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 together with our financial statements and the related notes and other financial information included elsewhere in this Form 10-K. Some of the information contained in this discussion and analysis contains forward-looking statements that involve risks and uncertainties. You should review the section titled “Risk Factors” in this Form 10-K for a discussion of important factors that could cause actual results to differ materially from the results described below.
Overview
We are a genetic medicines company focused on developing transformative therapies for rare, monogenic central nervous system, or CNS, disorders with limited or no approved treatment options. Our vision is to finally fulfill the promise of gene therapy by developing groundbreaking therapies that transform the lives of patients with rare monogenic CNS diseases. The field of genetic medicine is rapidly expanding and we believe we have a differentiated approach to developing treatments for rare, monogenic CNS disorders that enables us to select and advance product candidates with a higher probability of technical and regulatory success. We have entered into a strategic research collaboration with the Trustees of the University of Pennsylvania’s, or Penn’s, Gene Therapy Program, or GTP, headed by Dr. James Wilson, a leader in the genetic medicines field. We also leverage our close working relationship with Penn’s Orphan Disease Center, or ODC, to develop historical and prospective comparable natural history patient profiles for comparison to participants in interventional trials. Through this collaboration we have assembled a deep portfolio of genetic medicine product candidates, including our three lead product candidates, all of which we retain global rights.
We were incorporated in July 2017 under the laws of the State of Delaware. Since inception, we have devoted substantially all of our resources to acquiring and developing product and technology rights, conducting research and development, organizing and staffing our company, business planning and raising capital. We have incurred recurring losses, the majority of which are attributable to research and development activities, and negative cash flows from operations. Historically, we have funded our operations through the sale of convertible preferred stock and then, in the first quarter of 2020, we closed our IPO and received net proceeds of $227.5 million. Our net loss was $112.2 million and $45.6 million for the years ended December 31, 2020 and 2019, respectively. As of December 31, 2020, we had an accumulated deficit of $170.9 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. Our ability to generate product revenue sufficient to achieve profitability will depend heavily on the successful development and eventual commercialization of one or more of our current or future product candidates. We expect to continue to incur significant expenses and operating losses for the foreseeable future as we advance our product candidates through all stages of development and clinical trials and, ultimately, seek regulatory approval. In addition, if we obtain marketing approval for any of our product candidates, we expect to incur significant commercialization expenses related to product manufacturing, marketing, sales and distribution. Furthermore, we expect to incur additional costs associated with operating as a public company, including significant legal, accounting, investor relations and other expenses that we did not incur as a private company. Our net losses may fluctuate significantly from quarter-to-quarter and year-to-year, depending on the timing of our clinical trials and our expenditures on other research and development activities.
We will need to raise substantial additional capital to support our continuing operations and pursue our growth strategy. Until such time as we can generate significant revenue from product sales, if ever, we plan to finance our operations through the sale of equity, debt financings or other capital sources, which may include collaborations with other companies or other strategic transactions. There are no assurances that we will be successful in obtaining an adequate level of financing as and when needed to finance our operations on terms acceptable to us or at all. 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 secure adequate additional funding, we may have to significantly delay, scale back or discontinue the development and commercialization of one or more product candidates or delay our pursuit of potential in-licenses or acquisitions.
As of December 31, 2020, we had cash, cash equivalents and marketable securities of $304.8 million. We expect our existing cash, cash equivalents and marketable securities, together with the net proceeds of $165.9 million from our
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follow-on offering completed in January of 2021, will enable us to fund our operating expense and capital expenditures requirements for at least 24 months as of the date of this filing.
COVID-19 Impact
We are continuing to proactively monitor and assess the current coronavirus disease 2019, or COVID-19, global pandemic. Since early March 2020 we have activated a management team taskforce to assess and monitor the potential impact on our business that may result from this rapidly evolving crisis and to avoid any unnecessary potential delays to our programs. At this time, our lead programs and research activities remain on track. To date, we and our collaborators, including Penn and Catalent, have continued to operate without material impact on our programs. In addition, in response to the pandemic, we have implemented or are planning to implement various strategies to minimize any disruptions to our planned clinical studies, including remote clinical assessments, concierge services and structured video capture of participants in their home. The safety and well-being of employees, patients and partners is our highest priority.
Financial Operations Overview
License Agreement
University of Pennsylvania
In May 2020, we entered into an amended and restated research, collaboration and licensing agreement, or the Penn Agreement, with Penn, for research and development collaborations and exclusive license rights to patents for certain products and technologies, which superseded the sponsored research, collaboration and licensing agreement that we entered into with Penn in September 2018. Under the Penn Agreement, in addition to the obligation to fund certain research relating to the preclinical development of our seven licensed programs, we will fund discovery research conducted by Penn for five years, beginning in May 2020, and will receive exclusive rights, subject to certain limitations, to technologies resulting from the discovery program for Passage Bio products developed with GTP, such as novel capsids, toxicity reduction technologies and delivery and formulation improvements. Our funding commitment is $5.0 million a year for five years, with quarterly payments of $1.3 million. Under the Penn Agreement we have 10 options available to us to commence additional licensed programs for rare, monogenic CNS indications until May 2025. If we were to exercise any of these remaining options, we would owe Penn a non-refundable fee of $1.0 million per product indication.
The Penn Agreement requires that we make payments of up to $16.5 million per product candidate in aggregate upon the achievement of specific development milestone events by such licensed product for a first indication, reduced development milestone payments for the second and third indications and no development milestone payments for subsequent indications. In addition, on a product by product basis, we are obligated to make up to $55.0 million in sales milestone payments on each licensed product based on annual sales of the licensed product in excess of defined thresholds.
Upon successful commercialization of a product using the licensed technology, we are obligated to pay to Penn, on a licensed product-by-licensed product and country-by-country basis, tiered royalties (subject to customary reductions) in the mid-single digits on annual worldwide net sales of such licensed product. In addition, we are obligated to pay to Penn a percentage of sublicensing income, ranging from the mid-single digits to low double digits, for sublicenses under the Penn Agreement.
Collaboration and Manufacturing and Supply Agreements
Catalent
We have a collaboration agreement with Catalent Maryland, Inc., or Catalent (formerly Paragon Bioservices, Inc.), or the Catalent Collaboration Agreement. As part of the Catalent Collaboration Agreement, we paid Catalent an upfront fee for the commissioning, qualification, validation and equipping of a clean room suite. Subject to validation of the clean
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room suite, which was completed in the fourth quarter of 2020, we will pay an annual fee for five years for the use of the clean room suite. We have commenced manufacturing operations in the suite to support AAV production for our lead gene therapy product candidates for the treatment of rare monogenic CNS disorders.
In April 2020, we entered into a development services and clinical supply agreement, or the Manufacturing and Supply Agreement, with Catalent to secure clinical scale manufacturing capacity for batches of active pharmaceutical ingredients for our gene therapy product candidates. The Manufacturing and Supply Agreement provides for a term of five years which period may be extended once, at our option, for an additional five year-period. The Collaboration Agreement also remains in effect. In consideration for the use of the clean room suite, we have agreed to a minimum amount of purchase commitments for each year in the term, subject to adjustments for inflation.
Under both the Catalent Collaboration Agreement and the Manufacturing and Supply Agreement, we have an annual minimum commitment of $10.6 million per year owed to Catalent for five years from the validation of the clean room suite, subject to certain inflationary adjustments.
Components of Results of Operations
Research and Development and Acquired In-Process Research and Development
Research and development expenses consist primarily of costs incurred in connection with the discovery and development of our product candidates. These expenses include:
● expenses incurred to conduct the necessary preclinical studies and clinical trials required to obtain regulatory approval, including payments to Penn for preclinical development;
● costs incurred in obtaining technology licenses related to technology that has not reached technological feasibility and has no alternative future use;
● personnel expenses, including salaries, benefits and share-based compensation expense for employees engaged in research and development functions;
● costs of funding research performed by third parties, including pursuant to agreements with CROs, as well as investigative sites and consultants that conduct our preclinical studies and clinical trials;
● expenses incurred under agreements with contract manufacturing organizations, or CMOs, including manufacturing scale-up expenses and the cost of acquiring and manufacturing preclinical study and clinical trial materials;
● fees paid to consultants who assist with research and development activities;
● expenses related to regulatory activities, including filing fees paid to regulatory agencies; and
● allocated expenses for facility costs, including rent, utilities, depreciation and maintenance.
We track outsourced development costs and other external research and development costs to specific product candidates on a program-by-program basis, such as expenses incurred under our collaboration with Penn, fees paid to CROs, CMOs and research laboratories in connection with our preclinical development, process development, manufacturing and clinical development activities. However, we do not track our internal research and development expenses on a program-by-program basis as they primarily relate to compensation, early research and other costs which are deployed across multiple projects under development.
Research and development activities are central to our business model. Product candidates in later stages of clinical development generally have higher development costs than those in earlier stages of clinical development, primarily due to the increased size and duration of later-stage clinical trials. We expect our research and development expenses to increase significantly over the next several years as we increase personnel costs, including share-based compensation, conduct our clinical trials, including later-stage clinical trials, for current and future product candidates and prepare regulatory filings for our product candidates.
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Costs incurred in obtaining technology licenses are charged to research and development expense as acquired in-process research and development if the technology licensed has not reached technological feasibility and has no alternative future use.
General and Administrative Expenses
General and administrative expenses consist primarily of personnel expenses, including salaries, benefits and share-based compensation expense, for employees and consultants in executive, finance, accounting, legal, and human resource functions. General and administrative expense also includes corporate facility costs, including rent, utilities, depreciation and maintenance, not otherwise included in research and development expense, as well as legal fees related to intellectual property and corporate matters and fees for accounting and consulting services.
We expect that our general and administrative expenses will increase in the future to support our continued research and development activities, potential commercialization efforts and continued increased costs of operating as a public company. These increases will likely include increased costs related to the hiring of additional personnel and fees to outside consultants, lawyers and accountants, among other expenses. Additionally, we anticipate increased costs associated with being a public company, including expenses related to services associated with maintaining compliance with the requirements of The Nasdaq Stock Market, LLC and the SEC, insurance and investor relations costs. If any of our current or future product candidates obtains U.S. regulatory approval, we expect that we would incur significantly increased expenses associated with building a sales and marketing team.
Change in Fair Value of Future Tranche Right Liability
Our Series A-1 convertible preferred stock issued in September 2018 included a future tranche participation right permitting investors to purchase 22,209,301 shares of Series A-2 convertible preferred stock at a fixed purchase price of $2.15 per share through December 31, 2019. The future tranche right was recorded at fair value using a Black-Scholes option pricing model and was re-measured at each reporting period until the redemption feature was exercised in May 2019, at which time the then estimated fair value was reclassified to convertible preferred stock.
Interest Income, net
Interest income, net consists of interest earned on our cash equivalents and marketable securities, offset by amortization of premium and discount on our marketable securities.
Results of Operations
Comparison of the Years Ended December 31, 2020 and 2019
The following table sets forth our results of operations for the years ended December 31, 2020 and 2019.
Year ended
December 31,
(in thousands)
2020
2019
Change
Operating expenses:
Research and development
$
81,788
$
29,738
$
52,050
Acquired in‑process research and development
1,000
500
500
General and administrative
30,114
6,951
23,163
Loss from operations
(112,902)
(37,189)
(75,713)
Change in fair value of future tranche right liability
—
(9,141)
9,141
Interest income
670
696
(26)
Net loss
$
(112,232)
$
(45,634)
$
(66,598)
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Research and Development Expenses
Research and development expenses increased by $52.1 million from $29.7 million for the year ended December 31, 2019 to $81.8 million for the year ended December 31, 2020. The increase was primarily due to an increase of $24.7 million in clinical manufacturing costs, an increase of $6.6 million in pre-clinical research and development costs incurred in preparation for IND filings, a $4.4 million increase in clinical development costs and a $3.4 million increase in consulting expense as we prepare for our clinical trials to begin in early 2021. We also had a $12.5 million increase in personnel-related costs, including share-based compensation, and a $0.5 million increase in facility and other costs due to an increase in employee headcount in the research and development function.
We track outsourced development, outsourced personnel costs and other external research and development costs of specific programs. We do not track our internal research and development costs on a program-by-program basis. Research and development expenses are summarized by program in the table below:
Year ended
December 31,
(in thousands)
2020
2019
GM1
$
14,176
$
6,186
FTD‑GRN
20,944
9,390
Krabbe
17,893
6,493
MLD
3,826
2,123
ALS
936
1,353
CMT2A
871
57
Internal costs, including personnel related
23,142
4,136
$
81,788
$
29,738
Acquired In-Process Research and Development Expenses
Acquired in-process research and development expenses were $1.0 million for the year ended December 31, 2020 compared to $0.5 million for the year ended December 31, 2019. The increase in acquired in-process research and development expense was due to higher license fees incurred under the Penn Agreement.
General and Administrative Expenses
General and administrative expenses increased by $23.2 million from $7.0 million for the year ended December 31, 2019 to $30.1 million for the year ended December 31, 2020. The increase was primarily due to a $15.3 million increase in personnel related and share-based compensation expense due to increases in employee headcount. Our professional fees and facility insurance and other costs increased by $3.3 million and $4.6 million, respectively, as we expanded our operations to support our research and development efforts.
Change in Fair Value of Future Tranche Right Liability
The change in fair value of our future tranche right liability related to our Series A-1 preferred stock was primarily due to the increase in the estimated fair value of our Series A-2 convertible preferred stock. The future tranche right liability was settled in May 2019.
Interest Income, net
Interest income, net was $0.7 million and $0.7 million for the year ended December 31, 2020 and 2019, respectively. Such income is primarily attributable to interest income earned on cash, cash equivalents and marketable securities.
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Liquidity and Capital Resources
Overview
From inception through December 31, 2019, we funded our operations through the sale of convertible preferred stock, receiving aggregate net proceeds of $221.1 million. Upon the completion of our IPO, we received net proceeds of $227.5 million and received another $165.9 million in net proceeds from our follow-on offering that was completed in January 2021. As of December 31, 2020, we had $304.8 million in cash, cash equivalents and marketable securities and had an accumulated deficit of $170.9 million. We expect our existing cash, cash equivalents and marketable securities, together with the net proceeds from the January 2021 follow-on offering, will enable us to fund our operating expense and capital expenditures for at least 24 months as of the date of this filing.
Funding Requirements
Our primary use of cash is to fund operating expenses, most significantly research and development 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 accounts payable, accrued expenses and prepaid expenses.
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, timing, progress and results of discovery, preclinical development, laboratory testing and clinical trials for our product candidates;
● the costs of manufacturing our product candidates for clinical trials and in preparation for marketing approval and commercialization;
● the extent to which we enter into collaborations or other arrangements with additional third parties in order to further develop our product candidates;
● the costs of preparing, filing and prosecuting patent applications, maintaining and enforcing our intellectual property rights and defending intellectual property-related claims;
● the costs and fees associated with the discovery, acquisition or in-license of additional product candidates or technologies;
● our ability to establish additional collaborations on favorable terms, if at all;
● the costs required to scale up our clinical, regulatory and manufacturing capabilities;
● the costs of future commercialization activities, if any, including establishing sales, marketing, manufacturing and distribution capabilities, for any of our product candidates for which we receive marketing approval; and
● revenue, if any, received from commercial sales of our product candidates, should any of our product candidates receive marketing approval.
We will need additional funds to meet operational needs and capital requirements for clinical trials, other research and development expenditures, and business 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 clinical studies.
Until such time, if ever, as we can generate substantial product revenue, we expect to finance our operations through a combination of equity offerings, debt financings, collaborations, strategic alliances and marketing, distribution or licensing arrangements. To the extent that we raise additional capital through the sale of equity or convertible debt securities, your ownership interest will be diluted, and the terms of these securities may include liquidation or other preferences that adversely affect your rights as a common stockholder. Debt financing and preferred equity financing, if available, may involve agreements that include covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making acquisitions or capital expenditures or declaring dividends. If we raise additional funds through collaborations, strategic alliances or marketing, distribution or licensing arrangements with third parties,
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we may have to relinquish valuable rights to our technologies, future revenue streams, research programs or drug candidates, or grant licenses on terms that may not be favorable to us. If we are unable to raise additional funds through equity or debt financings or other arrangements when needed, we may be required to delay, limit, reduce or terminate our research, product development or future commercialization efforts, or grant rights to develop and market product candidates that we would otherwise prefer to develop and market ourselves.
Cash Flows
The following table shows a summary of our cash flows for the periods indicated:
Year ended
December 31,
(in thousands)
2020
2019
Cash used in operating activities
$
(80,520)
$
(39,896)
Cash used in investing activities
(172,106)
(1,693)
Cash provided by financing activities
228,754
175,602
Net (decrease) increase in cash and cash equivalents
$
(23,872)
$
134,013
Net Cash Used in Operating Activities
During the year ended December 31, 2020, we used $80.5 million of net cash in operating activities, primarily to fund our operations related to the development of our product candidates. Cash used in operating activities reflected our net loss of $112.2 million, which was partially offset by non-cash charges of $17.3 million related to acquired in-process research and development expense, share-based compensation, depreciation, amortization of premium and discount, net and changes in deferred rent as well as a $14.4 million net increase in cash flows resulting from changes in our operating assets and liabilities.
During the year ended December 31, 2019, we used $39.9 million of net cash in operating activities. Cash used in operating activities reflected our net loss of $45.6 million and a $5.9 million net decrease in cash flows resulting from changes in our operating assets and liabilities. Cash used was offset by noncash charges of $9.1 million for the loss on the change in fair value of our future tranche right liability, $1.5 million in share-based compensation, $0.5 million related to an acquired in-process research and development charge, $0.1 million in depreciation expense and a $0.5 million change in our deferred rent balance.
Net Cash Used in Investing Activities
During the year ended December 31, 2020, we purchased $266.1 million in marketable securities and had sales and maturities of $95.6 million in marketable securities. During the years ended December 31, 2020 and 2019, we used $1.1 million and $1.2 million, respectively, for the purchase of property and equipment. We also used $0.5 million in each of the years ended December 31, 2020 and 2019 to purchase technology rights from Penn.
Net Cash Provided by Financing Activities
During the years ended December 31, 2020 and 2019, financing activities provided $228.3 million and $176.2 million, respectively, from the sale of our common and convertible preferred stock. During 2020, we received $0.3 million from the issuance of common stock under our employee stock purchase plan and received $0.2 million from the exercise of stock options. During 2019, we received $0.2 million from the exercise of stock options and paid $0.8 million in deferred offering costs.
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Contractual obligations and other commitments
The following table summarizes our contractual obligations and commitments at December 31, 2020:
Less than
1 to
3 to
More than
(in thousands)
1 year
3 years
5 years
5 years
Total
Operating leases
$ 1,174
$ 6,272
$ 7,171
$ 37,288
$ 51,905
Amounts owed to Catalent(1)
10,600
21,200
21,200
—
53,000
Total
$ 11,774
$ 27,472
$ 28,371
$ 37,288
$ 104,905
(1) Clean room validated in Q4 2020
In September 2018, we entered into an agreement to lease 8,887 square feet of office space in Philadelphia, Pennsylvania, for a term of seven years. The lease includes a renewal option for an additional five years. The initial rent commenced at $0.2 million per year, with 2.5% annual base rent increases plus operating expenses, real estate taxes, utilities and janitorial fees. We occupied this space in early 2019. In April 2020, we entered into an amendment to this lease, which provided that so long as we are not in breach of the initial lease agreement, the initial lease agreement shall terminate five business days after the One Commerce Commencement Date, as defined below.
In April 2020, we entered into an agreement to lease for approximately 37,000 square feet of office space in Philadelphia, Pennsylvania, or One Commerce Lease, with an expected commencement date of January 1, 2021, or the One Commerce Commencement Date, and expected expiration date of November 1, 2031. We have an option to extend the term of the One Commerce Lease by up to two five-year terms. The aggregate estimated rent payments due over the initial term of the One Commerce Lease is $20.4 million. We will post a security deposit in the amount of $34,000. The landlord of One Commerce Lease also will provide us with a tenant improvement allowance of up to $2.8 million.
In December 2020, we entered into an agreement lease for approximately 62,000 square feet of laboratory space in Hopewell, NJ. The initial annual rent under the lease is approximately $1.5 million (after partial rent abatement for the first year). The aggregate estimated rent payments due over the initial term of the lease is approximately $40.3 million.
In April 2020, we entered the Manufacturing and Supply Agreement with Catalent to secure clinical scale manufacturing capacity for batches of active pharmaceutical ingredients for our gene therapy product candidates. The Manufacturing and Supply Agreement provides for a term of five years, which period may be extended once, at our option, for an additional five year-period. In consideration for the use of the clean room suite, we have agreed to a minimum amount of purchase commitments for each year in the term, subject to adjustments for inflation. We have the right to terminate the Manufacturing and Supply Agreement for convenience or other reasons specified in the Manufacturing and Supply Agreement upon prior written notice. Either we or Catalent may terminate the Manufacturing and Supply Agreement upon an uncured material breach by the other party, upon the bankruptcy or insolvency of the other party or if the other party is suspended or debarred by the FDA or the U.S. government. If we terminate the Manufacturing and Supply Agreement for convenience and certain other specified events, we are obligated to pay an early termination fee to Catalent. Under the Collaboration Agreement, upon validation of the clean room suite, which was completed in the fourth quarter of 2020, we will pay an annual fee for five years for the use of the clean room suite.
Further, as part of amending and restating the Penn Agreement in May 2020, we agreed to fund discovery research conducted by Penn for five years, beginning in May 2020. Our funding commitment is $5.0 million a year for five years.
The commitment amounts in the table above are associated with contracts that are enforceable and legally binding and that specify all significant terms, including fixed or minimum services to be used, fixed, minimum or variable price provisions, and the approximate timing of the actions under the contracts. Payments due upon cancellation consisting only of payments for services provided or expenses incurred, including noncancelable obligations of our service
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providers, up to the date of cancellation are not included in the preceding table as the amount and timing of such payments are not known.
The contractual obligations table does not include any potential milestone or royalty payments that we may be required to make under our license and collaboration agreement with Penn. We excluded these royalty payments given that the timing of any such payments cannot be reasonably estimated at this time. We also did not include any amounts committed to fund research and development with Penn due to certain provisions for early cancellation of such committed amounts.
Off-Balance Sheet Arrangements
During the periods presented, we did not have, nor do we currently have, any relationships with unconsolidated entities or financial partnerships, including entities sometimes referred to as structured finance or special purpose entities that were established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. We do not engage in off-balance sheet financing arrangements. In addition, we do not engage in trading activities involving non-exchange traded contracts. We therefore believe that we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in these relationships.
Critical Accounting Policies and Estimates
Our management’s discussion and analysis of our financial condition and results of operations are based on our financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, and expenses and the disclosure of contingent assets and liabilities in our financial statements. On an ongoing basis, we evaluate our estimates and judgments, including those related to accrued expenses and share-based compensation. We base our estimates on historical experience, known trends and events, and various other factors that are believed to be 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.
While our significant accounting policies are described in more detail in Note 3 to our annual financial statements included elsewhere in this Form 10-K, we believe the following accounting policies are the most critical to the judgments and estimates used in the preparation of our financial statements.
Research and Development Expenses
Research and development expenses consist primarily of costs incurred in connection with the development of our product candidates. We expense research and development costs as incurred.
We accrue an expense for preclinical studies and clinical trial activities performed by Penn and other vendors based upon estimates of the proportion of work completed. We determine the estimates by reviewing contracts, vendor agreements and purchase orders, and through discussions with our internal clinical personnel and external service providers as to the progress or stage of completion of trials or services and the agreed-upon fee to be paid for such services. However, actual costs and timing of clinical trials are highly uncertain, subject to risks and may change depending upon a number of factors, including our clinical development plan.
We make estimates of our accrued expenses as of each balance sheet date in our financial statements based on facts and circumstances known at that time. If the actual timing of the performance of services or the level of effort varies from the estimate, we will adjust the accrual accordingly. Nonrefundable advance payments for goods and services, including fees for process development or manufacturing and distribution of clinical supplies that will be used in future research and development activities, are deferred and recognized as expense in the period that the related goods are consumed or services are performed.
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Share-Based Compensation
We recognize compensation costs related to share-based awards granted to employees and directors, including stock options and vesting restricted stock, based on the estimated fair value of the awards on the date of grant. We estimate the grant date fair value, and the resulting stock-based compensation, using the Black-Scholes option-pricing model. The grant date fair value of the stock-based awards is recognized on a straight-line basis over the requisite service period, which is generally the vesting period of the respective awards.
We estimate the fair value of stock options using the Black-Scholes option-pricing model, which requires assumptions, including the fair value of our common stock prior to our initial public offering, volatility, the expected term of our stock options, the risk-free interest rate for a period that approximates the expected term of our stock options, and our expected dividend yield. Certain assumptions used in our Black-Scholes option-pricing model represent management’s best estimates and involve a number of variables, uncertainties and assumptions and the application of management’s judgment, as they are inherently subjective. If any assumptions change, our stock-based compensation expense could be materially different in the future.
These subjective assumptions are estimated as follows:
Fair value of common stock — Historically, for all periods prior to our IPO, the fair value of the shares of common stock underlying our share-based awards was estimated on each grant date by our board of directors. To determine the fair value of our common stock underlying option grants, our board of directors considered, among other things, valuations 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, or the Practice Aid. Since becoming a public company we have used our stock price to determine fair value of our common stock
Expected volatility —As a privately held company we did not have any trading history for our common stock; accordingly the expected volatility was estimated based on the average volatility for comparable publicly traded biotechnology companies over a period equal to the expected term of the stock option grants. The comparable companies were chosen based on their similar size, stage in the life cycle or area of specialty. As a public company we have and will continue to use the average volatility for comparable publicly traded biotechnology companies until we have ample trading history of our own stock commensurate with the estimated expected term of our options.
Recent Accounting Pronouncements
See Note 3 to our financial statements found elsewhere in this Form 10-K for a description of recent accounting pronouncements applicable to our financial statements.
JOBS Act Accounting Election
We are an “emerging growth company” as defined in the Jumpstart Our Business Startups Act of 2012, or 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 would apply to private companies.
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 by 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.
We will remain an emerging growth company until the earliest of (1) the last day of our first fiscal year (a) in which we have total annual gross revenues of at least $1.07 billion, or (b) in which we are deemed to be a “large accelerated filer”, which means the market value of our common stock that is held by non-affiliates exceeds $700.0 million as of the prior
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June 30th, (2) the date on which we have issued more than $1.0 billion in non-convertible debt securities during the prior three-year period and (3) December 31, 2025.
In addition, the JOBS Act provides that an emerging growth company can take advantage of an extended transition period for complying with new or revised accounting standards. This allows an emerging growth company to delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. We have irrevocably elected not to avail ourselves of this exemption from new or revised accounting standards and, therefore, we are subject to the same new or revised accounting standards as other public companies that are not emerging growth companies.
We are also a “smaller reporting company,” meaning that the market value of our stock held by non-affiliates is less than $700.0 million and our annual revenue is less than $100.0 million during the most recently completed fiscal year. We may continue to be a smaller reporting company if either (i) the market value of our stock held by non-affiliates is less than $250.0 million or (ii) our annual revenue is less than $100.0 million during the most recently completed fiscal year and the market value of our stock held by non-affiliates is less than $700.0 million. If we are a smaller reporting company at the time we cease to be an emerging growth company, we may continue to rely on exemptions from certain disclosure requirements that are available to smaller reporting companies. Specifically, as a smaller reporting company we may choose to present only the two most recent fiscal years of audited financial statements in our Annual Report on Form 10-K and, similar to emerging growth companies, smaller reporting companies have reduced disclosure obligations regarding executive compensation.
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