Cabaletta Bio, Inc. 10-K

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 together with the section entitled “Selected Financial Information” and our financial statements and related notes appearing elsewhere in this Annual Report on Form 10-K, or this Annual Report. Some of the information contained in this discussion and analysis or 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. As a result of many factors, including those factors set forth in the section entitled “Risk Factors,” our actual results could differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis. You should carefully read the section entitled “Risk Factors” to gain an understanding of the important factors that could cause actual results to differ materially from our forward-looking statements. Please also see the section entitled “Special Note Regarding Forward-Looking Statements.” We do not assume any obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. Overview We are a clinical-stage biotechnology company focused on the discovery and development of engineered T cell therapies, and exploring their potential to provide a deep and durable, perhaps curative, treatment, for patients with B cell-mediated autoimmune diseases. Our proprietary technology utilizes C himeric A uto A ntibody R eceptor, or CAAR, T cells that are designed to selectively bind and eliminate only specific B cells that produce disease-causing autoantibodies, or pathogenic B cells, while sparing normal B cells. Our lead CAAR T cell product candidate was designed based on the clinically validated and commercially approved Chimeric Antigen Receptor, or CAR, T cell technology that is marketed for the treatment of B cell cancers. By harnessing the power of targeted cell therapy, we believe our CAAR T product candidates have the potential to provide responses that may be a safer and more effective option than current treatments. We believe our technology, in combination with our proprietary C abaletta A pproach for selective B cell A blation platform, called our CABA platform, has applicability across over two dozen B cell-mediated autoimmune diseases that we have identified, evaluated and prioritized. In order to accelerate product development for our lead program and to access a proven cell therapy manufacturing platform, we have entered into a collaboration with the University of Pennsylvania, or Penn. We hold multiple agreements with Penn to develop CAAR T cell therapies for the treatment of these diseases. Our goal is to leverage our team’s expertise in autoimmunity and engineered T cell therapy and our collaboration with Penn to rapidly discover and develop our portfolio of CAAR T product candidates. Our initial focus is mucosal pemphigus vulgaris, or mPV, which is an autoimmune blistering disease. We submitted an Investigational New Drug, or IND, application for our lead product candidate, DSG3-CAART, to the U.S. Food and Drug Administration, or the FDA, in August 2019 and our IND was cleared in September 2019. The FDA granted DSG3-CAART orphan drug designation for the treatment of PV in January 2020, and fast track designation for improving healing of mucosal blisters in patients with mucosal pemphigus vulgaris, or mPV, in May 2020. Our lead product candidate, DSG3-CAART, designed to treat patients with mPV, is currently enrolling patients for a Phase 1 trial, or the DesCAARTes TM trial. In December 2020, we announced that the first patient had been dosed in the DesCAARTes TM trial. We expect to report the acute safety data from the first cohort of patients in the DesCAARTes TM trial in the first half of 2021, with additional topline data from any completed dose cohorts throughout the second half of 2021 . Our lead preclinical product candidate is designed for the treatment of muscle-specific kinase myasthenia gravis, or MuSK MG, and is currently in IND enabling studies, with an IND submission expected in the second half of 2021. We are also advancing additional product candidates currently in discovery-stage or preclinical development for the treatment of mucocutaneous PV, or mcPV, and Hemophilia A with Factor VIII, or FVIII, alloantibodies in addition to three undisclosed targets. We were incorporated in April 2017. In August 2018, we entered into multiple agreements with Penn to develop the CAAR T technology to treat B cell-mediated autoimmune diseases. Our operations to date have been financed primarily by net proceeds of $86.4 million from the sale of convertible notes and convertible preferred stock and net proceeds of $71.0 million from the sale of common stock in our initial public offering, or IPO, in October 2019. As of December 31, 2020, we had $108.7 million in cash and cash equivalents and investments. 127 Amended and Restated License Agreement with t he Trustees of the University of Pennsylvania and the Children’s Hospital of Philadelphia In August 2018, we entered into a license agreement with Penn, which was amended and restated in July 2019 to include the Children’s Hospital of Philadelphia, or CHOP, collectively, the Institutions, and collectively with such amendment, as amended in May 2020, the License Agreement, pursuant to which we obtained (a) a non-exclusive, non-sublicensable, worldwide research license to make, have made and use products in two subfields of use, (b) effective as of October 2018, an exclusive, worldwide, royalty-bearing license, with the right to sublicense, under certain of the Institutions’ intellectual property to make, use, sell, offer for sale and import products in the same two subfields of use, and (c) effective as of October 2018, a non-exclusive, worldwide, royalty-bearing license, with limited rights to sublicense, under certain of Penn’s know-how to make, have made, use, sell, offer for sale, import and have imported products in the same two subfields of use. Our rights are subject to the rights of the U.S. government and certain rights retained by the Institutions. Unless earlier terminated, the License Agreement expires on the expiration or abandonment or other termination of the last valid claim in Penn’s intellectual property licensed by us. We may terminate the License Agreement at any time for convenience upon 60 days written notice. In the event of an uncured, material breach, Penn may terminate the License Agreement upon 60 days written notice. Sponsored Research Agreements We have two sponsored research agreements, or SRAs, with Penn for the laboratories of Drs. Payne and Milone, who are also our scientific co-founders and members of our scientific advisory board. In May 2020, the agreement with Dr. Payne, or the Payne SRA, was expanded to include CAAR design and optimization efforts in three additional B cell-mediated autoimmune diseases . In August 2020, the Payne SRA was further amended to extend the term of the original research plan. Under the amended agreements, we are committed to funding a defined research plan through February 2023. The total estimated cost of the agreements is $11.8 million, which satisfies the $2.0 million annual obligation under the License Agreement. As of December 31, 2020, $7.1 million of cost has been incurred pursuant to these agreements. Master Translational Research Services Agreement In October 2018, we entered into a Master Translational Services Agreement with Penn, or the Services Agreement, pursuant to which Penn agreed to perform certain services related to the research and development of the technology licensed to us under the License Agreement, as well as certain clinical, regulatory and manufacturing services. The Services Agreement will expire on the later of (i) October 19, 2021 or (ii) completion of the services for which we have engaged Penn under the Services Agreement. Either party may terminate this agreement with or without cause upon a certain number of days’ prior written notice. The services encompassed by the Services Agreement are performed by different organizations at Penn pursuant to certain addenda to the Services Agreement, including the Center for Advanced Retinal and Ocular Therapeutics, or CAROT, Addendum, as amended in May 2020, and the CVPF Addendum. Components of Operating Results Revenue To date, we have not generated any revenue from product sales and do not expect to generate any revenue from the sales of products for several years, if at all. If our development efforts for our current or future product candidates are successful and result in marketing approval, we may generate revenue in the future from product sales. We cannot predict if, when or to what extent we will generate revenue from the commercialization and sale of our product candidates. We may never succeed in obtaining regulatory approval for any of our product candidates. We may also in the future enter into license or collaboration agreements for our product candidates or intellectual property, and we may generate revenue in the future from payments as a result of such license or collaboration agreements. 128 Operating Expenses Research and Development Our research and development expenses include: • personnel costs, which include salaries, benefits and stock-based compensation expense; • expenses incurred under agreements with consultants and third-party contract organizations that conduct research and development activities on our behalf; • costs related to sponsored research service agreements; • costs related to production of preclinical and clinical materials, including fees paid to contract manufacturers; • licensing fees for intellectual property and know-how; • laboratory and vendor expenses related to the execution of preclinical studies and ongoing and planned clinical trials; and • laboratory supplies and equipment used for internal research and development activities and related depreciation expense. We have not reported program costs since inception because historically we have not tracked or recorded our research and development expenses on a pre-clinical program-by-program basis. We use our personnel and infrastructure resources across the breadth of our research and development activities, which are directed toward identifying and developing product candidates. We expense all research and development costs in the periods in which they are incurred. Costs for certain research and development activities are recognized based on an evaluation of the progress to completion of specific tasks using information and data provided to us by our vendors and third-party service providers. We expect our research and development expenses to increase substantially for the foreseeable future as we continue to invest in research and development activities related to developing our product candidates, including investments in manufacturing, as our programs advance and we conduct clinical trials. The process of conducting the necessary clinical research to obtain regulatory approval is costly and time-consuming, and the successful development of our product candidates is highly uncertain. As a result, we are unable to determine the duration and completion costs of our research and development projects or when and to what extent we will generate revenue from the commercialization and sale of any of our product candidates. Because of the numerous risks and uncertainties associated with product development, we cannot determine with certainty the duration and completion costs of the current or future preclinical studies and clinical trials or if, when, or to what extent we will generate revenues from the commercialization and sale of our product candidates. We may never succeed in achieving regulatory approval for our product candidates. The duration, costs and timing of preclinical studies and clinical trials and development of our product candidates will depend on a variety of factors, including: • successful completion of preclinical studies and IND-enabling studies; • development of chemistry, manufacturing and controls, or CMC, processes and procedures for purposes of IND applications; • successful patient enrollment in, and the initiation and completion of, clinical trials; • the impact of any business interruptions to our operations, including the timing and enrollment of patients in our ongoing and planned clinical trials, or to those of our clinical sites, manufacturers, suppliers, or other vendors resulting from the COVID-19 pandemic or similar public health crisis; • receipt of regulatory approvals from applicable regulatory authorities; • establishing commercial manufacturing capabilities or arrangements with third-party manufacturers; 129 • obtaining and maintaining patent and trade secret protection and non-patent exclusivity; • launching commercial sales of our product candidates, if and when approved, whether alone or in collaboration with others; • acceptance of our product candidates, if and when approved, by patients, the medical community and third-party payors; • effectively competing with other therapies and treatment options; • a continued acceptable safety and efficacy profile following approval; • enforcing and defending intellectual property and proprietary rights and claims; and • achieving desirable medicinal properties for the intended indications. We may never succeed in achieving regulatory approval for any of our product candidates. We may obtain unexpected results from our preclinical studies and clinical trials. We may elect to discontinue, delay or modify clinical trials of some product candidates or focus on others. A change in the outcome of any of these factors could mean a significant change in the costs and timing associated with the development of our current and future preclinical and clinical product candidates. For example, if the FDA or another regulatory authority, were to require us to conduct clinical trials beyond those that we currently anticipate will be required for the completion of clinical development, or if we experience significant delays in execution of or enrollment in any of our preclinical studies or clinical trials, we could be required to expend significant additional financial resources and time on the completion of preclinical and clinical development. We expect our research and development expenses to increase for the foreseeable future as we continue the development of product candidates. General and Administrative Expenses Our general and administrative expenses consist primarily of personnel costs, costs related to maintenance and filing of intellectual property, depreciation expense and other expenses for outside professional services, including legal, human resources, audit and accounting services. Personnel costs consist of salaries, benefits and stock-based compensation expense. We expect our general and administrative expenses to increase over the next several years to support our continued research and development activities, manufacturing activities, increased costs of operating as a public company and the potential commercialization of our product candidates. We anticipate our general and administrative costs will increase with respect to the hiring of additional personnel, developing commercial infrastructure, fees to outside consultants, lawyers and accountants, and increased costs associated with being a public company such as expenses related to services associated with maintaining compliance with Nasdaq listing rules and SEC requirements, insurance and investor relations costs. Other Income Other income consists of interest earned on our cash equivalents, amortization of bond discount or premium and investment gains and losses realized during the period. 130 Results of Operations for the years ended December 3 1 , 20 20 and 201 9 The following sets forth our results of operations: Year Ended December 31, 2020 2019 Change (in thousands) Statements of Operations Data: Operating expenses: Research and development $ 21,376 $ 11,671 $ 9,705 General and administrative 12,457 7,012 5,445 Total operating expenses 33,833 18,683 15,150 Loss from operations (33,833 ) (18,683 ) (15,150 ) Other income: Interest income 494 1,740 (1,246 ) Net loss $ (33,339 ) $ (16,943 ) $ (16,396 ) Research and Development Expenses Research and development expenses were $21.4 million for the year ended December 31, 2020 as compared to $11.7 million for the year ended December 31, 2019. The table below summarizes our research and development expenses: Year Ended December 31, 2020 2019 Change (in thousands) Sponsored research activities $ 3,062 $ 2,228 $ 834 License of intellectual property and subscription fee 143 268 (125 ) Manufacturing of preclinical and clinical supplies 4,652 2,382 2,270 Clinical trials 1,202 441 761 Personnel 7,827 4,006 3,821 Development services 4,350 2,146 2,204 Other 140 200 (60 ) $ 21,376 $ 11,671 $ 9,705 Specific changes in our research and development expenses year over year include a: • $3.8 million increase in personnel costs primarily driven by an increase in headcount to support overall growth , including an increase of $0.7 million in stock-based compensation expense; • $2.3 million increase in manufacturing costs primarily due to vector manufacturing and cell processing capabilities and related activities ; • $2.2 million increase in costs under our development services from increased outsourced preclinical research activities and lab related expenses; • $0.8 million increase in costs under our sponsored research agreements primarily due to an expanded scope of research; • $0.8 million increase in clinical trial costs for the DesCAARTes TM trial, including outsourced costs and investigator payments to clinical trial sites; and • $0.2 million decrease in license of intellectual property and subscription fees and other due primarily to a non-refundable payment made to Penn under a Subscription and Technology Transfer Agreement in the third quarter of 2019 . 131 General and Administrative Expenses General and administrative expenses were $12.5 million for the year ended December 31, 2020 as compared to $7.0 million for the year ended December 31, 2019. The increase of $5.5 million in our general and administrative expenses year over year includes: • $2.6 million of additional personnel costs primarily driven by an increase in headcount to support overall growth , including an increase of $1.4 million in stock-based compensation expense; • $1.9 million of increased insurance costs, primarily as a result of being a public company for a full year; and • $1.0 million of additional services, including legal, audit and accounting, public relations, recruiting and other consulting fees and other general and administrative expenses, primarily as a result of being a public company . Other Income Interest income has decreased $1.2 million for the year ended December 31, 2020 as compared to the year ended December 31, 2019 primarily as a result of a significant decrease in interest rates beginning in March 2020. 132 Liquidity and Capital Resources Since our inception in April 2017 through December 31, 2020, our operations have been financed by proceeds of $86.4 million from the sale of convertible notes and our convertible preferred stock and proceeds of $71.0 million from the sale of common stock in our initial public offering. As of December 31, 2020, we had $108.7 million in cash, cash equivalents and investments. Cash in excess of immediate requirements is invested in accordance with our investment policy, primarily with a view to liquidity and capital preservation. We have incurred losses since our inception and, as of December 31, 2020, we had an accumulated deficit of $66.3 million. Our primary use of cash is to fund operating expenses, which consist primarily of research and development expenditures, and to a lesser extent, general and administrative expenditures. Cash used to fund operating expenses is impacted by the timing of when we pay these expenses, as reflected in the change in our outstanding prepaid expenses and other current assets, accounts payable and accrued expenses. Any product candidates we may develop may never achieve commercialization and we anticipate that we will continue to incur losses for the foreseeable future. We expect that our research and development expenses, general and administrative expenses, and capital expenditures will continue to increase. As a result, until such time, if ever, as we can generate substantial product revenue, we expect to finance our cash needs through a combination of equity offerings, debt financings or other capital sources, including potentially collaborations, licenses and other similar arrangements. Our primary uses of capital are, and we expect will continue to be, compensation and related expenses, third-party clinical research, manufacturing and development services, costs relating to the build-out of our headquarters, laboratories and manufacturing facility, license payments or milestone obligations that may arise, laboratory and related supplies, clinical costs, manufacturing costs, legal and other regulatory expenses and general overhead costs. Based upon our current operating plan, we believe that our existing cash, cash equivalents and investments as of December 31, 2020 will enable us to fund our operating expenses and capital expenditure requirements through at least the third quarter of 2022. We have based this estimate on assumptions that may prove to be wrong, and we could utilize our available capital resources sooner than we currently expect. We will continue to require additional financing to advance our current product candidates through clinical development, to develop, acquire or in-license other potential product candidates and to fund operations for the foreseeable future. We will continue to seek funds through equity offerings, debt financings or other capital sources, including potentially collaborations, licenses and other similar arrangements. However, we may be unable to raise additional funds or enter into such other arrangements when needed on favorable terms or at all. If we do raise additional capital through public or private equity offerings, the ownership interest of our existing stockholders will be diluted, and the terms of these securities may include liquidation or other preferences that adversely affect our stockholders’ rights. If we raise additional capital through debt financing, we may be subject to covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making capital expenditures or declaring dividends. Any failure to raise capital as and when needed could have a negative impact on our financial condition and on our ability to pursue our business plans and strategies. If we are unable to raise capital, we will need to delay, reduce or terminate planned activities to reduce costs. At-The-Market Offering Sales Agreement On November 10, 2020, we filed a registration statement on Form S-3 (File No. 333-250006) with the SEC, which was declared effective on November 18, 2020 (the Shelf Registration Statement), in relation to the registration of common stock, preferred stock, debt securities, warrants and/or units of any combination thereof for the purposes of selling, from time to time, our common stock, debt securities or other equity securities in one or more offerings. We also simultaneously entered into a Sales Agreement with Cowen and Company, LLC, to provide for the offering, issuance and sale of up to an aggregate amount of $75.0 million of our common stock from time to time in “at-the-market” offerings under the Shelf Registration Statement and subject to the limitations thereof. No shares have been sold pursuant to the Sales Agreement as of December 31, 2020. 133 Because of the numerous risks and uncertainties associated with research, development and commercialization of pharmaceutical products, we are unable to estimate the exact amount of our operating capital requirements. Our future funding requirements will depend on many factors, including, but not limited to: • the scope, progress, results and costs of researching, developing and manufacturing our lead product candidates or any future product candidates, and conducting preclinical studies and clinical trials; • the timing of, and the costs involved in, obtaining regulatory approvals or clearances for our lead product candidates or any future product candidates; • the impact of any business interruptions to our operations or to those of our clinical sites, manufacturers, suppliers, or other vendors resulting from the coronavirus disease (COVID-19) outbreak or similar public health crisis; • the number and characteristics of any additional product candidates we develop or acquire; • the timing of any cash milestone payments if we successfully achieve certain predetermined milestones; • the cost of manufacturing our lead product candidate or any future product candidates and any products we successfully commercialize, including costs associated with building-out our manufacturing capabilities; • our ability to establish and maintain strategic collaborations, licensing or other arrangements and the financial terms of any such agreements that we may enter into; • the expenses needed to attract and retain skilled personnel; • the costs associated with being a public company; and • the timing, receipt and amount of sales of any future approved or cleared products, if any. Further, our operating plans may change, and we may need additional funds to meet operational needs and capital requirements for clinical trials and other research and development activities. We currently have no credit facility or committed sources of capital. Because of the numerous risks and uncertainties associated with the development and commercialization of our product candidates, we are unable to estimate the amounts of increased capital outlays and operating expenditures associated with our current and anticipated product development programs. Cash Flows The following table summarizes our cash flows for the periods indicated: Year Ended December 31, 2020 2019 (in thousands) Net cash provided by (used in): Operating activities $ (26,770 ) $ (16,045 ) Investing activities (7,981 ) (693 ) Financing activities (24 ) 119,925 Net (decrease) increase in cash and cash equivalents $ (34,775 ) $ 103,187 134 Operating Activities During the year ended December 31, 2020, cash used in operating activities of $26.8 million was attributable to our net loss of $33.3 million, offset by the net change of $1.6 million in our net operating assets and liabilities and non-cash charges of $4.9 million for stock-based compensation charges, amortization of premium on investments and depreciation. During the year ended December 31, 2019, cash used in operating activities of $16.0 million was attributable to our net loss of $16.9 million, increased by the net change of $1.5 million in our net operating assets and liabilities and offset by non-cash charges of $2.4 million for stock-based compensation charges and depreciation. Investing Activities During the year ended December 31, 2020, cash used in investing activities of $8.0 million was attributable to $11.1 million of purchases of investments and $0.6 million of purchases of property and equipment, partially offset by proceeds of $3.7 million from maturities of investments. During the year ended December 31, 2019, we used $0.7 million of cash and cash equivalents in investing activities consisting of purchases of property and equipment. Financing Activities During the year ended December 31, 2020, cash used in financing activities included $0.2 million in payments for common stock issuance costs from our IPO in October 2019, offset by $0.2 million in proceeds from stock option exercises and purchases of shares under the employee stock purchase plan. During the year ended December 31, 2019, cash provided by financing activities of $119.9 million was attributable to $48.7 million of net proceeds upon the issuance of Series B convertible preferred stock in January 2019 and $71.2 million of net proceeds from the issuance of common stock in our initial public offering in October 2019. Contractual Obligations and Commitments In February 2019, we entered into an operating lease agreement for office space in Philadelphia, Pennsylvania. The lease term commenced in May 2019 and will expire in July 2022. The initial annual base rent was $0.3 million, and such amount will increase by 2% annually on each anniversary of the commencement date. Our commitments include: • The License Agreement. Under the License Agreement, we are required to make milestone payments upon successful completion of certain development, regulatory and sales milestones on a product-by-product and geographical basis. The payment obligations under the License Agreement are contingent upon future events such as our achievement of specified development, regulatory and commercial milestones and we will be required to make development milestone payments and royalty payments in connection with the sale of products developed under the License Agreement. As of December 31, 2020, we are unable to estimate the timing or likelihood of achieving the milestones or making future product sales. We were also obligated to pay $2.0 million annually for three years beginning August 2018 for funding to the laboratories of Drs. Payne and Milone. Under the License Agreement, we must use commercially reasonable efforts to develop and commercialize a product in each subfield. During the term of the License Agreement until the first commercial sale of the first product, we are obligated to pay Penn a non-refundable, non-creditable annual license maintenance fee of $10,000. We are required to pay certain milestone payments upon the achievement of specified clinical and commercial milestones. Milestone payments are reduced by a certain percentage for the second product that achieves a milestone, by an additional percentage for the third product that achieves a milestone, and so on, for each subsequent product that achieves a milestone. In the event that we are able to successfully develop and launch multiple products under the License Agreement, total milestone payments could be approximately $21.0 million. Penn is also 135 eligible to receive tiered royalties at percentage rates in the low single-digits, subject to an annual minimum royalty, on annual worldwide net sales of any products that are commercialized by us or our sublicensees that contain or incorporate, or are covered by, the intellectual property licensed by us. To the extent we sublicense our license rights under the License Agreement, Penn would be eligible to receive tiered sublicense income at percentage rates in the mid-single to low double-digits. We have also entered into a subscription and technology transfer agreement with Penn, pursuant to which we owed Penn an upfront subscription fee, which was paid in 2019, and a nominal non-refundable royalty on net sales of products, a portion of which will be credited toward milestone payments and royalties under this License Agreement. Technology transfer activities would be at our cost and subject to agreement as to the technology to be transferred. • Master Translational Research Services Agreement with Penn. Under the Services Agreement, we have contracted for additional research and development services from various laboratories within Penn. The Services Agreement will expire upon completion of the services for which we have engaged Penn under the Services Agreement. In May 2020, the Company amended its Addendum with the Center for Advanced Retinal and Ocular Therapeutics (CAROT) to expand access to vector manufacturing. The Company may incur additional expenses up to $1.4 million through the remaining term of the CAROT Amended Addendum. • Sponsored Research Agreements. We have two sponsored research agreements, or SRAs, with Penn for the laboratories of our scientific co-founders Drs. Payne and Milone. In May 2020, the Payne SRA was expanded to include CAAR design and optimization efforts in three additional B cell-mediated autoimmune diseases . In August 2020, this agreement was further amended to extend the term of the original research plan. Under the amended agreements, we are committed to funding a defined research plan through February 2023. The total estimated cost of the agreements is $11.8 million, which satisfies the $2.0 million annual obligation under the License Agreement. As of December 31, 2020, $7.1 million of cost has been incurred pursuant to these agreements. • Manufacturing agreements . In January 2021, we entered into a Development and Manufacturing Services Agreement (Wuxi Agreement) with WuXi Advanced Therapies, Inc. (Wuxi) to serve as our cell processing manufacturing partner for the anticipated MuSK-CAART Phase 1 clinical trial. We have the right to terminate the Wuxi Agreement for convenience or other reasons specified in the Wuxi Agreement upon prior written notice. If we terminate the Wuxi Agreement, we will be obligated to pay an early termination fee of $1.5 million. In February 2021, we entered into a research service agreement with CHOP for vector manufacturing, with a total cost of $0.7 million, expected to be incurred during 2021. • Other Purchase Commitments. In the normal course of business, we enter into various purchase commitments with third-party contract manufacturers for the manufacture and processing of our product candidates and related raw materials, contracts with contract research organizations for clinical trials and agreements with vendors for other services and products for operating purposes. These agreements generally provide for termination or cancellation other than for costs already incurred. 136 Off-Balance Sheet Arrangements During the periods presented, we did not have, nor do we currently have, any off-balance sheet arrangements as defined under SEC rules. Critical Accounting Policies and Significant Judgments and Estimates Our management’s 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, or GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported expenses incurred during the reporting periods. Our estimates are based on our historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We believe that the accounting policies discussed below are critical to understanding our historical and future performance, as these policies relate to the more significant areas involving management’s judgments and estimates. While our significant accounting policies are described in more detail in Note 2 to our financial statements appearing elsewhere in this Annual Report, we believe that the following accounting policies are those most critical to the judgments and estimates used in the preparation of our financial statements. Research and Development Costs We estimate costs of research and development activities conducted by service providers, which include activities under the License Agreement, the conduct of sponsored research, preclinical studies and contract manufacturing activities. We record the estimated costs of research and development activities based upon the estimated amount of services provided and include these costs in the accrued and other current liabilities or prepaid expenses on the balance sheets and within research and development expense on the statements of operations. We estimate these costs based on factors such as estimates of the work completed and budget provided and in accordance with agreements established with our collaboration partners and third-party service providers. We make significant judgments and estimates in determining the accrued liabilities and prepaid expense balances in each reporting period. As actual costs become known, we adjust our accrued liabilities or prepaid expenses. We have not experienced any material differences between accrued costs and actual costs incurred since our inception. Stock-based Compensation We measure our stock-based awards granted to employees and non-employees and shares issued under our employee stock purchase plan based on the estimated fair values of the awards on the respective grant dates. We use the Black-Scholes option-pricing model (Black-Scholes) to estimate the fair value of its stock-based awards and shares purchased under the employee stock purchase plan. The Company recognizes compensation expense for time-based awards on a straight-line basis over the requisite service period, which is generally the vesting period of the award. The Company accounts for forfeitures of stock option awards as they occur. Black-Scholes requires the use of subjective assumptions to determine the fair value of stock-based awards. These assumptions include: Fair value of common stock —Prior to our IPO in October 2019, the fair value of our common stock underlying stock-based awards was estimated on each grant date by our board of directors. In order to determine the fair value of our common stock underlying stock-based awards, our board of directors considered, among other things, a valuation of our common stock prepared by an unrelated third-party valuation firm in accordance with the guidance provided by the American Institute of Certified Public Accountants Practice Guide, Valuation of Privately-Held-Company Equity Securities Issued as Compensation . 137 Expected term —The expected term represents the period that stock-based awards are expected to be outstanding. The expected term for option grants is determined using the simplified method , which is the midpoint between the vesting period and the contractual term of the option. Expected volatility —As a privately held company prior to our IPO in October 2019, we have a limited trading history for our common stock and, as such, the expected volatility is estimated based on the average volatility for comparable publicly traded biotechnology companies over a period equal to the expected term of the stock-based awards. The comparable companies were chosen based on their similar size, stage in the life cycle or area of specialty. We will continue to apply this process until a sufficient amount of historical information regarding the volatility of our own stock price becomes available. Risk-free interest rate —The risk-free interest rate is based on the U.S. Treasury zero coupon issues in effect at the time of grant for periods corresponding with the expected term of a stock-based award. Expected dividend —We have never paid dividends on our common stock and have no plans to pay dividends on our common stock. Therefore, we used an expected dividend yield of zero. We will continue to use judgment in evaluating the assumptions utilized for our stock-based compensation expense calculations on a prospective basis. In addition to the assumptions used in Black-Scholes, the amount of stock-based compensation expense we recognize in our financial statements includes stock option forfeitures as they occur. Emerging Growth Company Status We are an emerging growth company, as defined in the JOBS Act. Under the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards issued subsequent to the enactment of the JOBS Act until such time as those standards apply to private companies. Section 107 of the JOBS Act provides that an emerging growth company may take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act of 1933 for complying with new or revised accounting standards issued subsequent to the enactment of the JOBS Act until such time as those standards apply to private companies. Section 107 of the JOBS Act provides that we can elect to opt out of the extended transition period at any time, which election is irrevocable. We have elected to use this extended transition period for complying with new or revised accounting standards that have different effective dates for public and private companies until the earlier of the date we (i) are no longer an emerging growth company or (ii) affirmatively and irrevocably opt out of the extended transition period provided in the JOBS Act. As a result, our financial statements may not be comparable to companies that comply with new or revised accounting pronouncements as of public company effective dates. Subject to certain conditions, as an emerging growth company, we may rely on certain other exemptions and reduced reporting requirements, including without limitation (i) providing an auditor’s attestation report on our system of internal controls over financial reporting pursuant to Section 404(b) of the Sarbanes-Oxley Act and (ii) complying with any requirement that may be adopted by the Public Company Accounting Oversight Board regarding mandatory audit firm rotation or a supplement to the auditor’s report providing additional information about the audit and the consolidated financial statements, known as the auditor discussion and analysis. We will remain an emerging growth company until the earlier of (a) the last day of the fiscal year in which we have total annual gross revenue of $1.07 billion or more; (b) the last day of the fiscal year following the fifth anniversary of the date of the completion of our initial public offering; (c) the date on which we have issued more than $1.0 billion in nonconvertible debt during the previous three years; or (d) the date on which we are deemed to be a large accelerated filer under the rules of the SEC. Recently Issued Accounting Pronouncements Not Yet Adopted In February 2016, the Financial Accounting Standards Board, or the FASB, issued ASU 2016-02, Leases (Topic 842), with guidance regarding the accounting for and disclosure of leases. The update requires lessees to recognize the liabilities related all leases, including operating leases, with a term greater than 12 months on the balance sheet. This update also requires lessees and lessors to disclose key information about their leasing transactions. This guidance was effective for public companies for annual and interim periods beginning after December 15, 2018. For all other entities, including Emerging Growth Companies, this standard is effective for annual reporting periods beginning after December 15, 2020, and interim periods within annual periods beginning after December 15, 2021. Early adoption is permitted. As an Emerging Growth Company, we will adopt Topic 842 138 for our annual period ending December 31 , 2021 , and have not yet finalized our assessment of the impact that ASU 2016-02 will have on our financial statements or financial statement disclosures.