes that the disclosures made are adequate to make the information not misleading.

Significant Accounting Policies

The Company’s significant accounting policies are disclosed in the audited financial statements for the year ended December 31, 2017 included in the Company’s Form 10-K filed with the SEC on March 1, 2018. Since the date of such financial statements, there have been no changes to the Company’s significant accounting policies, except as it relates to the impact of the adoption of applicable new accounting guidance as described below under Recently Adopted Accounting Pronouncements and policies related to the collaboration agreement with Bayer Consumer Care AG (“Bayer”).

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Collaboration Arrangements

The Company evaluates its collaborative arrangements pursuant to ASC 808, Collaborative Arrangements (“ASC 808”) and ASC 606, Revenue from Contracts with Customers (“ASC 606”). The Company considers the nature and contractual terms of collaboration arrangements and assesses whether the arrangement involves a joint operating activity pursuant to which the Company is an active participant and is exposed to significant risks and rewards with respect to the arrangement. If the Company is an active participant and is exposed to significant risks and rewards with respect to the arrangement, the Company accounts for the arrangement as a collaboration under ASC 808. To date, the Company has only entered into a single collaboration agreement with Bayer which was determined to be within the scope of ASC 808.

ASC 808 does not address recognition or measurement matters related to collaborative arrangements. Payments between participants pursuant to a collaborative arrangement that are within the scope of other authoritative accounting literature on income statement classification are accounted for using the relevant provisions of that literature. If the payments are not within the scope of other authoritative accounting literature, the income statement classification for the payments is based on an analogy to authoritative accounting literature or if there is no appropriate analogy, a reasonable, rational and consistently applied accounting policy election. Payments received from a collaboration partner to which this policy applies may include upfront payments in respect of a license of intellectual property, regulatory and sales-based milestones, profit share payments, and royalties.

Refer to the discussion in Note 3. Collaboration Agreement, for further discussion of the accounting related to the Bayer agreement.

Revenue Recognition

The Company entered into a License, Development and Commercialization Agreement (the “Bayer Agreement”) in November 2017, which is within the scope of ASC 808. Under the Bayer Agreement, the Company has licensed certain rights to its larotrectinib and LOXO-195 product candidates to Bayer. The terms of the agreement include payment to the Company of one or more of the following: a non-refundable, up-front license fee, regulatory and commercial milestone payments, and royalties on net sales of licensed products.

Licenses of intellectual property: If the license of the Company’s intellectual property is determined to be a separate unit of accounting from the other performance obligations identified in the arrangement, the Company recognizes revenue from non-refundable, up-front fees allocated to the license when the license is transferred to the collaborative partner and the collaborative partner is able to use and benefit from the license. For licenses that are bundled with other promises, such as development activities, the Company recognizes revenue over time, using a proportional performance method as the related development activities are performed. Up-front payments are recorded as deferred revenue upon receipt and require deferral of revenue recognition to a future period until the Company performs its obligations under these arrangements. Amounts payable to the Company are recorded as accounts receivable when the Company’s right to consideration is unconditional.

Milestone payments: Regulatory or commercial milestone payments will be recognized as revenue in the period the milestone is achieved. To date, the Company has not recognized any milestone payments as revenue resulting from its collaboration arrangement.

Co-promote: In the United States, where the Company and Bayer will co-promote the products, the Company will be responsible for 50% of the commercial costs and receive 50% of the profits. Co-promote net cost/profit will be recognized when the related expenses and sales occur as a decrease/increase to Revenue from collaboration agreement. See Note 3 to the unaudited condensed consolidated financial statements for details of the co-promote net cost incurred to date.

Royalties: Sales-based royalties, including milestone payments based on the level of sales, will be recognized when the related sales occur. To date, the Company has not recognized any royalty revenue resulting from its collaboration arrangement.

Research and Development Expenses

Research and development costs are charged to expense as incurred. These costs include, but are not limited to, employee-related expenses, including salaries, benefits, stock-based compensation and travel as well as expenses related to asset acquisitions of IPR&D, third-party collaborations, contract research arrangements, chemistry, manufacturing and controls (“CMC”) related expenses and activities associated with the development of companion diagnostics for our product candidates. Under the Bayer Agreement, the Company receives reimbursement for 50% of its development activity expenses incurred for larotrectinib and LOXO-195 beginning January 1, 2018. This reimbursement of $7.1 million and $22.4 million for the three and nine months ended September 30, 2018, respectively, is recorded as a reduction to the Company’s research and development costs.

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Research and development activities are central to our business model. Product candidates in later stages of clinical development generally have higher development costs than those in earlier stages of clinical development, primarily due to the increased size and duration of later-stage clinical trials. As we advance our product candidates, we expect the amount of external research and development will continue to increase for the foreseeable future.

It is difficult to determine with certainty the duration and completion costs of our current or future preclinical programs and clinical trials of our product candidates, or if, when or to what extent we will generate revenue from the commercialization and sale of any of our product candidates that obtain regulatory approval. We may never succeed in achieving regulatory approval for any of our product candidates. The duration, costs and timing of clinical trials and development of our product candidates will depend on a variety of factors, including the uncertainties of future clinical and preclinical studies, uncertainties in clinical trial enrollment rate and significant and changing government regulation. In addition, the probability of success for each product candidate will depend on numerous factors, including competition, manufacturing capability and commercial viability. We will determine which programs to pursue and how much to fund each program in response to the scientific and clinical success of each product candidate, as well as an assessment of each product candidate’s commercial potential.

Cash, Cash Equivalents and Restricted Cash

The Company considers all highly-liquid investments that have maturities of three months or less when acquired to be cash equivalents. The Company’s cash and cash equivalents generally consist of a business checking account, repurchase agreements and a money market account. The Company’s restricted cash balance consists of cash held to collateralize an outstanding letter of credit associated with the lease of its corporate office space in Connecticut.

The following table provides a reconciliation of cash, cash equivalents and restricted cash in the consolidated balance sheets to the total amount shown in the consolidated statements of cash flows (in thousands):

Recently Adopted Accounting Pronouncements

In May 2017, the FASB issued ASU 2017-09, Compensation — Stock Compensation (Topic 718): Scope of Modification Accounting (“ASU 2017-09”).  ASU 2017-09 provides guidance about which changes to the terms or conditions of a share-based award require an entity to apply modification accounting under Topic 718 on a prospective basis.  Specifically, an entity would not apply modification accounting if the fair value, vesting conditions and classification of the awards are the same immediately before and after a modification.  ASU 2017-09 was effective for annual and interim periods beginning after December 15, 2017, with early adoption permitted. The Company adopted this standard effective January 1, 2018.  The adoption of ASU 2017-09 did not have an impact on the Company’s financial statements.

In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash (“ASU 2016-18”), which amended the existing accounting standards for the statement of cash flows by requiring restricted cash to be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. ASU 2016-18 was effective for the Company in the first quarter of 2018. All prior periods were retrospectively adjusted upon adoption of ASU 2016-18.

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (“ASU 2016-15”), which amended the existing accounting standards for the statement of cash flows by providing guidance on eight classification issues related to the statement of cash flows. ASU 2016-15 was effective for the Company in the first quarter of 2018. The adoption of ASU 2016-15 did not have an impact on the Company’s financial statements.

In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments - Overall (Subtopic 825-10), Recognition and Measurement of Financial Assets and Financial Liabilities (“ASU 2016-01”), which addresses certain aspects of recognition, measurement, presentation and disclosure of financial instruments. ASU 2016-01 was effective for the Company in the first quarter of 2018. The adoption of ASU 2016-01 did not have an impact on the Company’s financial statements.

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In May 2014, the FASB issued ASU No. 2014-09, which amends the guidance for accounting for revenue from contracts with customers (“ASU 2014-09”). ASU 2014-09 supersedes the revenue recognition requirements in ASC Topic 605, Revenue Recognition, and creates a new ASC Topic 606, Revenue from Contracts with Customers. Subsequent to May 2014, the FASB issued additional guidance that delayed the effective date and clarified various aspects of the new guidance, including principal versus agent considerations, identifying performance obligations and licensing, and also included other improvements and practical expedients. ASU 2014-09 was effective for the Company in the first quarter of 2018. The adoption of ASU 2014-09 did not have a material impact on the Company’s financial statements as the Company did not have any contracts with customers subject to the guidance.

Recent Accounting Pronouncements Not Yet Adopted

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). The new standard establishes a right-of-use, or ROU, model that requires a lessee to record a ROU asset and a lease liability on the condensed consolidated balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the condensed consolidated statement of operations. ASU 2016-02 is effective for annual periods beginning after December 15, 2018, including interim periods within those annual periods, with early adoption permitted. In July 2018, the FASB issued ASU No. 2018-11, Leases: Targeted Improvements, which provides an optional transition method that allows entities to apply the new guidance using a modified retrospective approach at the beginning of the year in which the new lease standard is adopted, rather than to the earliest comparative period presented in their financial statements. The Company will use the new transition option and is also utilizing the package of practical expedients that allows it to not reassess: (1) whether any expired or existing contracts are or contain leases, (2) lease classification for any expired or existing leases, and (3) initial direct costs for any expired or existing leases. The Company additionally expects to use the practical expedient that allows it to treat the lease and non-lease components of its leases as a single component. The Company is currently evaluating the effect that the updated standards will have on its consolidated financial statements and related disclosures and is in the process of completing an analysis of its existing lease arrangements including the assessment of any embedded leases. The new standard will have an impact on the Company’s consolidated financial statements as it will result in a lease liability and ROU asset on the Company’s consolidated balance sheets and additional lease-related disclosures in the footnotes to the consolidated financial statements.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments — Credit Losses, which replaces the incurred loss impairment methodology with a methodology that reflects expected credit losses. The update is intended to provide financial statement users with more useful information about expected credit losses. The amended standard is effective for fiscal years beginning after December 15, 2019, with early adoption permitted. The Company is currently evaluating the impact the standard will have on the Company’s financial statements and related disclosures.

In February 2018, the FASB issued ASU No. 2018-02, Income Statement — Reporting Comprehensive Income (“ASU 2018-02”), to allow reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act. ASU 2018-02 will be effective for annual and interim periods beginning after December 15, 2018, with earlier application permitted. The Company is currently evaluating the impact the standard will have on the Company’s financial statements and related disclosures.

In June 2018, the FASB issued ASU No. 2018-07, Compensation — Stock Compensation (“ASU 2018-07”) intended to reduce cost and complexity and to improve financial reporting for nonemployee share-based payments.  Currently, the accounting requirements for nonemployee and employee share-based payment transactions are significantly different. 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—Equity-Based Payments to Nonemployees. The amendments in ASU 2018-07 are effective for fiscal years beginning after December 15, 2018, with early adoption permitted. The Company is currently evaluating the impact the standard will have on the Company’s financial statements and related disclosures, including early adoption.

In August 2018, the SEC adopted the final rule under SEC Release No. 33-10532, Disclosure Update and Simplification, amending certain disclosure requirements that were redundant, duplicative, overlapping, outdated or superseded. In addition, the amendments expanded the disclosure requirements on the analysis of stockholders’ equity for interim financial statements. Under the amendments, an analysis of changes in each caption of stockholders’ equity presented in the balance sheet must be provided in a note or separate statement. The analysis should present a reconciliation of the beginning balance to the ending balance of each period for which a statement of comprehensive income is required to be filed. The Company anticipates its first presentation of changes in stockholders’ equity as required under the new SEC guidance will be included in its Form 10-Q for the quarter ended March 31, 2019.

In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement, which modifies certain disclosure requirements on fair value measurements

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in ASC 820. This ASU is effective for interim and annual periods beginning after December 15, 2019 and early adoption is permitted. The Company is currently evaluating the effect that ASU 2018-13 will have on its consolidated financial statements disclosures.

In August 2018, the FASB issued ASU No. 2018-15, Intangibles — Goodwill and Other — Internal-Use Software, Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract (“ASU 2018-15”), which requires a customer in a hosting arrangement that is a service contract to follow the internal-use software guidance to determine which implementation costs to capitalize as an asset related to the service contract and which costs to expense. The new guidance is effective for annual and interim periods beginning after December 15, 2019. Early adoption is permitted. The amendments in this update should be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption. The Company is currently evaluating the impact the standard will have on the Company’s consolidated financial statements.

3.                                      Collaboration Agreement

Agreement Terms

On November 14, 2017, the Company entered into the Bayer Agreement pursuant to which the Company and Bayer will collaborate to develop and commercialize larotrectinib and LOXO-195, the Company’s franchise of highly selective TRK inhibitors for patients with TRK fusion cancers. Pursuant to the Bayer Agreement, Loxo has granted co-exclusive development and commercialization licenses to Bayer for both larotrectinib and LOXO-195. Upon the effective date, the Company became eligible for a non-refundable, upfront cash payment of $400 million from Bayer. In accordance with the terms of the Bayer Agreement, the Company received $250 million in November 2017 and the remaining $150 million in March 2018.

In addition to the upfront cash payment of $400 million, the Company is eligible to receive $450 million in milestone payments upon larotrectinib regulatory approvals and first commercial sale events in certain major markets and an additional $200 million in milestone payments upon LOXO-195 regulatory approvals and first commercial sale events in certain major markets.

The Company will lead global development activities and regulatory activities in the United States. Bayer will lead regulatory activities outside the United States and global commercial activities. Globally, the Company will be responsible for 50% of development costs incurred after January 1, 2018. In the United States, where the Company and Bayer will co-promote the products, the Company will be responsible for 50% of the commercial costs and receive 50% of the profits. In addition to the milestones described above, Bayer will pay the Company a $25 million milestone upon achieving a certain aggregate U.S. net sales threshold. The Company will have the right to opt-out of the U.S. co-promotion, in which case the Company would receive a royalty in the low thirties percentage range on U.S. net sales, which is meant to approximate the economics of the 50/50 profit split. Both parties will participate on a Global Steering Committee and a Joint Steering Committee and will participate in working groups established by the Committees.

Outside of the United States, where Bayer will commercialize, Bayer will pay the Company tiered, double digit royalties on net sales, and sales milestones totaling $475 million.

The Bayer Agreement will terminate as to a product or country upon the expiration of the royalty term applicable to such product in such country. The Bayer Agreement may be terminated by either party for material breach or bankruptcy. In addition, (i) Bayer may terminate the Bayer Agreement after the fourth anniversary of the effective date upon written notice to the Company which termination shall be effective 18 months following the Company’s receipt of such notice, or (ii) Bayer shall have the right, but not the obligation, to terminate the Bayer Agreement with respect to the Co-Promotion Territory or in its entirety by written notice to the Company with immediate effect in the event that the Company receives a “complete response letter” from the U.S. Food and Drug Agency with respect to larotrectinib, or if the Company does not receive marketing approval for larotrectinib by December 31, 2018.

The Agreement contains customary representations, warranties and covenants by the Company and Bayer. Each of the Company and Bayer is required to indemnify the other party against all losses and expenses related to breaches of its representations, warranties and covenants under the Agreement.

To account for the Bayer Agreement, the Company applied the guidance in ASC 808 as the parties are active participants and are exposed to significant risks and rewards dependent on commercial success of the collaborative activity. The Company also determined that the arrangement does not represent a vendor-customer relationship. ASC 808 does not contain prescriptive guidance on the measurement or recognition of collaborative arrangements. Therefore, there was significant judgment applied in determining a reasonable, rational method of accounting for the Bayer Agreement, with the Company considering the guidance in ASC 606 as well as ASC 730 — Research and Development (“ASC 730”).

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Collaboration Revenue

The Company concluded that the upfront payment of $400 million related to the transfer of the licenses to Bayer. The Company considered the guidance in ASC 606 to determine whether and, if so, how to separate the licenses and concluded that Bayer is able to obtain the utility of the larotrectinib and LOXO-195 licenses separately.

The Company also considered the guidance in ASC 606 to determine the measurement of the arrangement consideration related to the licenses.  At contract inception, the Company determined that the upfront payment should be included in the transaction price and constituted the consideration to be allocated to the two licenses. The future potential milestone amounts were not included in the transaction price, as they were all determined to be fully constrained following the concepts of ASC 606. Additionally, the Company expects that any consideration related to royalties and sales-based milestones will be recognized when the subsequent sales occur.

The Company also considered the guidance in ASC 606 to allocate the arrangement consideration to the two licenses. The Company allocated the estimated consideration to the licenses based on its estimates of the relative estimated standalone selling prices. This resulted in an allocation at contract inception of $280 million to larotrectinib and $120 million to LOXO-195. In the event it is probable that a significant reversal of income will not occur for a regulatory milestone, it will be included in the license consideration and allocated to the specific license to which it relates.

In order to determine the period of attribution of the license consideration, the Company considered that Bayer is unable to obtain utility of the licenses without the benefit of the research and development. Therefore, the Company will recognize collaboration revenue for the licenses over time using a proportional performance method.  In applying the proportional performance method of recognition, collaboration revenue will be recognized based on actual development costs incurred as a percentage of the total budgeted development costs over the time period the Company completes its development activities, which the Company believes is the most appropriate measure of the utility provided to Bayer. The Company estimates that the collaboration revenue will be recognized over a remaining weighted average period of 1.1 years for larotrectinib and 1.7 years for LOXO-195. A proportional performance method of recognition requires management to make estimates of costs to complete the development activities. In making such estimates, significant judgment is required to evaluate assumptions related to cost estimates. The cumulative effect of increases in the license consideration related to regulatory milestones or revisions to estimated costs to complete the Company’s performance obligations will be recorded in the period in which changes are identified and amounts can be reasonably estimated. A significant change in these assumptions and estimates could have a material impact on the timing and amount of collaboration revenue recognized in future periods.

The Company has not yet recognized any revenues for milestone payments as the related regulatory or sales milestones have not yet been achieved.

Research and Development Activities

The Company is incurring global development costs, with Bayer responsible for 50% of such costs. The Company will record all costs associated with the development activities as research and development expenses in the consolidated statements of operations consistent with ASC 730. The reimbursement of a portion of the development costs by Bayer is representative of the joint risk sharing nature of the arrangement. The Company considered the guidance in ASC 808 and will recognize the payments received from Bayer as a reduction to research and development expense when the related costs are incurred. For the three and nine months ended September 30, 2018, the Company recognized the reimbursement from Bayer of $7.1 million and $22.4 million, respectively.

Commercialization Activities

Bayer is the principal as it relates to the commercialization of larotrectinib and LOXO-195. Therefore, profits and losses related to commercialization activities, including sales-based milestones, royalties and the Company’s 50% share of U.S. profits or losses incurred by Bayer, will be recognized as collaboration revenue. Commercialization costs incurred by the Company will be recognized as a reduction to the collaboration revenue.

The following table shows the components of revenue from the collaboration agreement for the three and nine months ended September 30, 2018 and 2017 (in thousands):

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4.                                      Net Loss Per Common Share

The following table sets forth the computation of basic and diluted net loss per share for the periods indicated (in thousands, except share and per share data):

The following outstanding securities at September 30, 2018 and 2017 have been excluded from the computation of diluted weighted average shares outstanding, as they would have been anti-dilutive:

5.                                      Fair Value Measurements

Financial Instruments

The financial instruments recorded in the Company’s balance sheets include cash and cash equivalents, receivable owed from collaboration partner, payable due to collaboration partner, investments, and accounts payable. Included in cash and cash equivalents are money market funds representing a type of mutual fund required by law to invest in low-risk securities (for example, U.S. government bonds, U.S. treasury bills and commercial paper) and overnight repurchase agreements. Money market funds are structured to maintain the fund’s net asset value at $1.00 per unit, which assists in providing adequate liquidity upon demand by the holder. Money market funds pay dividends that generally reflect short-term interest rates. Thus, only the dividend yield fluctuates. Also included in cash and cash equivalents are U.S. government sponsored enterprise debt securities that have a maturity of 3 months or less from their original acquisition date. Due to their short-term maturity, the carrying amounts of cash and cash equivalents (including money market funds), receivable owed from collaboration partner, payable due to collaboration partner and accounts payable approximate their fair values. The Company classifies its remaining investments as available-for-sale. Gains or losses on securities sold are based on the specific identification method.

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For investments classified as available-for-sale, the Company records unrealized gains or losses resulting from changes in fair value between measurement dates as a component of other comprehensive loss.

Fair value guidance establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include:

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

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

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

The Company’s financial assets measured at fair value on a recurring basis at September 30, 2018 were as follows (in thousands):

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The Company’s financial assets measured at fair value on a recurring basis at December 31, 2017 were as follows (in thousands):

There were no items that were accounted for at fair value on a non-recurring basis for the nine months ended September 30, 2018 and 2017. The Company’s Level 2 securities are typically valued utilizing third party pricing services or other observable market data. The pricing services utilize industry standard valuation models, including both income and market-based approaches and observable market inputs to determine value. These observable market inputs include reportable trades, benchmark yields, credit spreads, broker/dealer quotes, bids, offers, and other industry and economic events.

Financial instruments that potentially subject the Company to a concentration of credit risk consist of cash and cash equivalents. At September 30, 2018 and December 31, 2017, the Company’s cash and cash equivalents were held by two financial institutions and the amounts on deposit were in excess of Federal Deposit Insurance Company insurance limits. The Company mitigates this risk by depositing its uninsured cash in major well capitalized financial institutions, and by investing excess operating cash in overnight repurchase agreements which are 100% collateralized by U.S. government backed securities with the Company’s bank. The Company has not recognized any losses on its cash and cash equivalents.

6.                                      Stock-Based Compensation

Equity Incentive Plan (the “Plan”)

Effective July 2013, the Company adopted the 2013 Equity Incentive Plan, which was amended in November 2013 (the “2013 Plan”). The 2013 Plan provided for the granting of incentive stock options, non-statutory stock options and the issuance of restricted stock awards. In connection with the Company’s initial public offering, no further grants will be made under this plan and all remaining shares available for grant were transferred to the 2014 Equity Incentive Plan.

The Company adopted the 2014 Equity Incentive Plan (the “2014 Plan”) that became effective on July 30, 2014 and serves as the successor to the 2013 Plan. The 2014 Plan provides for the grant of awards to employees, directors, consultants, independent contractors and advisors, provided the consultants, independent contractors, directors and advisors are natural persons that render services other than in connection with the offer and sale of securities in a capital-raising transaction. The exercise price of stock options must be at least equal to the fair market value of the Company’s common stock on the date of grant.

In 2018, our Board of Directors approved the grant of non-plan inducement stock options (“non-plan inducement option grants”) to prospective employees pursuant to non-plan stock option agreements as a material inducement for entering into

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employment with the Company.  The non-plan inducement option grants must be made in connection with the commencement of employment, are subject to the Company’s standard vesting schedule and will expire no more than ten years from their respective dates of grant.  Additionally, recipients of non-plan inducement option grants must meet certain other pre-employment criteria. During the nine months ended September 30, 2018, the Company granted 98,525 inducement stock options to employees.

The Company adopted the Amended and Restated 2014 Equity Incentive Plan (the “A&R 2014 Plan”) on April 23, 2018. The A&R 2014 Plan reserved an additional 1,500,000 shares of the Company’s common stock for issuance under the A&R 2014 Plan, subject to certain additions and adjustments, and approved certain amendments to the A&R 2014 Plan to (i) change the automatic “evergreen” increase in shares reserved for issuance under the A&R 2014 Plan from 3% to 4% of the aggregate number of outstanding shares of the Company’s common stock as of the immediately preceding December 31 for each calendar year January 1, 2019 through January 1, 2023, (ii) impose a limit of 30,000 shares as the maximum number of shares that may be granted under the A&R 2014 Plan to each of the Company’s non-employee directors each year, (iii) prohibit shares that are withheld from exercised shares for taxes, payment of exercise price in connection with the exercise of options or stock appreciation rights from returning to the total number of shares reserved for awards, (iv) provide for a prohibition on payment of dividends on unvested awards, (v) prohibit repricing without stockholder approval, (vi) prohibit transfer of awards to third-party institutions for value and (vii) make certain modifications to reflect changes to the tax law by 2017 tax legislation.

As of September 30, 2018, the Company has reserved 5,228,625 shares of its common stock to be issued under the A&R 2014 Plan, including those shares transferred from the 2013 Plan to be issued under the A&R 2014 Plan, of which 1,521,732 shares were available for future issuance. The A&R 2014 Plan authorizes the award of stock options, restricted stock awards (“RSAs”), stock appreciation rights (“SARs”), restricted stock units (“RSUs”), performance awards and stock bonuses.

The following table summarizes stock option activity for the period from January 1, 2018 through September 30, 2018:

As of September 30, 2018, there was $108.8 million of total unrecognized compensation expense related to options granted but not yet vested of which $10.9 million is attributable to non-employee awards and subject to re-measurement until vested. The total unrecognized compensation expense of $108.8 million will be recognized as expense over a weighted-average period of 2.94 years.

The Company uses the Black-Scholes option pricing model to estimate the fair value of option awards with the following weighted-average assumptions, certain of which are based on industry comparative information, for the period indicated:

The weighted-average valuation assumptions were determined as follows:

·                  Risk-free interest rate: The Company bases the risk-free interest rate on the interest rate payable on U.S. Treasury securities in effect at the time of grant for a period that is commensurate with the assumed expected option term.

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·                  Expected annual dividends: The estimate for annual dividends is 0%, because the Company has not historically paid, and does not expect for the foreseeable future to pay, a dividend.

·                  Expected stock price volatility: The expected volatility used is based on historical volatilities of similar entities within the Company’s industry which were commensurate with the Company’s expected term assumption.

·                  Expected term of options: The expected term of options represents the period of time options are expected to be outstanding. The expected term of the options granted to employees is derived from the “simplified” method as described in Staff Accounting Bulletin 107 relating to stock-based compensation. The expected term for options granted to non-employees is equal to the contractual term of the awards.

·                  Expected forfeiture rate: The Company’s estimated forfeiture rate is based on historical forfeiture experience of its various employee groups.

·                  Estimated fair value of the Company’s stock-based awards: The estimated fair value of the Company’s stock-based awards is amortized on a straight-line basis over the awards’ service period for those awards with graded vesting and which contain only a service condition. For awards with graded vesting and a performance and service condition, when achievement of the performance condition is deemed probable, the Company recognizes compensation cost using the accelerated recognition method over the awards’ service period.

Share-based compensation expense recognized was as follows (in thousands):

7.                                      Commitments and Contingencies

Array Bio Pharma (“Array”) Collaboration

On July 3, 2013, the Company signed a multi-year strategic collaboration agreement with Array, and this agreement was subsequently amended on November 26, 2013, April 10, 2014, October 13, 2014, March 31, 2015 and February 18, 2016. Under the terms of the collaboration agreement, as amended, the Company obtained certain rights to Array’s tropomyosin receptor kinase (“TRK”) inhibitor program, as well as additional novel oncology targets, including rearranged during transfection (“RET”), and fibroblast growth factor receptor (“FGFR”). The Company received worldwide commercial rights to each product candidate from the collaboration, and Array participates in any potential successes through milestones and royalties.

Before the February 2016 amendment, in addition to larotrectinib, the parties designated 12 discovery targets, of which seven were selected for additional study in January 2015, which was to be reduced to four on or before January 2016. The Company had the option to maintain the total target number at five for an additional payment, and the Company exercised this option to maintain five discovery programs in January 2016. In the February 2016 amendment, the parties designated a total of six discovery targets. An additional payment was due at contract signing, satisfying a prior obligation of the April 2014 amendment.

As part of the agreement the Company agreed to pay Array a fixed amount per month, based on Array’s commitment to provide full-time equivalents and other support relating to the conduct of the discovery and preclinical development programs. For the three months ended September 30, 2018 and 2017, the Company recorded $2.4 million and $2.2 million, respectively, of research and development expenses related to the collaboration agreement. For the nine months ended September 30, 2018 and 2017, the Company recorded $7.3 million and $6.1 million, respectively, of research and development expenses related to the collaboration agreement. With respect to this discovery and preclinical program, the collaboration agreement, as amended, ran through September 30, 2018. Projects that were in-process at the time of the collaboration’s expiry have since been transferred to the Company’s internal discovery facility and team.

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Milestones

With respect to product candidates directed to TRK, including larotrectinib and LOXO-195, the Company could be required to pay Array up to $223 million in milestone payments for each compound, the substantial majority of which are due upon the achievement of commercial milestones. The Company has made or accrued $7.0 million and $1.3 million in larotrectinib and LOXO-195 milestone payments, respectively, from inception through September 30, 2018. No expense relating to a milestone payment was recognized in research and development expenses for either larotrectinib or LOXO-195 in the three and nine months ended September 30, 2018. A milestone payment of $1.0 million was recognized in research and development expenses relating to LOXO-195 in the three and nine months ended September 30, 2017.

With respect to product candidates directed to targets other than TRK, including LOXO-292, the Company could be required to pay Array up to $213 million in milestone payments, the substantial majority of which are due upon the achievement of commercial milestones. The Company has made or accrued $8.3 million in LOXO-292 milestone payments from inception through September 30, 2018. Milestone payments of $4.0 million and $7.0 million were recognized in research and development expenses for LOXO-292 in the three and nine months ended September 30, 2018, respectively. A milestone payment of $1.0 million for LOXO-292 was recognized in research and development expenses in the nine months ended September 30, 2017.

Royalties

The Company is required to pay Array mid-single digit royalties on worldwide net sales of products that were discovered under the agreement. With respect to the royalty on products directed to targets other than TRK, including LOXO-292, the Company has the right to credit certain milestone payments against royalties on sales of products directed to such target.

Research and Development Arrangements

In the course of normal business operations, the Company enters into agreements with contract research organizations (“CROs”) to assist in the performance of research and development and preclinical activities, and contract manufacturers to assist with CMC related expenses. Expenditures to CROs may represent a significant cost in preclinical and clinical development for the Company in future periods. The Company can elect to discontinue the work under these agreements at any time. The Company also enters into agreements with third parties to develop and commercialize companion diagnostics. The Company could also enter into additional collaborative research, contract research, manufacturing, and supplier agreements in the future, which may require upfront payments and long-term commitments of cash.

Legal Proceedings

The Company is not involved in any legal proceeding that it expects to have a material effect on its business, financial condition, results of operations and cash flows.

8.                                     Related Party Transactions

Dr. Lori Kunkel, a board member, had a consulting agreement with the Company to assist in the Company’s drug development process, which was modified, effective as of October 31, 2015, to provide that she receives only the standard director compensation for her services. Dr. Kunkel also received stock option grants in 2013 and 2014 as compensation for her consulting services. As of September 30, 2018, these stock options are fully vested. During the three and nine months ended September 30, 2018, the Company recognized stock-based compensation expense of $0.2 million and $1.0 million, respectively, and during the three and nine months ended September 30, 2017, the Company recognized stock-based compensation of $0.3 million and $1.7 million, respectively, in accordance with the terms of the consulting agreement.

Dr. Keith Flaherty, a board member, has an agreement with the Company to serve as Scientific Advisor Board (“SAB”) Chair for which he receives cash compensation. Dr. Flaherty also received stock option grants in 2013, 2014, and 2018 as compensation for his SAB services. The stock options granted in 2013 are fully vested, stock options granted in 2014 and 2018 continue to vest. Both cash compensation that was expensed as incurred and stock-based compensation are recorded as a component of research and development expenses. During the three months ended September 30, 2018 and 2017, the Company recognized cash compensation expense of $15 thousand and $15 thousand, respectively, and stock-based compensation expense of $0.1 million and $0.5 million, respectively, in accordance with the terms of the SAB agreement. During the nine months ended September 30, 2018 and 2017, the Company recognized cash compensation expense of $48 thousand and $45 thousand, respectively, and stock-based compensation expense of $0.8 million and $2.3 million, respectively, in accordance with the terms of the SAB agreement.

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

The interim unaudited condensed consolidated financial statements and this Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the financial statements and notes thereto for the year ended December 31, 2017 and the related Management’s Discussion and Analysis of Financial Condition and Results of Operations, both of which are contained in our Annual Report on Form 10-K filed with the SEC on March 1, 2018. As used in this report, unless the context suggests otherwise, “we,” “us,” “our,” “the Company” or “Loxo” refer to Loxo Oncology, Inc.

Forward Looking Statements

The information in this discussion contains forward-looking statements and information within the meaning of Section 27A of the Securities Act of 1933, as amended, (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended, (the “Exchange Act”), which are subject to the “safe harbor” created by those sections. This Quarterly Report on Form 10-Q contains forward-looking statements that involve substantial risks and uncertainties. In some cases, you can identify forward-looking statements by the words “may,” “might,” “will,” “could,” “would,” “should,” “expect,” “intend,” “plan,” “objective,” “anticipate,” “believe,” “estimate,” “predict,” “project,” “potential,” “continue” and “ongoing,” or the negative of these terms, or other comparable terminology intended to identify statements about the future. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from the information expressed or implied by these forward-looking statements. Although we believe that we have a reasonable basis for each forward-looking statement contained in this Form 10-Q, we caution you that these statements are based on a combination of facts and factors currently known by us and our expectations of the future, about which we cannot be certain. You should refer to the risks set forth in Part II, Item 1A, “Risk Factors” in this Quarterly Report on Form 10-Q for a discussion of important factors that may cause our actual results to differ materially from those expressed or implied by our forward-looking statements. Furthermore, such forward-looking statements speak only as of the date of this report. We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.

Overview

Loxo Oncology is a biopharmaceutical company developing highly selective medicines for patients with genomically defined cancers. Our pipeline focuses on cancers that are uniquely dependent on single gene abnormalities, such that a single drug has the potential to treat the cancer with dramatic effect. We believe that the most selective, purpose-built medicines have the highest probability of maximally inhibiting the intended target, thereby delivering best-in-class disease control and safety. Our management team seeks out experienced industry partners, world-class scientific advisors and innovative clinical-regulatory approaches to deliver new cancer therapies to patients as quickly and efficiently as possible.

With our scientific knowledge, collaborative partnerships and targeted approach, we are developing multiple small molecule therapeutics utilizing focused clinical development strategies in well-defined patient populations. Larotrectinib, a selective TRK inhibitor currently in clinical development, is being evaluated in three ongoing multi-center studies that include patients with solid tumors that harbor TRK gene fusions. In May 2018, we announced that the U.S. Food and Drug Administration (“FDA”) accepted the company’s New Drug Application (“NDA”) and granted Priority Review for larotrectinib for the treatment of adult and pediatric patients with locally advanced or metastatic solid tumors harboring an NTRK gene fusion. The FDA set a target action date of November 26, 2018, under the Prescription Drug User Fee Act (“PDUFA”). In October 2018, updated clinical data for larotrectinib were presented at the European Society for Medical Oncology (ESMO) 2018 Congress. The oral presentation provided approximately one year of additional follow-up for the primary dataset, the 55 patients with TRK fusion cancer described in the larotrectinib New England Journal of Medicine publication from February 2018. In addition, the update included data for a supplementary dataset, an additional 67 patients with TRK fusion cancer who were subsequently enrolled across the larotrectinib development program. Response evaluations were based on investigator assessment. As of a data cut-off date of July 30, 2018, in the primary dataset (n=55), the overall response rate (ORR) was 80% (44/55) (95% CI: 67-90%) and in the supplementary dataset (n=67), the ORR was 81% (44/54) (95% CI: 69-91%). Across both datasets, the ORR was 81% (88/109) (95% CI: 72-88%). The ORR analyses for the supplementary and integrated datasets included nine patients with unconfirmed partial responses awaiting confirmatory response assessments, but did not include 13 patients who were awaiting an initial response assessment and continuing on study. Median duration of response (DOR) had not been reached in either the primary dataset or supplementary dataset, with median follow-up of 17.6 months and 7.4 months, respectively. Larotrectinib was well tolerated, with the majority of adverse events recorded as grade 1 or 2. The most common treatment-emergent adverse events occurring in 15% or more of patients in the trial were fatigue, dizziness, nausea, constipation, anemia, increased ALT, increased AST, cough, diarrhea, vomiting, pyrexia, dyspnea, headache, myalgia and peripheral oedema.

In June 2018, we announced positive interim clinical data from the LOXO-292 dose escalation trial in RET-altered cancers that were presented at the American Society of Clinical Oncology Annual Meeting (“ASCO”), and announced updated data at the International Association for the Study of Lung Cancer (IASLC) 19th World Conference on Lung Cancer in September 2018 and the

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Annual Meeting of the American Thyroid Association in October 2018. In August 2018, we announced that we recently conducted a meeting with the FDA for LOXO-292. Based on written minutes from the FDA, we expect to submit an NDA for LOXO-292 in late 2019, utilizing data generated from the ongoing LIBRETTO-001 clinical trial.

We also have programs in development for TRK (“LOXO-195”), RET (“LOXO-292”), BTK (“LOXO-305”), FGFR and other targets.

Since inception, we have incurred significant operating losses. Our net loss for the three and nine months ended September 30, 2018 was $27.1 million and $42.3 million, respectively, including approximately $56.9 million and $130.5 million, respectively, of total research and development expenses, and approximately $15.9 million and $43.8 million, respectively, of total general and administrative expenses, partially offset by revenue from our Bayer collaboration agreement of $42.5 million and $123.5 million, respectively. We expect to incur significant expenses and operating losses for the foreseeable future as we continue the discovery, development and clinical trials of, and seek regulatory approval for and pursue potential commercialization of, our product candidates. In addition, we will also incur additional expenses if and as we enter into additional collaboration agreements, acquire or in-license products and technologies, enter into companion diagnostics collaborations, establish sales, marketing and distribution infrastructure, expand our lab and scientific infrastructure and/or expand and protect our intellectual property portfolio.

While we have substantial cash on hand for immediate operations, we will need to obtain substantial additional funding in connection with our long term continuing operations. We will seek to fund our operations through the sale of equity, debt financings or other sources, including potential collaborations. We may be unable to raise additional funds or enter into such other agreements when needed on favorable terms, or at all. If we fail to raise capital or enter into such other arrangements as, and when, needed, we may have to significantly delay, scale back or discontinue the development and commercialization of one or more of our product candidates.

Bayer License, Development and Commercialization Agreement

In November 2017, we entered into a license, development and commercialization agreement with Bayer pursuant to which we and Bayer will collaborate to develop and commercialize larotrectinib and LOXO-195, our franchise of highly selective TRK inhibitors for patients with TRK fusion cancers. Pursuant to the Bayer Agreement, we granted co-exclusive development and commercialization licenses to Bayer for both larotrectinib and LOXO-195.

In addition to an upfront cash payment of $400.0 million, we are eligible to receive $450.0 million in milestone payments upon larotrectinib regulatory approvals and first commercial sale events in certain major markets and an additional $200.0 million in milestone payments upon LOXO-195 regulatory approvals and first commercial sale events in certain major markets. Bayer will also pay us a $25.0 million milestone upon achieving a certain U.S. net sales threshold.

We will lead global development activities and regulatory activities in the United States. Bayer will lead regulatory activities outside the United States and global commercial activities. Globally, we will be responsible for 50% of development costs incurred after January 1, 2018. In the United States, where we and Bayer will co-promote the products, we will be responsible for 50% of the commercial costs and receive 50% of the profits. We will have the right to opt-out of the U.S. co-promotion, in which case we would receive a royalty in the low thirties percent range on U.S. net sales, which is meant to approximate the economics of the 50/50 profit split.

Outside of the United States, where Bayer will commercialize, Bayer will pay us tiered, double digit royalties on net sales, and sales milestones totaling $475.0 million.

The Bayer Agreement also includes a standstill provision that prevents Bayer from acquiring five percent or more of our voting securities.

The Bayer Agreement will terminate as to a product or country upon the expiration of the royalty term applicable to such product in such country. The Bayer Agreement may be terminated by either party for material breach or bankruptcy. In addition, Bayer may terminate the Bayer Agreement after the fourth anniversary of the effective date upon written notice to us, or in the event that we receive a “complete response letter” from the FDA with respect to larotrectinib, or if we do not receive marketing approval for larotrectinib by December 31, 2018.

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Components of Operating Results

Revenue from Collaboration Agreement

Our revenue from collaboration agreement is derived from payments we receive under the license, development and commercialization collaboration agreement with Bayer. This currently includes a portion of the upfront payment, to be recognized as revenue over time using a proportional performance method as the related research and development activities are performed by us, partially offset by our share of co-promote costs.

Research and Development Expenses

Research and development costs are charged to expense as incurred. These costs include, but are not limited to, employee-related expenses, including salaries, benefits, stock-based compensation and travel as well as expenses related to asset acquisitions of IPR&D, third-party collaborations, contract research arrangements and activities associated with the development of companion diagnostics for our product candidates. Under the Bayer Agreement, we receive reimbursement for 50% of our development activity expenses incurred for larotrectinib and LOXO-195 beginning January 1, 2018. This reimbursement is recorded as a reduction to our research and development costs.

Research and development activities are central to our business model. Product candidates in later stages of clinical development generally have higher development costs than those in earlier stages of clinical development, primarily due to the increased size and duration of later-stage clinical trials. As we advance our product candidates, we expect the amount of external research and development will continue to increase for the foreseeable future, while our internal spending should increase at a slower and more controlled pace.

It is difficult to determine with certainty the duration and completion costs of our current or future preclinical programs and clinical trials of our product candidates, or if, when or to what extent we will generate revenue from the commercialization and sale of any of our product candidates that obtain regulatory approval. We may never succeed in achieving regulatory approval for any of our product candidates. The duration, costs and timing of clinical trials and development of our product candidates will depend on a variety of factors, including the uncertainties of future clinical and preclinical studies, uncertainties in clinical trial enrollment rate and significant and changing government regulation. In addition, the probability of success for each product candidate will depend on numerous factors, including competition, manufacturing capability and commercial viability. We will determine which programs to pursue and how much to fund each program in response to the scientific and clinical success of each product candidate, as well as an assessment of each product candidate’s commercial potential.

General and Administrative Expenses

General and administrative expenses consist principally of salaries and related costs for executive and other personnel, including stock-based compensation and travel expenses. General and administrative expenses also include facility-related costs, communication expenses and professional fees for legal, patent prosecution and maintenance, consulting and accounting services.

Interest Income, net

Interest income, net consists principally of the interest earned from our short-term and long-term investments and amortization of premiums related to certain of our investments, partially offset by the amortization of discounts recorded in connection with the purchase of certain investments.

Critical Accounting Policies and Significant Judgments and Estimates

This discussion and analysis of our financial condition and results of operations is based on our financial statements, which have been prepared in accordance with generally accepted accounting principles in the U.S. (“GAAP”). The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. In accordance with GAAP, we base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.

We believe there have been no significant changes in our critical accounting policies as discussed in our Form 10-K filed on March 1, 2018 with the SEC, except for those related to our collaboration agreement with Bayer and from the adoption of new accounting standards, as described in Note 2 to these condensed consolidated financial statements.

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Results of Operations

Comparison of the Three Months Ended September 30, 2018 and 2017 (in thousands)