Prelude Therapeutics Inc 10-K

Item 8. Financial Statements and Supplementary Data. 121 INDEX TO FINANCIAL STATEMENTS Report of Independent Registered Public Accounting Firm 123 Balance Sheets as of December 31, 2020 and 2019 124 Statements of Operations for the Years ended December 31, 2020 and 2019 125 Statements of Changes in Convertible Preferred Stock and Stockholders’ Equity (Deficit) for the Years ended December 31, 2020 and 2019 126 Statements of Cash Flows for the Years ended December 31, 2020 and 2019 127 Notes to Financial Statements 128 122 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and the Board of Directors of Prelude Therapeutics Incorporated Opinion on the Financial Statements We have audited the accompanying balance sheets of Prelude Therapeutics Incorporated (the Company) as of December 31, 2020 and 2019, the related statements of operations, changes in convertible preferred stock and stockholders’ equity (deficit) and cash flows for the years then ended, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2020 and 2019, and the results of its operations and its cash flows for the years then ended in conformity with U.S. generally accepted accounting principles. Basis for Opinion These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. /s/ Ernst & Young LLP We have served as the Company’s auditor since 2019. Philadelphia, Pennsylvania March 16, 2021 123 PRELUDE THERAPEUTICS INCORPORATED BALANCE SHEETS December 31, (in thousands, except share and per share data) 2020 2019 Assets Current assets: Cash and cash equivalents $ 218,309 $ 18,879 Prepaid expenses and other current assets 2,500 1,345 Total current assets 220,809 20,224 Property and equipment, net 2,480 1,647 Deferred offering costs 301 — Total assets $ 223,590 $ 21,871 Liabilities, convertible preferred stock and stockholders’ equity (deficit) Current liabilities: Capital lease obligation $ — $ 258 Accounts payable 3,920 1,974 Accrued expenses and other current liabilities 7,455 2,603 Total current liabilities 11,375 4,835 Other liabilities 32 5 Total liabilities 11,407 4,840 Convertible preferred stock, $0.0001 par value: Series A convertible preferred stock: No shares and 13,574,008 shares authorized at December 31, 2020 and 2019, respectively; No shares and 11,736,119 shares issued and outstanding at December 31, 2020 and 2019, respectively — 36,595 Series B convertible preferred stock: No shares and 18,500,000 shares authorized at December 31, 2020 and 2019, respectively; No shares and 7,628,846 shares issued and outstanding at December 31, 2020 and 2019, respectively — 29,848 Series C convertible preferred stock: No shares authorized, issued or outstanding at December 31, 2020 and 2019 — — Total convertible preferred stock — 66,443 Commitments (note 7) Stockholders’ equity: Voting common stock, $0.0001 par value: 487,149,741 and 42,000,000 shares authorized at December 31, 2020 and 2019, respectively; 32,595,301 and 3,161,653 shares issued and outstanding at December 31, 2020 and 2019, respectively 3 — Non-voting common stock, $0.0001 par value: 12,850,259 and no shares authorized at December 31, 2020 and 2019, respectively; 11,110,371 and no shares issued and outstanding at December 31, 2020 and 2019, respectively 1 — Additional paid-in capital 319,605 1,085 Accumulated deficit (107,426 ) (50,497 ) Total stockholders’ equity (deficit) 212,183 (49,412 ) Total liabilities, convertible preferred stock and stockholders’ equity (deficit) $ 223,590 $ 21,871 See accompanying notes to financial statements. 124 PRELUDE THERAPEUTICS INCORPORATED STATEMENTS OF OPERATIONS Year ended December 31, (in thousands, except share and per share data) 2020 2019 Operating expenses: Research and development $ 48,177 $ 24,279 General and administrative 10,586 3,830 Total operating expenses 58,763 28,109 Loss from operations (58,763 ) (28,109 ) Other income, net 1,834 539 Net loss $ (56,929 ) $ (27,570 ) Per share information: Net loss per share of common stock, basic and diluted $ (4.56 ) $ (16.52 ) Weighted average common shares outstanding, basic and diluted 12,478,463 1,668,549 See accompanying notes to financial statements. 125 PRELUDE THERAPEUTICS INCORPORATED STATEMENTS OF CHANGES IN CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS’ EQUITY (DEFICIT) Convertible preferred stock Stockholders’ equity (deficit) Series A Series B Series C Voting common stock Non-voting common stock Additional paid-in capital Accumulated deficit Total (in thousands, except shares) Shares Amount Shares Amount Shares Amount Shares Amount Shares Amount Balance at January 1, 2019 11,736,119 $ 36,595 — $ — — $ — 2,380,270 $ — — $ — $ 234 $ (22,927 ) $ (22,693 ) Exercise of stock options — — — — — — 3,242 — — — 5 — 5 Sale of Series B convertible preferred stock, net of issuance costs of $152 — — 7,628,846 29,848 — — — — — — — — — Stock-based compensation expense, including issuance of restricted stock awards — — — — — — 778,141 — — — 846 — 846 Net loss — — — — — — — — — — — (27,570 ) (27,570 ) Balance at December 31, 2019 11,736,119 36,595 7,628,846 29,848 — — 3,161,653 — — — 1,085 (50,497 ) (49,412 ) Exercise of stock options — — — — — — 100,545 — — — 100 — 100 Sale of Series B convertible preferred stock, net of issuance costs of $58 — — 7,628,846 29,942 — — — — — — — Sale of Series C convertible preferred stock, net of issuance costs of $174 — — — — 3,443,612 49,826 — — — — — — — Conversion of convertible preferred stock upon initial public offering (11,736,119 ) (36,595 ) (15,257,692 ) (59,790 ) (3,443,612 ) (49,826 ) 19,327,052 2 11,110,371 1 146,208 — 146,211 Sale of common stock in initial public offering, net of issuance costs of $2,538 — — — — — — 9,573,750 1 — — 166,629 — 166,630 Stock-based compensation expense, including issuance of restricted stock awards — — — — — — 432,301 — — — 5,583 — 5,583 Net loss — — — — — — — — — — — (56,929 ) (56,929 ) Balance at December 31, 2020 — $ — — $ — — $ — 32,595,301 $ 3 11,110,371 $ 1 $ 319,605 $ (107,426 ) $ 212,183 See accompanying notes to financial statements. 126 PRELUDE THERAPEUTICS INCORPORATED STATEMENTS OF CASH FLOWS Year ended December 31, (in thousands) 2020 2019 Cash flows used in operating activities: Net loss $ (56,929 ) $ (27,570 ) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 542 382 Loss on disposal of property and equipment 11 10 Stock-based compensation 5,583 846 Changes in operating assets and liabilities: Prepaid expenses and other current assets (1,155 ) (1,345 ) Accounts payable 1,157 546 Accrued expenses and other liabilities 4,614 1,466 Net cash used in operating activities (46,177 ) (25,665 ) Cash flows used in investing activities: Purchases of property and equipment (621 ) (780 ) Net cash used in investing activities (621 ) (780 ) Cash flows provided by financing activities: Proceeds from the issuance of common stock upon initial public offering, net of offering costs 166,630 — Proceeds from the sale of Series C convertible preferred stock, net of offering costs 49,826 — Proceeds from the sale of Series B convertible preferred stock, net of offering costs 29,942 29,848 Payment of offering costs associated with January 2021 offering (12 ) — Payment of capital lease obligation (258 ) (124 ) Proceeds from the exercise of stock options 100 5 Net cash provided by financing activities 246,228 29,729 Net increase in cash and cash equivalents 199,430 3,284 Cash and cash equivalents at beginning of year 18,879 15,595 Cash and cash equivalents at end of year $ 218,309 $ 18,879 Supplemental disclosures: Property and equipment in accounts payable $ 765 $ 66 Offering costs in accrued expenses $ 265 $ — Offering costs in accounts payable $ 24 $ — Issuance of capital lease obligation in connection with purchase of property and equipment $ — $ 382 See accompanying notes to financial statements. 127 PRELUDE THERAPEUTICS INCORPORATED NOTES TO FINANCIAL STATEMENTS 1. Nature of Operations Prelude Therapeutics Incorporated (the “Company”) was incorporated in Delaware on February 5, 2016 and is a clinical-stage biotechnology company focused on discovering and developing new medicines targeting chromatin function to treat cancer and rare diseases. Since beginning operations, the Company has devoted substantially all its efforts to research and development, conducting preclinical and clinical studies, recruiting management and technical staff, administration, and raising capital. 2. Risks and Liquidity The Company is subject to a number of risks common to early-stage companies in the biotechnology industry. Principal among these risks are the uncertainties in the development process, development of the same or similar technological innovations by competitors, protection of proprietary technology, dependence on key personnel, compliance with government regulations and approval requirements, and the need to obtain additional financing to fund operations. Product candidates currently under development will require significant additional research and development efforts, including extensive pre-clinical and clinical testing and regulatory approval, prior to commercialization. These efforts require significant amounts of additional capital, adequate personnel infrastructure, and extensive compliance-reporting capabilities. There can be no assurance that the Company’s research and development will be successfully completed, that adequate protection for the Company’s technology will be obtained, that any products developed will obtain necessary government regulatory approval, or that any approved products will be commercially viable. The Company operates in an environment of rapid change in technology and substantial competition from pharmaceutical and biotechnology companies. In addition, the Company is dependent upon the services of its employees, consultants and contractors. Since its inception, the Company has incurred operating losses and has an accumulated deficit of $107.4 million at December 31, 2020. The Company has no revenue to date and devotes its efforts to research and development. The Company anticipates incurring additional losses until such time, if ever, that it can generate significant sales of its product candidates currently in development. The Company believes that its existing cash and cash equivalents, together with the net proceeds of $161.4 million from the sale of common stock in January 2021 (see Note 11), will be sufficient to fund its operating expenses and capital expenditure requirements into 2023. To fund its operating expenses and capital expenditure requirements after that date, the Company plans to seek additional funding through public or private equity offerings, debt financings, collaborations, strategic alliances and licensing arrangements. The Company may not be able to obtain financing on acceptable terms, or at all, and the Company may not be able to enter into strategic alliances or other arrangements on favorable terms, or at all. The terms of any financing may adversely affect the holdings or the rights of the Company’s stockholders. If the Company is unable to obtain funding, the Company could be required to delay, reduce or eliminate research and development programs, product portfolio expansion or future commercialization efforts, which could adversely affect its business prospects. On March 10, 2020, the World Health Organization characterized the novel COVID-19 virus as a global pandemic. There is significant uncertainty as to the likely effects of this disease which may, among other things, materially impact the Company’s planned clinical trials. This pandemic or outbreak could result in difficulty securing clinical trial site locations, CROs, and/or trial monitors and other critical vendors and consultants supporting the trial. In addition, outbreaks or the perception of an outbreak near a clinical trial site location could impact the Company’s ability to enroll patients. These situations, or others associated with COVID-19, could cause delays in the Company’s clinical trial plans and could increase expected costs, all of which could have a material adverse effect on the Company’s business and its financial condition. At the current time, the Company is unable to quantify the potential effects of this pandemic on its future financial statements. 3. Summary of Significant Accounting Policies Basis of Presentation The accompanying financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). Any reference in these notes to applicable guidance is meant to refer to GAAP as 128 PRELUDE THERAPEUTICS INCORPORATED NOTES TO FINANCIAL STATEMENTS — Continued found in the Accounting Standards Codification (“ASC”) and Accounting Standards Updates (“ASU”) promulgated by the Financial Accounting Standards Board (“FASB”). On September 18, 2020, in connection with the Company’s initial public offering (IPO) of common stock, the Company’s board of directors and stockholders approved a 1.1566-to-one reverse stock split of the Company’s issued and outstanding shares of common stock and convertible preferred stock. All share and per share amounts in the financial statements and notes hereto have been retrospectively adjusted for all periods presented to give effect to the reverse stock split. The completion of the IPO, as described above, impacts the comparability of certain amounts to the corresponding prior year period, including earnings per share. Use of Estimates The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and contingent liabilities at the date of the financial statements and the reported amounts of expenses during the reporting period. Actual results could differ from those estimates. Estimates and assumptions are periodically reviewed and the effects of the revisions are reflected in the accompanying financial statements in the period they are determined to be necessary. Significant areas that require management’s estimates include the fair value of the Company’s common stock prior to the IPO, stock-based compensation assumptions, and accrued clinical trial expenses. Concentration of Credit Risk Financial instruments that potentially subject the Company to significant concentrations of credit risk consist of cash and cash equivalents. The Company maintains deposits in federally insured financial institutions in excess of federally insured limits. The Company has not experienced any losses in such accounts and believes it is not exposed to significant credit risk beyond the normal credit risk associated with commercial banking relationships. Segment Information Operating segments are defined as components of an enterprise about which separate discrete information is available for evaluation by the chief operating decision maker, or decision-making group, in deciding how to allocate resources and in assessing performance. The Company views and manages its operations as a single operating segment. Fair Value of Financial Instruments Management believes that the carrying amounts of the Company’s financial instruments, including cash, accounts payable, accrued expenses and a capital lease obligation, approximate fair value due to the short-term nature of these instruments. Cash Equivalents The Company’s cash equivalents include short-term highly liquid investments with an original maturity of 90 days or less when purchased and are carried at fair value in the accompanying balance sheets. 129 PRELUDE THERAPEUTICS INCORPORATED NOTES TO FINANCIAL STATEMENTS — Continued Property and Equipment Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation expense is recognized using the straight-line method over the estimated useful life of the asset, ranging from 5-7 years as follows: Fixed Asset Type Estimated useful life Lab equipment 5 years Computers 5 years Furniture and fixtures 7 years Leasehold improvements are amortized over the shorter of the estimated useful life of the assets or the remaining lease term. Assets under capital leases are recorded in property and equipment, net on the balance sheets and depreciated in a manner similar to other property and equipment. Expenditures for repairs and maintenance of assets are charged to expense as incurred, while major betterments are capitalized. Upon retirement or sale, the cost and related accumulated depreciation of assets disposed of are removed from the accounts and any resulting gain or loss is included in the statements of operations. The Company reviews long-lived assets, such as property and equipment, for impairment when events or changes in circumstances indicate the carrying amount of the assets may not be recoverable. If indicators of impairment are present, the assets are tested for recoverability by comparing the carrying amount of the assets to the related estimated future undiscounted cash flows that the assets are expected to generate. If the expected cash flows are less than the carrying value of the asset, then the asset is considered to be impaired and its carrying value is written down to fair value, based on the related estimated discounted future cash flows. Deferred offering costs The Company capitalizes costs that are directly associated with in-process equity financings until such financings are consummated, at which time such costs are recorded against the gross proceeds from the applicable financing. If a financing is abandoned, deferred offering costs are expensed. Deferred offering costs were $0.3 million at December 31, 2020. Comprehensive loss Comprehensive loss includes net loss and certain changes in stockholders’ equity (deficit) that are excluded from net loss. The Company’s comprehensive loss was equal to net loss for the years ended December 31, 2020 and 2019. Stock-Based Compensation The Company measures share-based awards at their grant-date fair value and records compensation expense on a straight-line basis over the vesting period of the awards. Estimating the fair value of share-based awards requires the input of subjective assumptions, including, prior to the IPO, the estimated fair value of the Company’s common stock, and, for stock options, the expected life of the options and stock price volatility. The Company accounts for forfeitures for stock option awards as they occur. The Company uses the Black-Scholes option pricing model to value its stock option awards. The assumptions used in estimating the fair value of share-based awards represent management’s estimate and involve inherent uncertainties and the application of management’s judgment. As a result, if factors change and management uses different assumptions, share-based compensation expense could be materially different for future awards. The expected life of the stock options is estimated using the "simplified method," as the Company has limited historical information from which to develop reasonable expectations about future exercise patterns and post-vesting employment termination behavior for its stock option grants. The simplified method is the midpoint between the vesting period and the contractual term of the option. For stock price volatility, the Company uses comparable public companies as a basis for its 130 PRELUDE THERAPEUTICS INCORPORATED NOTES TO FINANCIAL STATEMENTS — Continued expected volatility to calculate the fair value of option grants. The risk-free rate is based on the U.S. Treasury yield curve commensurate with the expected life of the option. Grant Income and Research and Development Tax Credits The Company recognizes grant income and Delaware research and development tax credits, which are refundable irrespective of taxable income, in other income, net in the statements of operations when it is probable that the amounts will be received and the necessary qualifying conditions, as stated in the agreements, are met. Research and Development Research and development costs are expensed as incurred. Research and development expenses consist principally of personnel costs, including salaries, stock-based compensation, and benefits of employees, and other operational costs related to the Company’s research and development activities, including allocated facility-related expenses and external costs of outside vendors, such as clinical research organizations and clinical manufacturing organizations, and other direct and indirect costs. Management makes estimates of the Company’s accrued research and development expenses as of each balance sheet date in the Company’s financial statements based on facts and circumstances known to the Company at that time. If the actual timing of the performance of services or the level of effort varies from the estimate, the Company 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. Income Taxes Income taxes are accounted for under the asset-and-liability method as required by FASB ASC Topic 740, Income Taxes (“ASC 740”). Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period corresponding to the enactment date. Under ASC 740, a valuation allowance is required when it is more likely than not all or some portion of the deferred tax assets will not be realized through generating sufficient future taxable income. FASB ASC Subtopic 740-10, Accounting for Uncertainty of Income Taxes , (“ASC 740-10”) defines the criterion an individual tax position must meet for any part of the benefit of the tax position to be recognized in financial statements prepared in conformity with GAAP. The Company may recognize the tax benefit from an uncertain tax position only if it is more likely than not such tax position will be sustained on examination by the taxing authorities, based solely on the technical merits of the respective tax position. The tax benefits recognized in the financial statements from such a tax position should be measured based on the largest benefit having a greater than 50% likelihood of being realized upon ultimate settlement with the tax authority. In accordance with the disclosure requirements of ASC 740-10, the Company’s policy on income statement classification of interest and penalties related to income tax obligations is to include such items as part of total interest expense and other expense, respectively. Net Loss Per Share Basic net loss per share of common stock is computed by dividing net loss by the weighted-average number of shares of common stock outstanding during each period. The weighted-average number of shares of common stock outstanding used in the basic net loss per share calculation does not include unvested restricted stock awards as these instruments are considered contingently issuable shares until they vest. Diluted net loss per share of common stock includes the effect, if any, from the potential exercise or conversion of securities, such as convertible preferred stock and stock options, which would result in the issuance of incremental shares of common stock. For diluted net loss per share, the weighted-average number of shares of common stock is the same for basic net loss per share due to the fact that when a net loss exists, dilutive securities are not included in the calculation as the impact is anti-dilutive. The Company’s convertible preferred stock and unvested restricted 131 PRELUDE THERAPEUTICS INCORPORATED NOTES TO FINANCIAL STATEMENTS — Continued stock entitles the holder to participate in dividends and earnings of the Company, and, if the Company were to recognize net income, it would have to use the two-class method to calculate earnings per share. The two-class method is not applicable during periods with a net loss, as the holders of the convertible preferred stock and unvested restricted stock have no obligation to fund losses. The following potentially dilutive securities have been excluded from the computation of diluted weighted-average shares of common stock outstanding, as they would be anti-dilutive: December 31, 2020 2019 Series A convertible preferred stock — 11,736,119 Series B convertible preferred stock — 7,628,846 Unvested restricted stock awards 1,214,767 1,335,349 Stock options 6,839,091 2,269,742 8,053,858 22,970,056 Amounts in the above table reflect the common stock equivalents. Recently Issued Accounting Pronouncements Emerging Growth Company Status The Company is an emerging growth company, as defined in the Jumpstart Our Business Startups Act of 2012 (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. The Company has 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 that it (i) is no longer an emerging growth company or (ii) affirmatively and irrevocably opts out of the extended transition period provided in the JOBS Act. As a result, these financial statements may not be comparable to companies that comply with the new or revised accounting pronouncements as of public company effective dates. Recent Accounting Pronouncements In February 2016, the FASB issued ASU No. 2016-02, Leases (“ASC 842”), which requires a lessee to record a right-of-use asset and a corresponding lease liability on the balance sheet for most leases including operating leases. Lessees will classify leases as either finance or operating leases and lessors classify all leases as sales-type, direct financing or operating leases. The statement of operations presentation and expense recognition for lessees for finance leases is similar to that of capital leases under ASC 840 with separate interest and amortization expense with higher periodic expense in the earlier periods of a lease. For operating leases, the statement of operations presentation and expense recognition is similar to that of operating leases under ASC 840 with single lease cost recognized on a straight-line basis. The standard is effective for the Company beginning January 1, 2022, with early adoption permitted, using a modified retrospective approach. While the Company continues to evaluate the provisions of ASC 842 to determine how it will be impacted, the primary effect of adopting the new standard will be to record a right-of-use asset and a lease liability on the balance sheet for all leases with a term of greater than twelve months regardless of their classification. The adoption of ASC 842 is not expected to have a material impact on the Company's results of operations or cash flows. 4. Fair Value of Financial Instruments Fair value is the price that could be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. Fair value determination in accordance with applicable accounting guidance requires that a number of significant judgments be made. Additionally, fair value is used on a nonrecurring basis to evaluate assets for impairment or as required for disclosure purposes by applicable accounting guidance on disclosures about fair value of financial instruments. Depending on the nature of the assets and liabilities, various valuation techniques and assumptions are used when estimating fair value. The Company follows the provisions of ASC 820, for financial assets and liabilities 132 PRELUDE THERAPEUTICS INCORPORATED NOTES TO FINANCIAL STATEMENTS — Continued measured on a recurring basis. The guidance requires fair value measurements be classified and disclosed in one of the following three categories: • Level 1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities. • Level 2: Quoted prices in markets that are not active, or inputs which are observable, either directly or indirectly, for substantially the full term of the asset or liabilities. • Level 3: Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported by little or no market activity). The following fair value hierarchy table presents information about the Company’s assets and liabilities measured at fair value on a recurring basis: Fair value measurement at reporting date using (in thousands) Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable inputs (Level 3) December 31, 2020: Assets: Cash equivalents (Money Market Funds) $ 217,072 $ — $ — December 31, 2019: Assets: $ 18,779 $ — $ — Cash equivalents (Money Market Funds) 5. Property and Equipment Property and equipment consisted of the following: December 31, (in thousands) 2020 2019 Lab equipment $ 3,010 $ 1,842 Leasehold improvements 448 312 Computers — 10 Furniture and fixtures 105 39 3,563 2,203 Less accumulated depreciation (1,083 ) (556 ) Property and equipment, net $ 2,480 $ 1,647 Depreciation and amortization expense was $0.5 million and $0.4 million for the years ended December 31, 2020 and 2019, respectively. In September 2019, the Company signed a 12-month capital lease for $0.4 million of lab equipment with an effective interest rate of 9.67%. At December 31, 2020, the Company had $0.1 million of accumulated amortization related to the capital lease. At December 31, 2020, the Company has no further lease payments under the capital lease. 133 PRELUDE THERAPEUTICS INCORPORATED NOTES TO FINANCIAL STATEMENTS — Continued 6. Accrued Expenses Accrued expenses consisted of the following: December 31, (in thousands) 2020 2019 Compensation and related benefits $ 3,614 $ 1,631 Research and development 3,421 658 Other 420 314 $ 7,455 $ 2,603 7. Commitments Operating Leases The Company leases office and laboratory space in Wilmington, Delaware under two separate noncancelable leases, which expire in December 2022 and March 2021, respectively. The Company has an option to renew both leases for additional 1-year and 6-months periods, respectively. The leases are classified as operating leases and the Company recognizes rent expense on a straight-line basis over the lease terms. The Company recognized rent expense of $1.2 million and $0.9 million during the years ended December 31, 2020 and 2019, respectively, related to these leases. The future minimum lease payments under the Company’s operating lease agreements as of December 31, 2020 are $1.4 million for both 2021 and for 2022, with no commitments thereafter. Employment Agreements The Company entered into employment agreements with key personnel providing for compensation and severance in certain circumstances, as defined in the respective employment agreements. 401(k) Defined Contribution Plan The Company sponsors a 401(k) defined‑contribution plan covering all employees. Participants are permitted to contribute up to 100% of their eligible annual pretax compensation up to an established federal limit on aggregate participant contributions. The Company provides a safe harbor match with a maximum amount of 4% of the participant’s compensation. The Company has not yet made any matching contributions since inception. Other Research and Development Arrangements The Company enters into agreements with contract research organizations (“CROs”) to assist in the performance of research and development activities. Expenditures to CROs will represent a significant cost in clinical development for the Company. 8. Convertible Preferred Stock and Common Stock Preferred Stock Financings In May 2019, the Company issued an aggregate of 7,628,846 shares of Series B convertible preferred stock (“Series B”) to existing investors at $3.9325 per share for aggregate net proceeds of $29.8 million. Pursuant to the Series B Stock Purchase Agreement, the Series B investors could elect to purchase an aggregate of 7,628,846 additional shares of the Company’s Series B at a fixed purchase price of $3.9325 per share (the “Series B Future Tranche Right”). The Company determined that the Series B Future Tranche Right did not meet the definition of a freestanding financial instrument as it was not legally detachable. The Series B Future Tranche Right was also evaluated as an embedded derivative and the Company determined it did not meet the definition of a derivative instrument for which 134 PRELUDE THERAPEUTICS INCORPORATED NOTES TO FINANCIAL STATEMENTS — Continued bifurcation would be required. In March 2020, the Company’s Series B investors exercised their Future Tranche Right and purchased 7,628,846 shares of Series B for net proceeds of approximately $ 29.9 million. In August 2020, the Company’s existing Convertible Preferred Stock investors as well as a new investor purchased 3,443,612 shares of Series C at a price of $14.5197 per share for net proceeds of approximately $49.8 million. Initial Public Offering In September 2020, the Company completed its IPO in which the Company sold 9,573,750 shares of its common stock at a public offering price of $19.00 per share. The Company received net proceeds of $166.6 million after deducting underwriting discounts, commissions, and other offering expenses paid by the Company. In addition, immediately prior to the closing of the IPO on September 29, 2020, (i) all of the Company’s outstanding shares of convertible preferred stock converted into an aggregate of 30,437,423 shares of common stock (of which, 11,110,371 shares are non-voting common stock) and (ii) the Company filed an amended and restated certificate of incorporation to, among other things, increase the number of authorized shares of common stock to 500,000,000. Common Stock The Company has two classes of common stock; “voting common stock” and “non-voting common stock.” The holders of the voting common stock are entitled to one vote for each share of voting common stock held at all meetings of stockholders. Except as otherwise required by law, the holders of non-voting common stock shall not be entitled to vote at any meetings of stockholders (or written actions in lieu of meetings) and the shares of non-voting common stock shall not be included in determining the number of shares voting or entitled to vote on any matter. Unless required by law, there shall be no cumulative voting. Any holder of non-voting common stock may elect to convert each share of non-voting common stock into one fully paid and non-assessable share of voting common stock at any time by providing written notice to the Company; provided that as a result of such conversion, such holder, together with its affiliates and any members of a Schedule 13(d) group with such holder, would not beneficially own in excess of 9.99% of the Company’s common stock immediately prior to and following such conversion, unless otherwise as expressly provided for in the Company’s restated certificate of incorporation. However, this ownership limitation may be increased (not to exceed 19.99%) or decreased to any other percentage designated by such holder of non-voting common stock upon 61 days’ notice to the Company. 9. Stock-Based Compensation The Company has two equity incentive plans: the 2016 Equity Incentive Plan, as amended, and the 2020 Equity Incentive Plan. New awards can only be granted under the 2020 Equity Incentive Plan (the “Plan”). The total number of shares initially authorized under the Plan was 4,680,000. Of this amount, 4,485,907 shares were available for future grants as of December 31, 2020. The number of shares of the Company’s common stock that may be issued pursuant to rights granted under the Plan shall automatically increase on January 1st of each year, commencing on January 1, 2021 and continuing for ten years, in an amount equal to five percent of the total number of shares of the Company’s common stock outstanding on December 31st of the preceding calendar year, subject to the discretion of the board of directors or compensation committee to determine a lesser number of shares shall be added for such year. As such, on January 1, 2021, 2,185,283 shares were added to the Plan. The Plan provides for the granting of common stock, incentive stock options, nonqualified stock options, restricted stock awards, and/or stock appreciation rights to employees, directors, and other persons, as determined by the Company’s board of directors. The Company’s stock options vest based on the terms in each award agreement, generally over four-year periods with 25% of options vesting after 1 year and then monthly thereafter, and have a term of ten years. In September 2020, the Company also adopted the 2020 Employee Stock Purchase Plan (the “ESPP”), which includes 520,000 shares of common stock reserved for future issuance. No shares have been issued from the ESPP as of December 31, 2020. The number of shares of the Company’s common stock that may be issued pursuant to rights granted under the ESPP shall automatically increase on January 1st of each year, commencing on January 1, 2021 and continuing for ten years, in an amount equal to one percent of the total number of shares of the Company’s common stock outstanding on December 31st of the preceding calendar year, subject to the discretion of the board of directors or compensation committee to determine a lesser number of shares shall be added for such year. As such, on January 1, 2021, 437,056 shares were added to the ESPP. 135 PRELUDE THERAPEUTICS INCORPORATED NOTES TO FINANCIAL STATEMENTS — Continued The Company measures stock-based awards at their grant-date fair value and records compensation expense on a straight-line basis over the vesting period of the awards. The Company recorded stock-based compensation expense in the following expense categories in its accompanying statements of operations: Year Ended December 31, (in thousands) 2020 2019 Research and development $ 2,585 $ 437 General and administrative 2,998 409 $ 5,583 $ 846 Stock Options The following table summarizes stock option activity for the Plan in the years indicated: Number of shares Weighted average exercise price per share Weighted average remaining contractual term (years) Outstanding at January 1, 2019 588,961 $ 1.11 9.35 Granted 1,703,692 $ 1.84 Exercised (19,669 ) $ 1.16 Forfeited (3,242 ) $ 1.02 Outstanding at December 31, 2019 2,269,742 $ 1.66 9.20 Granted 4,785,630 $ 11.35 Exercised (100,545 ) $ 0.99 Forfeited (115,736 ) $ 1.37 Outstanding at December 31, 2020 6,839,091 $ 8.46 9.17 Exercisable at December 31, 2020 951,669 $ 1.85 8.22 At December 31, 2020, the aggregate intrinsic value of outstanding options and exercisable options was $431.5 million and $66.3 million, respectively. The following table summarizes information about stock options outstanding and exercisable at December 31, 2020 under the Plan: Options Outstanding Options Exercisable Range of Exercise Prices Number Outstanding Weighted Average Remaining Contractual Life (in years) Weighted Average Exercise Price Number Exercisable Weighted Average Exercise Price $0.31 - $1.66 555,852 7.62 $ 1.23 327,859 $ 1.18 $1.67 - $7.37 2,954,883 8.88 1.89 606,757 1.89 $7.38 - $15.93 3,129,940 9.67 12.85 16,477 12.85 $15.94 - $69.92 198,416 9.90 57.25 576 19.00 6,839,091 951,669 The weighted-average grant date fair value of options granted was $10.12 and $1.41 per share for the years ended December 31, 2020 and 2019, respectively. The aggregate intrinsic value of options exercised was $0.4 million and for the year ended December 31, 2020. The Company recorded stock-based compensation expense of $ 4.8 million and $0.4 million for the years ended December 31, 2020 and 2019, respectively, related to stock options. As of December 31, 2020, the total 136 PRELUDE THERAPEUTICS INCORPORATED NOTES TO FINANCIAL STATEMENTS — Continued unrecognized compensation expense related to unvested stock option awards was $ 45.8 million, which the Company expects to recognize over a weighted-average period of 3.54 years . The fair value of each option was estimated on the date of grant using the weighted average assumptions in the table below: Year Ended December 31, 2020 2019 Expected volatility 115.17 % 91.60 % Risk-free interest rate 0.43 % 1.87 % Expected life (in years) 6.25 6.25 Expected dividend yield — — Restricted Stock Awards The Company issues restricted stock awards (“RSA”) to employees that generally vest over a four-year period with 25% of awards vesting after 1 year and then monthly thereafter. Any unvested shares will be forfeited upon termination of services. The fair value of an RSA is equal to the fair market value price of the Company’s common stock on the date of grant. RSA expense is amortized straight-line over the vesting period. The following table summarizes activity related to RSA stock-based payment awards: Number of shares Weighted- average grant date fair value Unvested balance at January 1, 2019 856,438 $ 0.74 Granted 778,141 $ 1.89 Vested (299,230 ) $ 0.68 Unvested balance at December 31, 2019 1,335,349 $ 1.42 Granted 432,301 $ 3.26 Vested (552,883 ) $ 1.37 Unvested balance at December 31, 2020 1,214,767 $ 2.09 The Company recorded stock-based compensation expense of $0.8 million and $0.4 million for the years ended December 31, 2020 and 2019, respectively, related to RSAs. As of December 31, 2020, the total unrecognized expense related to all RSAs was $2.2 million, which the Company expects to recognize over a weighted-average period of 2.71 years. 137 PRELUDE THERAPEUTICS INCORPORATED NOTES TO FINANCIAL STATEMENTS — Continued 10. Income Taxes The tax effects of temporary differences that gave rise to significant portions of the deferred tax assets and liabilities were as follows: December 31, (in thousands) 2020 2019 Deferred tax assets: Net operating loss carryforwards $ 28,283 $ 13,659 Research and development credits 4,753 2,216 Stock-based compensation 33 — Gross deferred tax assets 33,069 15,875 Less: valuation allowance (32,899 ) (15,409 ) Total deferred tax asset 170 466 Deferred tax liability Stock-based compensation — (399 ) Depreciation (170 ) (67 ) Total deferred tax liabilities (170 ) (466 ) $ — $ — In assessing the need for a valuation allowance, management must determine that there will be sufficient taxable income to allow for the realization of deferred tax assets. Based upon the historical and anticipated future losses, management has determined that the deferred tax assets do not meet the more likely than not threshold for realizability. Accordingly, a full valuation allowance has been recorded against the Company’s net deferred tax assets as of December 31, 2020 and 2019. The valuation allowance increased by $17.5 million and $9.2 million during the years ended December 31, 2020 and 2019, respectively. A reconciliation of the federal income tax rate to the Company’s effective tax rate is as follows: Year ended December 31, 2020 2019 Federal tax benefit at statutory rate (21.0 )% (21.0 )% State tax, net of federal benefit (6.5 ) (6.9 ) Return to provision — (0.7 ) Permanent differences 1.2 0.4 Research and development (4.4 ) (5.4 ) Change in valuation allowance 30.7 33.6 — % — % The following table summarizes carryforwards of federal, state and local net operating losses (“NOL”) and research tax credits: December 31, (in thousands) 2020 2019 NOL carryforwards - Federal $ 101,471 $ 49,005 NOL carryforwards - State 101,471 49,005 Research tax credits - Federal 4,720 2,182 Research tax credits - State 43 43 The NOL carryforwards begin expiring in 2036 for federal and Delaware state income tax purposes, however; all federal and Delaware state NOL carryforwards generated subsequent to January 1, 2018, are able to be carried forward 138 PRELUDE THERAPEUTICS INCORPORATED NOTES TO FINANCIAL STATEMENTS — Continued indefinitely. As of December 31, 20 20 , the Company also had federal and Delaware research and development tax credit carryforwards of $ 4 . 7 million and $ 43,000 , respectively that will begin to expire in 2036 , unless previously utilized. The NOL and tax credit carryforwards are subject to review and possible adjustment by the Internal Revenue Service and state tax authorities. NOL and tax credit carryforwards may become subject to an annual limitation in the event of certain cumulative changes in the ownership interest of significant stockholders over a three year period in excess of 50%, as defined under Sections 382 and 383 of the Internal Revenue Code, respectively, as well as similar state provisions. This could limit the amount of tax attributes that can be utilized annually to offset future taxable income or tax liabilities. The amount of the annual limitation is determined based on the value of the Company immediately prior to the ownership change. Subsequent ownership changes may further affect the limitation in future years. To date, the Company has not performed an analysis to determine whether or not ownership changes have occurred since inception. Delaware state NOLs may also be limited. As of December 31, 2020, the Company had no accrued interest or penalties related to uncertain tax positions and no amounts have been recognized in the Company’s statement of operations. Due to NOL and tax credit carry forwards that remain unutilized, income tax returns for tax years from 2016, 2017, 2018 and 2019 remain subject to examination by the taxing jurisdictions. The NOL carryforwards remain subject to review until utilized. 11. Subsequent Event In January 2021, the Company sold 2,875,000 shares of its common stock at a public offering price of $60.00 per share. The Company received net proceeds of $161.4 million after deducting underwriting discounts, commissions, and other offering expenses paid by the Company. 139 Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure. None.