Description of Business, Basis of Presentation and Summary of Significant Accounting Policies (Policies)

3 Months Ended

Mar. 31, 2019

The accompanying condensed consolidated financial statements include the accounts of Arcturus Therapeutics Ltd. and its subsidiaries and are unaudited. All intercompany accounts and transactions have been eliminated in consolidation. These condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In management’s opinion, the accompanying condensed consolidated financial statements reflect all adjustments, consisting of normal recurring adjustments, considered necessary for a fair presentation of the results for the interim periods presented.

Interim financial results are not necessarily indicative of results anticipated for the full year. These condensed consolidated financial statements should be read in conjunction with the audited financial statements and footnotes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018.

These condensed consolidated financial statements are prepared in accordance with GAAP with United States Dollars (“USD”) as the functional currency, which requires management to make estimates and assumptions regarding the valuation of certain debt and equity instruments, the equity method investment, share-based compensation, accruals for liabilities, income taxes, deferred revenue, expense accruals, and other matters that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Although these estimates are based on management’s knowledge of current events and actions the Company may undertake in the future, actual results may ultimately differ from these estimates and assumptions.

Unless the context otherwise requires, references to the “Company” and “Arcturus” refer to Arcturus Therapeutics Ltd. and its subsidiaries.

Going Concern

The Company’s activities since inception have consisted principally of performing research and development activities, general and administration activities, and raising capital. The Company’s activities are subject to significant risks and uncertainties, including failing to secure additional funding before the Company achieves sustainable revenues and profit from operations.

The Company is a pre-clinical bioscience company that is dependent on obtaining external equity and debt financings to fund its operations. Historically, the Company’s primary sources of financing have been through the sale of its securities, through issuance of debt and through collaboration agreements. The Company raised $10.0 million in gross proceeds from a long-term debt agreement entered into on October 12, 2018 with Western Alliance Bank (Note 5). In addition, on October 15, 2018, the Company entered into a Sales Agreement (the “Sales Agreement”) with Leerink Partners LLC (“Leerink”), pursuant to which it may sell from time to time, at its option, up to an aggregate of $30.0 million of the Company’s Ordinary Shares through Leerink, as sales agent. Research and development activities have required significant capital investment since the Company’s inception.

The Company expects its operations to continue to require cash investment to pursue the Company’s research and development activities, including preclinical studies, formulation development, clinical trials and related drug manufacturing. The Company has experienced net losses since its inception and as of March 31, 2019 has an accumulated deficit of $52.6 million. The Company expects to continue to incur additional losses for the foreseeable future, and the Company will need to raise additional debt or equity financing or enter into additional collaborations to fund its development. The ability of the Company to transition to profitability is dependent on identifying and developing successful mRNA drug candidates. In the near future, if the Company is not able to achieve planned milestones, incurs costs in excess of its forecasts, or does not meet the covenant requirements associated with its debt (Note 5), it will need to reduce discretionary spending, discontinue the development of some or all of its products, which will delay part of its development programs, all of which will have a material adverse effect on the Company’s ability to achieve its intended business objectives. There can be no assurances that additional financing will be secured or, if secured, will be on favorable terms to the Company. Management has prepared cash flow forecasts which indicate that based on the Company’s expected operating losses and negative cash flows, there is substantial doubt about the Company’s ability to continue as a going concern within twelve months after the date that the condensed consolidated financial statements for the quarter ended March 31, 2019 are issued. The accompanying condensed consolidated financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business. The condensed consolidated financial statements do not reflect any adjustments related to the recoverability and classification of assets or the amounts and classification of liabilities that might be necessary if the Company is unable to continue as a going concern.

Recent Developments

The Company has initiated a process to redomicile from an Israeli limited company to a Delaware corporation (the “Redomiciliation”). The Redomiciliation is subject to the approval of the Company’s shareholders via proxy vote, the Tel-Aviv District Court (the “Israeli Court”) approval and approval of the listing of the shares in the Delaware corporation by the NASDAQ Stock Market LLC (“Nasdaq”), among other conditions precedent. On February 11, 2019, the Company filed an application with the Israeli Court to approve the convening of a general shareholders meeting of the Company for the approval of the Redomiciliation pursuant to Sections 350 and 351 of the Israeli Companies Law (the “Companies Law”). Following the Israeli Court approval dated March 13, 2019, the Company filed with the SEC a registration statement on Form S-4 (the “Form S-4”), which included a joint proxy statement/prospectus for the convening of the general shareholder meeting, scheduled to be held on May 17, 2019, as described in the Form S-4. If the general shareholders meeting results in the approval of the Redomiciliation, the Company will then approach the Israeli Court and request its approval of the Redomiciliation.

In connection with the Redomiciliation, the Company entered into a share exchange agreement (the “Exchange Agreement”) with a special-purpose company, Arcturus Therapeutics Holdings Inc. (“NewCo”).

In furtherance of the Redomiciliation, and pursuant to the terms of the Exchange Agreement, the holders of Ordinary Shares of the Company as of a future record date and the holders of options to purchase Ordinary Shares of the Company as of the same record date will transfer their Ordinary Shares of the Company and options to purchase Ordinary Shares of the Company, respectively, to NewCo and, in exchange thereof, will receive one share of common stock of NewCo for each ordinary share of the Company and an option to purchase one share of common stock of NewCo in exchange for each ordinary share of the Company underlying the existing option to be so exchanged, respectively.

The Company intends the common stock of NewCo to be listed on NASDAQ. Upon consummation of the transactions contemplated by the Share Exchange Agreement, it is expected that the Company’s Ordinary Shares will be delisted from trading on NASDAQ, and the Company is expected to become a private company (as defined in the Companies Law) wholly-owned by NewCo.

Pursuant to the Exchange Agreement, and as disclosed in the Form S-4, the Company also has the right, exercisable in its sole discretion and subject to the conditions precedent set forth therein, to transfer all of the shares of Arcturus Therapeutics Inc. (“Arcturus Sub”), a wholly-owned subsidiary of the Company, to NewCo through a reduction of the Company’s equity and the distribution of a dividend-in-kind, such that Arcturus Sub and the Company shall each become a wholly-owned and direct subsidiary of NewCo. The Company will determine if it will proceed with this second step prior to December 31, 2019.

Segment Information

Operating segments are identified as components of an enterprise about which separate discrete financial information is available for evaluation by the chief operating decision-maker in making decisions regarding resource allocation and assessing performance. The Company and its chief operating decision-maker view the Company’s operations and manage its business in one operating segment, which is the research and development of medical applications for the Company’s nucleic acid-focused technology.

Revenue Recognition

Effective January 1, 2019, the Company adopted ASU 2014-09, Revenue from Contracts with Customers (Topic 606), or Topic 606, using the modified retrospective transition method. Topic 606 provides a unified model to determine how revenue is recognized and the Company applied the standard to collaborative research and technology agreements that were in progress as of the effective date, January 1, 2019. The Company determines revenue recognition for arrangements within the scope of Topic 606 by performing the following five steps: (i) identify the contract; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when, or as, the company satisfies a performance obligation.

The terms of the Company’s collaborative research and development agreements include license fees, upfront payments, milestone payments when and if certain research or technology transfer milestones are achieved, development milestones and reimbursement for research and development activities, option exercise fees, other contingent payments for the achievement of defined collaboration objectives and certain preclinical, clinical, regulatory and sales-based events, as well as royalties on sales of commercialized products. Arrangements that include up-front payments are recorded as deferred revenue upon receipt or when due and may require deferral of revenue recognition to a future period until the Company perform obligations under these arrangements. The Company records research funding as accounts receivable when the right to consideration is unconditional. The event-based milestone payments represent variable consideration, and the Company uses the most likely amount method to estimate this variable consideration because the Company will either receive the milestone payment or will not, which makes the potential milestone payment a binary event. The most likely amount method requires the Company to determine the likelihood of earning the milestone payment. Given the high degree of uncertainty around achievement of these milestones, the Company determines the milestone amounts to be fully constrained and does not recognize revenue until the uncertainty associated with these payments is resolved. The Company will recognize revenue from sales-based royalty payments when or as the sales occur. The Company will re-evaluate the transaction price in each reporting period as uncertain events are resolved and other changes in circumstances occur.

A performance obligation is a promise in a contract to transfer a distinct good or service to the collaborative partner and is the unit of account in Topic 606. A contract’s transaction price is allocated to each distinct performance obligation based on relative standalone selling price and recognized as revenue when, or as, the performance obligation is satisfied. Under Topic 606, the Company elected to use the practical expedients permitted related to adoption, which does not require the Company to disclose certain information regarding certain remaining performance obligations as of the end of the reporting period. Topic 606 is applicable for revenue recognized in accordance with the practical expedient for measuring progress toward satisfaction of a performance obligation, and variable consideration classified as a sales-based or usage-based royalty promised in exchange for a license.

See Note 2, “Collaboration Revenue” for specific details surrounding the Company’s collaboration arrangements.

Leases

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which requires lessees to recognize most leases on the balance sheet as lease liabilities with corresponding right-of-use assets and to disclose key information about leasing arrangements. The Company adopted Topic 842 on its effective date in the first quarter of 2019 using a modified retrospective approach. The Company elected the available package of practical expedients upon adoption, which allowed it to carry forward historical assessment of whether existing agreements contained a lease and the classification of existing operating leases. The Company continues to report its financial position as of December 31, 2018 under the former lease accounting standard (Topic 840) in the condensed consolidated balance sheet.

The adoption impact was due to the recognition of an operating lease liability with a corresponding right-of-use asset based on the present value of remaining minimum lease payments. A reduction of the right-of-use asset was recorded to reflect the balance of the deferred rent obligation and there was no impact to retained earnings.

Research and Development, net

Research and Development, Net

Research and development costs are expensed as incurred. These expenses result from the Company’s independent research and development efforts as well as efforts associated with collaboration arrangements. Research and development costs include salaries and personnel-related costs, consulting fees, fees paid for contract research and manufacturing services, the costs of laboratory supplies, equipment and facilities and other external costs are shown net of any royalty bearing grants.

Statement of Cash Flows

The following table provides a reconciliation of cash and cash equivalents and restricted cash reported within the condensed consolidated balance sheet to the total of the same such amounts shown in the condensed consolidated statement of cash flows:

(in thousands)	March 31, 2019		March 31, 2018
Cash and cash equivalents	$	31,220	$	36,289
Non-current restricted cash		107		107
Total cash, cash equivalents and restricted cash shown in the statement of cash flows	$	31,327	$	36,396

Net Loss per Share

Basic net loss per share is calculated by dividing the net loss by the weighted-average number of ordinary shares outstanding for the period, without consideration for ordinary share equivalents. Diluted net loss per share is calculated by dividing the net loss by the weighted-average number of ordinary shares and dilutive ordinary share equivalents outstanding for the period determined using the treasury-stock method. Dilutive ordinary shares are comprised of share options.

No dividends were declared or paid during the reported periods.

Recently Adopted Accounting Pronouncements

Revenue from Contracts with Customers

In May 2014, the Financial Accounting Standards Board (FASB) issued Topic 606, which supersedes nearly all existing revenue recognition guidance under GAAP. The FASB subsequently issued amendments to Topic 606 that have the same effective date and transition date.

The Company adopted this new guidance, effective January 1, 2019, using the modified retrospective transition method, in which the standard is applied as of the date of initial adoption. The Company recorded the cumulative effect of initially applying the standard as an adjustment to the opening balance of accumulated deficit. The adoption of the new revenue recognition guidance resulted in an increase of $0.8 million to deferred revenue and an increase of $0.8 million to accumulated deficit as of January 1, 2019. The change in revenue was due to a change in how the Company accounts for changes in the measure of progress and changes to the transaction price and for the recognition of revenue. Under Topic 605, the Company accounted for changes to the measure of progress and changes to the transaction price prospectively. Topic 606 requires companies to account for a change to the measure of progress or a change to the transaction price as a cumulative catch-up in the period of change. There were no other impacts upon the adoption of Topic 606. The Company will apply the standard to all new contracts initiated on or after the effective date.

Under prior guidance, collaboration revenue recognized would have been $4.1 million for the three months ended March 31, 2019, which is $0.3 million lower than the amount recognized under current guidance.

Leases

In February 2016, the FASB issued Accounting Standards Update ("ASU") 2016-02, Leases (Topic 842) in order to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet for those leases classified as operating leases under previous GAAP. ASU 2016-02 requires a lessee to recognize a liability for lease payments (the lease liability) and a right-of-use asset (representing its right to use the underlying asset for the lease term) on the balance sheet. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018 (including interim periods within those periods) using a modified retrospective approach.

In July 2018, the FASB issued ASU 2018-11, Leases (Topic 842): Targeted Improvements, which provides entities an optional transition method to apply the new guidance as of the adoption date, rather than as of the earliest period presented. In transition, entities may also elect a package of practical expedients that must be applied in its entirety to all leases commencing before the effective date, unless the lease was modified, to not reassess (a) the existence of a lease, (b) lease classification or (c) determination of initial direct costs, which effectively allows entities to carryforward accounting conclusions under previous U.S. GAAP.

The Company adopted ASU 2016-02, using the optional transition method and electing the package of practical expedients described above on January 1, 2019. Due to the adoption, the Company recognized a new lease liability on the Company's consolidated balance sheet for its operating lease of office and lab space of $6.2 million on January 1, 2019, with a corresponding right-of-use asset of $5.7 million based on the present value of the remaining minimum rental payments. See Note 11 for further discussion.

Arcturus Therapeutics Ltd. 10-Q