Item 7. Management’s Discussion and Analysis
Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion and analysis of our financial condition and results of operations in conjunction with the consolidated financial statements and the related notes contained elsewhere in this Annual Report. Some of the information contained in this discussion and analysis are set forth elsewhere in this Annual Report, including information with respect to our plans and strategy for our business and related financing, includes forward-looking statements that involve risks and uncertainties. See “Special Note Regarding Forward-Looking Statements.” Our actual results may differ substantially from those referred to herein due to a number of factors, including but not limited to risks described in the section entitled “Risk Factors” and elsewhere in this Annual Report.
Our predecessor, C3 Jian, Inc., was incorporated under the laws of the state of California on November 4, 2005. On February 26, 2016, as part of a reorganization transaction, C3 Jian, Inc. merged with a wholly owned subsidiary of C3J, and as part of this process, C3 Jian, Inc. was converted to a limited liability company organized under the laws of the State of California named C3 Jian, LLC. On May 9, 2019, C3J completed a reverse merger with AmpliPhi, where Ceres Merger Sub, Inc., a wholly-owned subsidiary of AmpliPhi, merged with and into C3J. Following the completion of the Merger, and a $10.0 million concurrent private placement financing, the former C3J stockholders owned approximately 76% of our common stock and the former AmpliPhi stockholders owned approximately 24% of our common stock.
Immediately prior to the Merger, AmpliPhi completed a 1-for-14 reverse stock split and changed its name to Armata Pharmaceuticals, Inc. Our common stock is traded on the NYSE American exchange under the symbol “ARMP.” We are headquartered in Marina Del Rey, CA, in a 35,500 square-foot research and development facility built for product development with capabilities spanning from bench to clinic. In addition to microbiology, synthetic biology, formulation, chemistry and analytical laboratories, the facility is equipped with two licensed GMP drug manufacturing suites enabling the production, testing and release of clinical material.
Statements contained in this Annual Report that are not statements of historical fact are forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995. Such forward-looking statements include, without limitation, statements concerning product development plans, commercialization of our products, the expected market opportunity for our products, the use of bacteriophages and synthetic phages to kill bacterial pathogens, having resources sufficient to fund our operations into the first quarter of 2023, future funding sources, general and administrative expenses, clinical trial and other research and development expenses, costs of manufacturing, costs relating to our intellectual property, capital expenditures, the expected benefits of our targeted phage therapies strategy, the potential market for our products, tax credits and carry-forwards, and litigation-related matters. Words such as “believe,” “anticipate,” “plan,” “expect,” “intend,” “will,” “goal,” “potential” and similar expressions are intended to identify forward-looking statements, though not all forward-looking statements necessarily contain these identifying words. These statements are subject to risks and uncertainties. Our actual results could differ materially from those
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anticipated in these forward-looking statements as a result of various factors, including those set forth below under Item 1A, “Risk Factors” and elsewhere in this Annual Report on Form 10-K. These forward-looking statements speak only as of the date on which they were made, and we undertake no obligation to update any forward-looking statements.
Overview
We are a clinical-stage biotechnology company focused on the development of pathogen-specific bacteriophage therapeutics for the treatment of antibiotic-resistant and difficult-to-treat bacterial infections using our proprietary bacteriophage-based technology. Bacteriophages or “phages” have a powerful and highly differentiated mechanism of action that enables binding to and killing specific bacteria, in contrast to traditional broad-spectrum antibiotics. We believe that phages represent a promising means to treat bacterial infections, especially those that have developed resistance to current standard of care therapies, including the so-called multidrug-resistant or “superbug” strains of bacteria. We are a leading developer of phage therapeutics which are uniquely positioned to address the growing worldwide threat of antibiotic-resistant bacterial infections .
We are combining our proprietary approach and expertise in identifying, characterizing and developing both naturally-occurring and engineered (synthetic) bacteriophages with our proprietary phage-specific current good manufacturing practice regulation (“cGMP”) manufacturing capabilities to advance a broad pipeline of high-quality bacteriophage product candidates. We believe that synthetic phage, engineered using advances in sequencing and synthetic biology techniques, represent a promising means to advance phage therapy, including improving upon the ability of natural phage to treat bacterial infections, especially those that have developed resistance to current antibiotic therapies, including the multidrug-resistant or “superbug” bacterial pathogens.
We are developing and advancing our lead clinical phage candidate for Pseudomonas aeruginosa . On October 14, 2020, Armata received the approval to proceed from the U.S. Food and Drug Administration (“FDA”) for its Investigational New Drug application for AP-PA02. We plan to continue to advance the “SWARM- P.a. ” study – a Phase 1b/2a, multicenter, double-blind, randomized, placebo-controlled, single ascending dose (“SAD”) and multiple ascending dose (“MAD”) clinical trial to evaluate the safety and tolerability of inhaled AP-PA02 in subjects with CF and chronic pulmonary P. aeruginosa infection, provided that the impacts of COVID-19 do not further impede our ability to enroll subjects in this clinical trial. This study is supported by the Cystic Fibrosis Foundation (“CFF”), which granted us a Therapeutics Development Award of up to $5.0 million.
We are also developing a phage product candidate for Staphylococcus aureus for the treatment of S. aureus bacteremia. On June 15, 2020, we entered into an agreement (the “MTEC Agreement”) with the Medical Technology Enterprise Consortium (“MTEC”), pursuant to which we expect to receive a $15.0 million grant and entered into a three-year program administered by the U.S Department of Defense (“DoD”) through MTEC with funding from the Defense Health Agency and Joint Warfighter Medical Research Program. We expect to use the grant to partially fund a Phase 1/2, multi-center, randomized, double-blind, placebo- controlled dose escalation study, provided that the COVID-19 pandemic has been reduced to the point that clinical trials in patients are enrolling, that will assess the safety, tolerability, and efficacy of this development program, using our phage-based candidate, AP-SA02, for the treatment of adults with S. aureus bacteremia .
In addition to our more advanced pipeline programs, we have phage development efforts underway to target other indications including non-cystic fibrosis bronchiectasis (“NCFB”), prosthetic joint infections (“PJI”) and hospitalized pneumonia.
Our proprietary phage engineering platform serves to enhance the clinical and commercial prospects of phage therapy.
We are committed to conducting randomized controlled clinical trials required for FDA approval in order to move toward the commercialization of alternatives to traditional antibiotics and provide a potential method of treating patients suffering from drug-resistant and difficult-to-treat bacterial infections.
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The following chart summarizes the status of our phage product candidate development programs and partners.
We have generally incurred net losses since our inception and our operations to date have been primarily limited to research and development and raising capital. As of December 31, 2021, we had an accumulated deficit of $202.9 million. We anticipate that a substantial portion of our capital resources and efforts in the foreseeable future will be focused on completing the development and seeking to obtain regulatory approval of our product candidates.
We currently expect to use our existing cash and cash equivalents for the continued research and development of our product candidates, including through our targeted phage therapies strategy, and for working capital and other general corporate purposes. We expect to continue to incur significant and increasing operating losses at least for the next several years. We do not expect to generate product revenue unless and until we successfully complete development and obtain marketing approval for at least one of our product candidates.
We may also use a portion of our existing cash and cash equivalents for the potential acquisition of, or investment in, product candidates, technologies, formulations or companies that complement our business, although we have no current understandings, commitments or agreements to do so. Our existing cash and cash equivalents will not be sufficient to enable us to complete all necessary development of any potential product candidates. Accordingly, we will be required to obtain further funding through one or more other public or private equity offerings, debt financings, collaboration, strategic financing, grants or government contract awards, licensing arrangements or other sources. Our ability to raise additional capital may be adversely impacted by potential worsening global economic conditions and the recent disruptions to, and volatility in, financial markets in the United States and worldwide resulting from the ongoing COVID-19 pandemic. Adequate additional funding may not be available to us on acceptable terms, or at all. If we are unable to raise capital when needed or on acceptable terms, we may be required to defer, reduce or eliminate significant planned expenditures, restructure, curtail or eliminate some or all of our development programs or other operations, dispose of assets, enter into arrangements that may require us to relinquish rights to certain of our product candidates, technologies or potential markets, file for bankruptcy or cease operations altogether. Any of these events could have a material adverse effect on our business, financial condition and results of operations and result in a loss of investment by our stockholders.
Business Update Regarding COVID-19
In March 2020, the World Health Organization (“WHO”) declared COVID-19 a global pandemic and the United States declared a national emergency with respect to COVID-19.
The COVID-19 pandemic has directly and indirectly impacted our business, results of operations and financial condition and is expected to continue to impact our business. For example, the COVID-19 pandemic has resulted in delays in our clinical trials due to the implementation of COVID-19 protocols at investigator sites, which resulted in
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longer than anticipated site identification and initiation activities. In addition, while we currently do not anticipate any interruptions in our supply chain, it is possible that the COVID-19 pandemic and the continuing response efforts may have a future impact on our third-party suppliers and partners. It is possible that due to the continued development and manufacturing of vaccines for COVID-19, certain basic supply chain materials such as resins, vessels, vials and stoppers may be in high demand by the pharmaceutical companies developing and manufacturing vaccines and our ability to obtain these materials for our development activities could be negatively impacted. Although we have experienced some delays of this nature during 2021, such delays have not had a material adverse impact on our business, results of operations or financial condition .
The full extent of the COVID-19 pandemic impact continues to depend on future developments that remain highly uncertain and cannot be accurately predicted, including new information that may emerge concerning COVID-19, the actions taken to contain it or treat its impact, the identification and spread of COVID-19 variants such as the Delta and the Omicron variants, the distribution of vaccines, the acceptance of vaccines and the implementation of vaccine mandates, and the economic impact on local, regional, national and international markets. Management continues to actively monitor the developments regarding the pandemic and the impact that the pandemic could have on our financial condition, liquidity, ability to enroll patients in our contemplated clinical trials, manufacturing and research and development operations, suppliers to our operations and suppliers to our outside clinical trial organizations, biotech industry overall, and importantly the health and safety of our workforce. Given the continued volatility of the COVID-19 pandemic and the global responses to curb its spread, we are not able to estimate the effects of the COVID-19 pandemic on our results of operations, financial condition, or liquidity for 2022. Any recovery from negative impacts to our business and related economic impact due to the COVID-19 pandemic may also be slowed or reversed by a number of factors, including the recent widespread resurgence in COVID-19 infections attributable to the Omicron variant, combined with the seasonal flu.
Recent Events
NCFB Investigational New Drug (“IND”) Approval
On February 22, 2022, we announced that the U.S. FDA has cleared Armata's IND application to initiate a clinical trial of its optimized lead therapeutic candidate, AP-PA02, in a second indication, NCFB. The company plans to initiate a Phase 2 trial in 2022.
February 2022 Private Placement
On February 9, 2022, we entered into a securities purchase agreement to sell our common stock and warrants to Innoviva Strategic Opportunities LLC, a wholly ‐ owned subsidiary of Innoviva, Inc. (Nasdaq: INVA) (collectively, "Innoviva"), our largest shareholder. The gross proceeds from the transaction are expected to be $45 million, before deducting estimated offering expenses.
Pursuant and subject to the terms and conditions of the securities purchase agreement and related agreements, Innoviva will purchase 9,000,000 newly issued shares of our common stock, at a price of $5.00 per share, and warrants to purchase up to 4,500,000 additional shares of our common stock, with an exercise price of $5.00 per share. The stock purchases are expected to occur in two tranches. Upon execution, Innoviva purchased approximately 3,614,792 shares of common stock and warrants to purchase approximately 1,807,396 shares of common stock for an aggregate purchase price of approximately $18.1 million. At the closing of the second tranche, upon our stockholders voting in
favor of the transaction, Innoviva will purchase approximately 5,385,208 shares of common stock and warrants to purchase approximately 2,692,604 shares of common stock for an aggregate purchase price of $26.9 million.
Subject to the satisfaction of certain closing conditions, including the approval of our stockholders, the second closing contemplated by the securities purchase agreement is expected to occur near the end of the first quarter of 2022.
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October 2021 Private Placements
On October 28, 2021, we entered into a securities purchase agreement (the “October 2021 Securities Purchase Agreement”) with the Cystic Fibrosis Foundation, a Delaware corporation (“CFF”), our partner for the lead Phase 1b/2a clinical development program, and Innoviva for the private placement of newly issued shares of our common stock. Pursuant to the October 2021 Securities Purchase Agreement, we issued and sold 909,091 shares to CFF and 1,212,122 shares to Innoviva, each at a per share price of $3.30 (the “October 2021 Private Placements”). We received aggregate gross proceeds from the October 2021 Private Placements of approximately $7.0 million, before deducting transaction expenses .
2021 Lease Agreement
On October 28, 2021, we entered into a lease for office and research and development space under a non-cancellable lease in Los Angeles, CA (the “2021 Lease”). The leased space comprises approximately 56,000 square feet. The 2021 Lease payment start date is May 1, 2022 and the total lease term is for 16 years and runs through 2038. Monthly rent for 2022 and 2023 will be fully or partially abated while we and the lessor complete planned tenant improvements to the facility. Base monthly rent will be approximately $0.25 million in 2024. We are entitled to receive an allowance for tenant improvements of up to $7.3 million.
Selected Financial Data
The selected consolidated financial data set forth below as of December 31, 2021 and 2020, and for the years ended December 31, 2021 and 2020, are derived from our audited consolidated financial statements included elsewhere in this report. This information should be read in conjunction with those consolidated financial statements, the notes thereto, and with “ Management’s Discussion and Analysis of Financial Condition and Results of Operations .”
For the year ended December 31,
2021
2020
Statement of Operations Data:
Grant revenue
$
4,474,000
$
823,000
Loss from operations
$
(23,822,000)
$
(21,587,000)
Net loss
$
(23,155,000)
$
(22,181,000)
Net loss per share, basic and diluted
$
(0.96)
$
(1.35)
Shares used in computing net loss per share, basic and diluted
24,104,146
16,415,012
As of December 31,
2021
2020
Balance Sheet Data:
Cash and cash equivalents
$
10,288,000
$
9,649,000
Working capital
10,181,000
4,141,000
Total assets
69,768,000
39,516,000
Total liabilities
44,371,000
20,659,000
Accumulated deficit
(202,857,000)
(179,702,000)
Total stockholders’ equity
$
25,397,000
$
18,857,000
Results of Operations
Comparison of year ended December 31, 2021 and 2020
Grant Revenue
We recognized $4.5 million and $0.8 million of grant revenue during the year ended December 31, 2021 and 2020, respectively, which represents the Medical Technology Enterprise Consortium (“MTEC’s”) share of the costs incurred for the Company’s AP-SA02 program for the treatment of Staphylococcus aureus bacteremia infections.
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Research and Development
Research and development expenses for the year ended December 31, 2021 and 2020 were $20.0 million and $14.4 million, respectively. The net increase of $5.6 million was primarily related to an increase of $5.3 million in increased contracted research costs, laboratory supplies and consulting expenses related to ongoing clinical trials and an increase of $2.7 million in personnel costs, These increases were offset by credits to research and development expenses of $2.8 million related to our award agreement with the Cystic Fibrosis Foundation (“CFF”) and a $0.6 million tax rebate from Australian tax authorities during the year ended December 31, 2021, as compared to $1.1 million received from CFF and the the National Institute of Health (“NIH”) during the year ended December 31, 2020 .
General and Administrative
General and administrative expenses for the year ended December 31, 2021 were $8.3 million, which remained largely consistent with $8.0 million for the same period during 2020.
Gain upon extinguishment of Paycheck Protection Program loan
In April 2020, we received loan proceeds of $717,000 (“PPP Loan”) under the Paycheck Protection Program (“PPP”). The PPP, established as part of the Coronavirus Aid, Relief and Economic Security Act, provides for loans to qualifying businesses for amounts up to 2.5 times the average monthly payroll expenses of the qualifying business, calculated as provided under the PPP. The PPP provides a mechanism for forgiveness of up to the full amount borrowed, and in July 2021, we received notification of forgiveness of the full loan amount and associated interest from the Small Business Administration. We recorded a gain of $0.7 million from the PPP Loan extinguishment in the statement of operations during the year ended December 31, 2021.
Other Income (Expense)
For the year ended December 31, 2021 and 2020, we recorded noncash interest expense of $0.1 million and $0.6 million, respectively, as a result of interest accretion on the time-based cash payments due in connection with the asset acquisition transaction with Synthetic Genomics, Inc. (“SGI”).
Income Taxes
There was no income tax expense or benefit for the year ended December 31, 2021 or December 31, 2020.
Operating Activities
Net cash used in operating activities for the year ended December 31, 2021 was $23.6 million, as compared to $18.3 million for the year ended December 31, 2020. The increase of $5.3 million was due to a $1.0 million increase in net loss, $2.0 million net decrease in non-cash adjustments to cash used in operating activities, offset by a $2.3 million net decrease in operating assets and liabilities.
Investing Activities
Net cash used in investing activities of $1.3 million and $0.8 million for the years ended December 31, 2021 and 2020 was related to purchases of property and equipment.
Financing Activities
Net cash provided by financing activities was $25.5 million for the year ended December 31, 2021, which was primarily comprised of $19.3 million net proceeds raised from the January 2021 private placement transactions with Innoviva, $6.9 million net proceeds raised from the October 2021 private placement transaction with CFF and Innoviva, and $0.6 million of proceeds received from stock option exercises, offset by a principal payment of $1.4 million in deferred consideration related to the time-based payment obligation in connection with the SGI asset acquisition.
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Net cash provided by financing activities was $23.2 million for the year ended December 31, 2020, which was primarily comprised of $22.9 million net proceeds raised from the 2020 Private Placement transaction with Innoviva, $0.7 million proceeds from the PPP loan, and $0.2 million proceeds received from warrant and employee stock option exercises, offset by a payment of $0.6 million in deferred consideration related to the time-based payment obligation in connection with the SGI asset acquisition.
Liquidity, Capital Resources and Financial Condition
We have prepared our consolidated financial statements on a going concern basis, which assumes that we will realize our assets and satisfy our liabilities in the normal course of business. However, we have incurred net losses since our inception and have negative operating cash flows. These circumstances raise substantial doubt about our ability to continue as a going concern. The accompanying financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classifications of liabilities that may result from the outcome of the uncertainty concerning our ability to continue as a going concern. Management plans to raise additional capital through equity offerings, debt financings, or other capital sources, including potential collaborations, licenses and other similar arrangements. While management believes this plan to raise additional funds will alleviate the conditions that raise substantial doubt, these plans are not entirely within its control and cannot be assessed as being probable of occurring. We may not be able to secure additional financing in a timely manner or on favorable terms, if at all.
On January 26, 2021 and October 28, 2021, we entered into the Securities Purchase Agreement in connection with the January and October 2021 Private Placements. On February 9, 2022, we entered into the Securities Purchase Agreement in connection with the February 2022 Private Placement. See the section entitled “Business—Recent Developments” for a description of the 2021 and 2022 Private Placements, which is incorporated herein by reference.
Management believes our existing cash resources and expected proceeds from the second tranche of the February 2022 Private Placement will be sufficient to fund our planned operations into the first quarter of 2023, but not one year from the issuance of the 2021 financial statements. For the foreseeable future, our ability to continue our operations is dependent upon our ability to obtain additional capital.
Future Capital Requirements
We will need to raise additional capital in the future to continue to fund our operations. Our future funding requirements will depend on many factors, including:
● the costs and timing of our research and development activities;
● the progress and cost of our clinical trials and other research and development activities;
● manufacturing costs associated with our targeted phage therapies strategy and other research and development activities;
● the terms and timing of any collaborative, licensing, acquisition or other arrangements that we may establish;
● whether and when we receive future Australian tax rebates, if any;
● the costs and timing of seeking regulatory approvals;
● the costs of filing, prosecuting and enforcing any patent applications, claims, patents and other intellectual property rights; and
● the costs of potential lawsuits involving us or our product candidates.
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We may seek to raise capital through a variety of sources, including:
● the public equity market;
● private equity financings;
● collaborative arrangements, government grants or strategic financings;
● licensing arrangements; and
● public or private debt.
Any additional fundraising efforts may divert our management team from their day-to-day activities, which may adversely affect our ability to develop and commercialize our product candidates. Our ability to raise additional funds will depend, in part, on the success of our product development activities, including our targeted phage therapies strategy and any clinical trials we initiate, regulatory events, our ability to identify and enter into in-licensing or other strategic arrangements, and other events or conditions that may affect our value or prospects, as well as factors related to financial, economic and market conditions, many of which are beyond our control. We cannot be certain that sufficient funds will be available to us when required or on acceptable terms. If we are unable to secure additional funds on a timely basis or on acceptable terms, we may be required to defer, reduce or eliminate significant planned expenditures, restructure, curtail or eliminate some or all of our development programs or other operations, dispose of technology or assets, pursue an acquisition of our company by a third party at a price that may result in a loss on investment for our stockholders, enter into arrangements that may require us to relinquish rights to certain of our product candidates, technologies or potential markets, file for bankruptcy or cease operations altogether. Any of these events could have a material adverse effect on our business, financial condition and results of operations. Moreover, if we are unable to obtain additional funds on a timely basis, there will be substantial doubt about our ability to continue as a going concern and increased risk of insolvency and loss of investment by our stockholders. To the extent that additional capital is raised through the sale of equity or convertible debt securities, the issuance of such securities could result in dilution to our existing stockholders. Our ability to raise additional capital may be adversely impacted by potential worsening global economic conditions and the recent disruptions to, and volatility in, financial markets in the United States and worldwide resulting from the ongoing COVID-19 pandemic.
Critical Accounting Policies and Use of Estimates
Our significant accounting policies are described in Note 3 to the consolidated financial statements included in this Annual Report.
Our management’s discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements as of December 31, 2021 and December 31, 2020, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, and expenses and the related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates and judgments, including those related to impairment assessment of our grants and awards, indefinite lived intangible assets, and stock-based compensation. We base our estimates on historical experience, known trends and events, and various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
Grants and Awards
We determined that grants and awards are out of the scope of ASC Topic 606, Revenue from Contracts with Customers (“ASC 606”) because the funding entities do not meet the definition of a “customer”, as defined by ASC 606, as there is no transfer of control of goods or services. With respect to each grant or award, we determine if it has a collaboration in accordance with ASC Topic 808, Collaborative Arrangements (“ASC 808”). To the extent the grant or award is within the scope of ASC 808, we recognize the award upon achievement of certain milestones as credits to
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research and development expenses. For grant and awards outside the scope of ASC 808, we apply ASC 606 or International Accounting Standards No. 20, Accounting for Government Grants and Disclosure of Government Assistance , by analogy, and revenue is recognized when we incur expenses related to the grants for the amount we are entitled to under the provisions of the contract.
We also consider the guidance in ASC Topic 730, Research and Development (“ASC 730”), which requires an assessment, at the inception of the grant or award, of whether the agreement is a liability . If we are obligated to repay funds received regardless of the outcome of the related research and development activities, then we are required to estimate and recognize that liability. Alternatively, if we are not required to repay the funds, then payments received are recorded as revenue or contra-expense as the expenses are incurred.
Deferred grant or award liability represents award funds received or receivable for which the allowable expenses have not yet been incurred as of the balance sheet date.
Valuation of Goodwill and Intangible Assets with Indefinite Lives
Our goodwill represents the excess of the cost over the fair value of net assets acquired from our business combination. The determination of the value of goodwill and intangible assets arising from the business combination requires extensive use of accounting estimates and judgments to allocate the purchase price to the fair value of the net tangible and intangible assets acquired, including capitalized in-process research and development (“IPR&D”). Intangible assets acquired in a business combination that are used for IPR&D activities are considered indefinite lived until the completion or abandonment of the associated research and development efforts. Upon commercialization of the relevant research and development project, we will amortize the acquired in-process research and development over its estimated useful life or expense the acquired in-process research and development should the research and development project be unsuccessful with no future alternative use.
Goodwill and IPR&D are not amortized; however, they are assessed for impairment using fair value measurement techniques on an annual basis or more frequently if facts and circumstance warrant such a review. The goodwill or IPR&D are considered to be impaired if we determine that the carrying value of the reporting unit or IPR&D exceeds its respective fair value, respectively.
Impairment of Goodwill
We perform our goodwill impairment analysis at the reporting unit level. For the years ended December 31, 2021 and 2020, our company has one reporting unit. We perform our annual impairment analysis by either doing a qualitative assessment of a reporting unit’s fair value from the last quantitative assessment to determine if there is potential impairment, or comparing a reporting unit’s estimated fair value to its carrying amount. If a quantitative assessment is performed the evaluation includes management estimates of cash flow projections based on internal future projections and/or use of a market approach by looking at market values of comparable companies. Our market capitalization is also considered as a part of this analysis.
In accordance with our accounting policy, we completed the annual evaluation for impairment of goodwill as of December 31, 2021 using the qualitative method and determined that no impairment existed.
Impairment Review of In-process Research and Development
We test our IPR&D asset for impairment as of December 31 of each year or more frequently if indicators of impairment are present. The authoritative accounting guidance provides an optional qualitative assessment for any indicators that indefinite-lived intangible assets are impaired. If it is determined that it is more likely than not that the indefinite-lived intangible assets, including IPR&D, are impaired, the fair value of the indefinite-lived intangible assets is compared with the carrying amount and impairment is recorded for any excess of the carrying amount over the fair value of the indefinite-lived intangible assets.
If and when a quantitative analysis of IPR&D assets is required based on the result of the optional qualitative assessment, the estimated fair value of IPR&D assets is calculated based on the income approach, which includes discounting expected future net cash flows associated with the assets to a net present value. The fair value measurements
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utilized to perform the impairment analysis are categorized within Level 3 of the fair value hierarchy. Significant management judgment is required in the forecast of future operating results that are used in our impairment analysis. The estimates management use are consistent with the plans and estimates that it uses to manage its business. Significant assumptions utilized the income approach model include the discount rate, timing of clinical studies and regulatory approvals, the probability of success of its research and development programs, timing of commercialization of these programs, forecasted sales, gross margin, selling, general and administrative expenses, capital expenditures, as well as anticipated growth rates. Our analysis indicated no impairment existed.
Research and Development
All research and development costs are expensed as incurred. Research and development costs consist primarily of salaries, employee benefits, costs associated with preclinical studies and clinical trials (including amounts paid to clinical research organizations and other professional services) and in process research and development expenses. Payments made prior to the receipt of goods or services to be used in research and development are capitalized until the goods or services are received.
We record accruals for estimated research and development costs, comprising payments for work performed by third party contractors, laboratories, participating clinical trial sites, and others. Some of these contractor’s bill monthly based on actual services performed, while others bill periodically based upon achieving certain contractual milestones. For the latter, we accrue the expenses as goods or services are used or rendered. Clinical trial site costs related to patient enrollment are accrued as patients enter and progress through the trial. Judgments and estimates are made in determining the accrued balances at the end of the reporting period.
Leases
We determine if an arrangement contains a lease at inception. We currently only have operating leases. We recognize a right-of-use operating lease asset and associated short- and long-term operating lease liability on the consolidated balance sheet for operating leases greater than one year. The right-of-use assets represent our right to use an underlying asset for the lease term and the lease liabilities represent our obligation to make lease payments arising from the lease arrangements. Right-of-use operating lease assets and lease liabilities are recognized based on the present value of the future minimum lease payments we will pay over the lease term. We determine the lease term at the inception of each lease, which includes renewal options only if we conclude that such options are reasonably certain to be exercised.
As our leases do not provide an interest rate implicit in the lease,we use our incremental borrowing rate, based on the information available on the date of adoption of Topic 842, Leases , as of the lease inception date or at the lease option extension date in determining the present value of future payments. We recognize rent expense for the minimum lease payments on a straight-line basis over the expected term of the leases. We recognize period expenses, such as common area maintenance expenses, in the period such expenses are incurred.
Stock-Based Compensation
Compensation expense related to stock options granted is measured at the grant date based on the estimated fair value of the award and is recognized on an accelerated attribution method over the requisite service period. We determine the estimated fair value of each stock option on the date of grant using the Black-Scholes valuation model which uses assumptions regarding a number of complex and subjective variables. The risk-free interest rate is based on the U.S. Treasury yield for a period consistent with the expected term of the option in effect at the time of the grant. Expected volatility is based on an analysis of the historical volatility of Armata and peer companies’ common stock. The expected term represents the period that we expect our stock options to be outstanding. The expected term assumption is estimated using the simplified method set forth in the U.S. Securities and Exchange Commission’s (the “SEC”) Staff Accounting Bulletin 110, which is the mid-point between the option vesting date and the expiration date. For stock options granted to parties other than employees or directors, we elect, on a grant by grant basis, to use the expected term or the contractual term of the option award. We have never declared or paid dividends on our common stock and have no plans to do so in the foreseeable future. Forfeitures are recognized as a reduction of stock-based compensation expense as they occur. Changes in these assumptions may lead to variability with respect to the amount of stock compensation expense we recognize related to stock options.
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Stock-based compensation expense for an award with a performance condition is recognized when the achievement of such performance condition is determined to be probable. If the outcome of such performance condition is not determined to be probable or is not met, no compensation expense is recognized and any previously recognized compensation expense is reversed.
Recent Accounting Pronouncements
Refer to Note 3 of the notes to the consolidated financial statements contained elsewhere in this Annual Report.
Off-Balance Sheet Arrangements
As of December 31, 2021, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. In addition, we do not engage in trading activities involving non-exchange traded contracts. Therefore, we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in these relationships.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are a smaller reporting company as defined by Rule 12b-2 of the Exchange Act and are not required to provide the information required under this item.