Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis are meant to provide material information relevant to an assessment of the financial condition and results of operations of our Company, including an evaluation of the amounts and certainty of cash flows from operations and from outside sources, so as to allow investors to better view our Company from management’s perspective. You should read the following discussion and analysis of our financial condition and results of operations together with our audited consolidated financial statements and related notes appearing elsewhere in this Annual Report on Form 10-K. In addition to historical information, this discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors. We discuss factors that we believe could cause or contribute to these differences below and elsewhere in this report, including those set forth under Item 1A. “Risk Factors” in this Annual Report on Form 10-K.
Overview and Recent Developments
We are a clinical stage biopharmaceutical company focused on developing novel therapies for the treatment of orphan pulmonary and fibrosis indications with no approved or limited effective treatments. We currently have two product candidates in clinical development, LTI-03 and LTI-01, and multiple candidates in preclinical development focused on fibrosis indications. Our pipeline includes:
• LTI-03, a peptide, for which we are currently recruiting patients for a Phase 1b dose-ranging, placebo-controlled safety, tolerability, and pharmacodynamic biomarker activity trial in development for the treatment of IPF, that has demonstrated the ability to protect healthy lung epithelial cells and reduce pro-fibrotic signaling;
• LTI-01, a proenzyme that completed a Phase 2a dose-ranging, placebo-controlled trial and a Phase 1b safety, tolerability and proof of mechanism trial in LPE patients, an indication that has no approved drug treatment; and
• preclinical programs targeting cystic fibrosis and a peptide program focused on the Cav1 protein for systemic fibrosis indications.
Prior to the termination of development of our main product candidate in February 2023 and the acquisition of Lung (as described below), our focus was the development of our main product candidate, ALRN-6924, a MDM2/MDMX dual inhibitor that leveraged our proprietary peptide drug technology. Since our inception, we have devoted a substantial portion of our resources to developing our product candidates, including ALRN-6924, developing our proprietary stabilized cell-permeating peptide platform, building our intellectual property portfolio, business planning, raising capital and providing general and administrative support for these operations.
Announcement of Exploration of Strategic Alternatives
In February 2023, we announced a review of initial data from our Phase 1b chemoprotection trial of ALRN-6924 in patients with p53-mutated breast cancer. Based on these findings, we decided to terminate the Phase 1b breast cancer trial and further development of ALRN-6924. We also announced that we were exploring a range of strategic alternatives to maximize shareholder value. We engaged Ladenburg Thalmann & Co., Inc. to act as a strategic advisor for this process. Strategic alternatives that were being evaluated included, but were not limited to, an acquisition, a merger, a business combination, a sale of assets or other transactions. In addition, in February 2023, we determined to reduce our workforce from nine to three full-time employees, which we completed in the second quarter of 2023.
The Lung Acquisition
On October 31, 2023, we acquired Lung Therapeutics, Inc., or Lung, pursuant to an Agreement and Plan of Merger, or the Lung Acquisition Agreement. Following our acquisition of Lung, or the Lung Acquisition, the business conducted by Lung became the business primarily conducted by the Company and we shifted our operating disease focus to advancing a pipeline of first-in-class medicines to address significant unmet medical needs in orphan pulmonary and fibrosis indications.
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Under the terms of the Lung Acquisition Agreement, at the closing of the Lung Acquisition, we issued to the stockholders of Lung 344,345 shares of our common stock and 19,903 shares of our newly designated Series X Preferred Stock. Each share of Series X Preferred Stock is convertible into 1,000 shares of common stock. In addition, we assumed (i) all Lung stock options and all warrants exercisable for Lung common stock immediately outstanding prior to the closing of the Lung Acquisition, each subject to adjustment pursuant to the terms of the Lung Acquisition Agreement.
Immediately following the closing of the Lung Acquisition, we entered into a Stock and Warrant Purchase Agreement, or the Purchase Agreement, with a group of accredited investors, or the Investors, led by Bio Partners, the majority stockholder of Lung prior to the closing of the Lung Acquisition, and including Nantahala Capital, as well as additional undisclosed investors, pursuant to which we issued and sold (i) an aggregate of 4,707 shares of Series X Preferred Stock, and (ii) warrants to purchase up to an aggregate of 2,353,500 shares of common stock, or the Warrant Shares, for an aggregate purchase price of approximately $18.4 million, which included the conversion of certain convertible promissory notes in the aggregate principal amount of approximately $1.6 million issued by Lung to Bios Partners prior to the closing of the Lung Acquisition at a 10% discount to the per share price of the Series X Preferred Stock,, or the Financing, and collectively with the Lung Acquisition, the Transactions. The Financing closed on November 2, 2023.
On February 28, 2024, we held our 2023 annual meeting of stockholders in which our stockholders approved the issuance, in accordance with Nasdaq Listing Rule 5635(a), of shares of common stock, upon conversion of our outstanding Series X Preferred Stock. Following approval of the conversion of outstanding Series X Preferred Stock, the Company had approximately 29,495,512 shares of common stock issued and outstanding on a pro forma basis, which gives effect to the full conversion of the Series X Preferred Stock as of the date of our 2023 annual meeting of stockholders, without regard to beneficial ownership limitations that may limit the ability of certain holders of Series X Preferred Stock to convert such shares to common stock as such time. On March 5, 2024, based upon existing beneficial ownership limitations, 12,087 shares of Series X Preferred Stock were automatically converted into 12,087,075 shares of common stock. The remaining approximately 12,522 shares of Series X Preferred Stock (which are convertible into 12,522,925 shares of common stock) will remain convertible at the option of the holder thereof, subject to certain beneficial ownership limitations.
We have not completed the development of any of our product candidates, have not generated any revenue from product sales and have never generated an operating profit.
To date, we have financed operations primarily through $145.5 million in net proceeds from sales of common stock and warrants, $131.2 million from sales of preferred stock prior to our IPO, $34.9 million from a collaboration agreement in 2010, and $18.4 million in gross proceeds, less issuance costs of $0.9 million, in connection with the Financing following the Lung Acquisition, which included the conversion of certain convertible promissory notes in the aggregate principal amount of approximately $1.6 million issued by Lung to Bios Partners prior to the closing of the Lung Acquisition at a 10% discount to the per share price of the Series X Preferred Stock.
Since our inception, we have incurred significant losses on an aggregate basis. Our net losses were $15.7 million and $27.3 million for the years ended December 31, 2023 and 2022, respectively. As of December 31, 2023, we had an accumulated deficit of $288.5 million. These losses have resulted primarily from costs incurred in connection with research and development activities, licensing and patent investment and general and administrative costs associated with our operations. In February 2023, we discontinued development of ALRN-6924 which substantially reduced our operating expenses. Notwithstanding these events, we expect to continue to incur operating losses for the foreseeable future.
After the Lung Acquisition, we believe that, based on our current operating plan, our cash and cash equivalents of $17.3 million as of December 31, 2023, will enable us to fund our operating expenses into the fourth quarter of 2024 following the date of this Annual Report on Form 10-K. We have concluded that as of the date of this Annual Report on Form 10-K there is substantial doubt about our ability to continue as a going concern. Our funding estimates are based on assumptions that may prove to be wrong and we could use our available capital resources sooner than we currently expect, see “Liquidity and Capital Resources.” We intend to fund our operations primarily through utilization of our current financial resources and additional raises of capital. Our future viability is dependent on our ability to raise additional capital, enter into a financing, consummate a successful acquisition, merger, business
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combination, or a sale of assets or other transaction. If we become unable to continue as a going concern, we may have to liquidate our assets and the values we receive for our assets in liquidation or dissolution could be significantly lower than the values reflected in our consolidated financial statements.
Components of Aileron’s Results of Operations
Revenue
We have not generated any revenue from product sales and we do not expect to generate any revenue from the sale of products in the foreseeable future.
Operating Expenses
Our expenses since inception have consisted solely of research and development costs, general and administrative, and restructuring costs.
Research and Development Expenses
For the periods presented in this Annual Report on Form 10-K, research and development expenses consist primarily of costs incurred for our research activities, including our discovery efforts, and the development of our product candidates, and include:
• salaries, benefits and other related costs, including stock-based compensation expense, for personnel engaged in research and development functions;
• expenses incurred in connection with the clinical development of its product candidates, including under agreements with third parties, such as consultants and contract research organizations, or CROs;
• the cost of manufacturing product candidates for use in its clinical trials and preclinical studies, including under agreements with third parties, such as consultants and contract manufacturing organizations, or CMOs;
• expenses incurred in connection with the preclinical development of its product candidates, including outsourced professional scientific development services, consulting research fees and payments made under sponsored research arrangements with third parties;
• the costs of laboratory supplies and acquiring, developing and manufacturing preclinical study and clinical trial materials;
• third-party license fees;
• costs related to compliance with regulatory requirements; and
• facility-related expenses, which included direct depreciation costs and allocated expenses for rent and maintenance of facilities and other operating costs.
We expense research and development costs as incurred. We recognize costs for certain development activities, such as clinical trials, based on an evaluation of the progress to completion of specific tasks using data such as patient enrollment, clinical site activations or information provided to us by our vendors and our clinical investigative sites. Payments for these activities are based on the terms of the individual agreements, which may differ from the pattern of costs incurred, and are reflected in our financial statements as prepaid or accrued research and development expenses.
In addition, we typically used our employee and infrastructure resources across our development programs. We tracked outsourced development costs and milestone payments made under our licensing arrangements by product candidate or development program, but we did not allocate personnel costs, license payments made under our licensing arrangements or other internal costs to specific development programs or product candidates because these costs are deployed across multiple programs and, as such, are not separately classified.
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Research and development activities are central to our business model. The duration, costs and timing of clinical trials and development of a product candidate will depend on a variety of factors, including:
• the scope, rate of progress, expense and results of clinical trials of the product candidate that we are developing and other research and development activities that we have conducted;
• uncertainties in clinical trial design and patient enrollment rates;
• significant and changing government regulation and regulatory guidance;
• the timing and receipt of any marketing approvals; and
• the expense of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights.
A change in the outcome of any of these variables with respect to the development of a product candidate could mean a significant change in the costs and timing associated with the development of that product candidate. For example, if the FDA, or another regulatory authority were to have required us to conduct clinical trials beyond those that we anticipated would be required for the completion of clinical development of a product candidate, or if we experienced significant trial delays due to patient enrollment or other reasons, we would have been required to expend significant additional financial resources and time on the completion of clinical development.
General and Administrative Expenses
General and administrative expenses consist primarily of salaries and other related costs, including stock-based compensation, for personnel in our executive, finance and corporate and administrative functions. General and administrative expenses are comprised of professional fees associated with being a public company including costs of accounting, auditing, legal, regulatory, tax and consulting services associated with maintaining compliance with exchange listing and SEC requirements, director and officer insurance costs; and both public and investor relations costs. General and administrative expenses also include legal fees relating to patent and corporate matters; legal and other professional fees relating to our strategic process; other insurance costs; travel expenses; and facility-related expenses, which include direct depreciation costs and allocated expenses for rent and maintenance of facilities and other operating costs.
Restructuring Costs
Restructuring-related charges are comprised of one-time termination costs in connection with the reduction-in-workforce, including severance, benefits, and related costs.
Other Income, net
Interest and Other Income
Interest income consists of interest income earned on our cash and cash equivalents. Historically, our interest income had not been significant due to low investment balances and low interest earned on those balances. We anticipate that our interest income will fluctuate in the future in response to our cash and cash equivalents and the interest rate environment.
Other income, net consists of gains or losses recognized from non-routine items such as accretion on short-term investments, and gains or losses recognized from foreign currency transactions, and the disposal of fixed assets.
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Results of Operations
Comparison of the Years Ended December 31, 2023 and 2022
The following tables summarize our results of operations for the years ended December 31, 2023 and 2022 in thousands:
Year Ended December 31,
Increase
2023
2022
(Decrease)
Operating expenses:
Research and development
$
3,991
$
17,967
(13,976
)
General and administrative
11,357
9,680
1,677
Restructuring and other
928
—
928
Total operating expenses
16,276
27,647
(11,371
)
Loss from operations
(16,276
)
(27,647
)
11,371
Other income, net
544
318
226
Net loss
$
(15,732
)
$
(27,329
)
$
11,597
Research and Development Expenses
Year Ended December 31,
Increase
2023
2022
(Decrease)
Direct research and development services
$
2,406
$
12,145
$
(9,739
)
Employee related expenses
1,214
3,266
(2,052
)
Professional fees for services
324
2,166
(1,842
)
Facilities and other expenses
47
390
(343
)
Total research and development expenses
$
3,991
$
17,967
$
(13,976
)
Research and development expenses for the year ended December 31, 2023 were $4.0 million, compared to $18.0 million for the year ended December 31, 2022. The decrease of $14.0 million was primarily a result of reduced spending of $6.0 million for our completed Phase 1b NSCLC trial, $1.6 million for our completed healthy volunteer study, $2.6 million for our terminated Phase 1b breast cancer trial, $2.0 million for ALRN-6924 manufacturing costs, and $1.0 million for other research expenses, and reduced spending of $2.7 million for employee related expenses and facilities and other expenses, offset by the research and development expense of $1.4 million and employee related expenses of $0.5 million incurred by Lung during 2023 after the acquisition.
General and Administrative Expenses
Year Ended December 31,
Increase
2023
2022
(Decrease)
Employee related expenses
$
2,723
$
3,068
$
(345
)
Professional fees for services
7,053
4,633
2,420
Facilities and other expenses
1,581
1,979
(398
)
Total general and administrative expenses
$
11,357
$
9,680
$
1,677
General and administrative expenses were $11.4 million for the year ended December 31, 2023, compared to $9.7 million for the year ended December 31, 2022. The increase of $1.7 million in general and administrative expense was primarily the result of $2.4 million more professional fees during 2023 as compared to the year 2022 mainly due to the acquisition in October 2023, offset by $0.3 million lower headcount costs and $0.4 million lower facilities and other expenses during 2023 as compared to the year 2022.
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Restructuring and Other
On February 16, 2023, our Board of Directors determined to reduce the Company’s remaining workforce from nine to three full-time employees. The determination to affect the workforce reduction was made in connection with our decision to terminate the Phase 1b breast cancer trial of ALRN-6924 and further development of ALRN-6924.
As a result of the above restructuring initiatives, we incurred restructuring-related charges of $0.9 million for the year ended December 31, 2023. Restructuring-related charges were comprised of one-time termination costs in connection with the reduction-in-workforce, including severance, benefits, and related costs.
Other Income, net
Other income, net of $0.5 million for the year ended December 31, 2023 consisted of interest income of $0.4 million and investment accretion of $0.2 million. We anticipate that our interest income and investment accretion will fluctuate in the future in response to our then-current cash and cash equivalents, and then-current interest rates.
Income Taxes
As of December 31, 2023, we had federal and state net operating loss carryforwards of $56.5 million and $8.2 million, respectively, which begin to expire in 2036 and 2043, respectively. As of December 31, 2023, we also had federal research and development tax credit carryforwards of $1.1 million, which begin to expire in 2035. The Company also has federal orphan drug tax credit carryforwards of $6.7 million which begin to expire in 2039.
Utilization of the net operating loss carryforwards and research and development tax credit carryforwards may be subject to a substantial annual limitation under Section 382 of the Internal Revenue Code of 1986 due to ownership changes that have occurred previously or that could occur in the future. These ownership changes may limit the amount of carryforwards that can be utilized annually to offset future taxable income. In general, an ownership change, as defined by Section 382, results from transactions increasing the ownership of certain stockholders or public groups in the stock of a corporation by more than 50% over a three-year period. As a result of the Company’s acquisition of Lung Therapeutics, the tax attributes have been limited under Section 382. The Company has reflected the reduction of these tax attributes within the income tax footnote at December 31, 2023.
On October 31, 2023, the Company acquired, in accordance with the terms of the Merger Agreement, the stock of Lung Therapeutics. In accordance with ASC 805-740-25-3, recognition of deferred tax assets and liabilities is required for substantially all temporary differences and acquired tax carryforwards and credits. The Company has computed estimated temporary differences and acquired tax carryforwards and credits as of the transaction date. The Company will not have tax basis in intangible assets recorded as part of the purchase. For accounting purposes, the intangible assets will not be amortized and subject to impairment review and testing. Though the tax effects may be delayed indefinitely, ASC 740-10-55-63 states that “deferred tax liabilities may not be eliminated or reduced because a reporting entity may be able to delay the settlement of those liabilities by delaying the events that would cause taxable temporary differences to reverse.” As such, the Company has recorded a deferred tax liability for the portion of the liability that cannot be offset with indefinite lived deferred tax assets.
Liquidity and Capital Resources
Sources of Liquidity
Since our inception, we have incurred significant losses on an aggregate basis. We have not commercialized any product candidates, and as we do not have any product candidates under development, we do not expect to generate revenue from sales of any products. We have financed our operations through sales of common stock in our initial public offering and follow-on public offerings, sales of common stock and warrants in a private placement, sales of common stock in “at-the-market” offerings, sales of common stock under our equity line with Lincoln Park Capital LLC, or LPC, sales of preferred stock prior to our initial public offering, payments received under a collaboration agreement and sales of common stock, preferred stock and warrants in connection with the Lung Acquisition and the Financing. As of December 31, 2023, we had cash and cash equivalents of $17.3 million.
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At-the-Market Program
In January 2021, we entered into a Capital on Demand Sales Agreement, or the ATM Sales Agreement, with JonesTrading Institutional Services LLC, or JonesTrading, and William Blair & Company, L.L.C., or William Blair, as agents, under which we may issue and sell shares of common stock, having an aggregate offering price of up to $30.0 million. Sales of common stock through JonesTrading and William Blair may be made by any method that is deemed an “at the market” offering as defined in Rule 415(a)(4) under the Securities Act of 1933, as amended. We are not obligated to make any sales of common stock under the ATM Sales Agreement. Pursuant to a prospectus relating to the ATM Sales Agreement we filed with the SEC on June 21, 2022, we may offer and sell shares of our common stock having an aggregate offering price of up to $14.0 million under the ATM Sales Agreement. There were no sales under the ATM Sales Agreement during the year ended December 31, 2023, or the year ended December 31, 2022.
Equity Line Financing
On September 21, 2020, we entered into a purchase agreement, or the Equity Line Purchase Agreement, with LPC for an equity line financing. The Equity Line Purchase Agreement provided that, subject to the terms and conditions set forth therein, we had the right, but not the obligation, to sell to LPC, and LPC is obligated to purchase up to $15.0 million of shares of common stock at our sole discretion, over a 36-month period that commenced in October 2020. We filed a registration statement on Form S-1 covering the sale of shares of common stock that are issued to LPC under the Equity Line Purchase Agreement, which was declared effective on October 15, 2020. The Equity Line Purchase Agreement was terminated in October 2023 pursuant to the terms thereof.
There were no sales under the Equity Line Purchase Agreement during the years ended December 31, 2023 and 2022.
The Lung Acquisition and Financing Transaction
On October 31, 2023, we acquired Lung, a privately held biopharmaceutical company focused on developing novel therapies for the treatment of orphan pulmonary and fibrosis indications that have no approved or limited effective treatments. Immediately following the acquisition of Lung, we entered into a definitive agreement for the sale of (i) 4,707 shares of Series X Non-Voting Convertible Preferred Stock, at par value of $0.001, or the Series X Preferred Stock, and (ii) warrants to purchase an aggregate of 2,353,500 shares of Aileron's common stock in a private placement to a group of accredited investors led by Bios Partners, all affiliated entities are collectively called Bios, and including Nantahala Capital, as well as additional undisclosed investors, or the Financing.
The Financing resulted in gross proceeds to Aileron of approximately $18.4 million, which included the conversion of certain convertible promissory notes in the aggregate principal amount of approximately $1.6 million issued by Lung to Bios Partners prior to the closing of the Lung Acquisition at a 10% discount to the per share price of the Series X Preferred Stock. The Financing closed on November 2, 2023.
The exercise price of the Warrants is $4.89 per share, subject to certain price and share adjustments, including for stock splits, stock dividends, recapitalizations, subdivisions, combinations, noncash distributions and cash dividends. The Warrants issued under the Financing will be exercisable any time after May 2, 2024, and on or prior to May 2, 2027. Payment for Warrant shares upon exercise of the Warrants may be (i) in cash or (ii) in the event that there is no registration statement available for the resale of Warrant shares, by cashless exercise.
Under the terms of the Warrants, the Company shall not effect the exercise of any portion of any Warrant, and a holder shall not have the right to exercise any portion of any Warrant, to the extent that after giving effect to such exercise, the holder (together with its affiliates and any other persons acting as a group together with the holder or any of its affiliates), would beneficially own in excess of a percentage elected by the holder up to 19.99% of the number of shares of common stock outstanding immediately after giving effect to such exercise, as such percentage ownership is determined in accordance with the terms of the Warrants. However, any holder may, upon written notice to the Company, increase or decrease such percentage to any other percentage not in excess of 19.99%; provided that any
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increase or decrease in such percentage will not be effective until 61 days after such notice is delivered to the Company.
In connection with the Financing, we entered into a Registration Rights Agreement, or the Registration Rights Agreement, with certain investors. Pursuant to the Registration Rights Agreement, we filed a resale registration statement with the SEC on January 29, 2024, which was declared effective on February 5, 2024. The Registration Rights Agreement also contains customary terms, including an obligation to indemnify the investors, their officers, directors, agents, partners, members, managers, stockholders, affiliates and employees under the registration statement from certain liabilities and pay all fees and expenses (excluding any underwriting discounts and selling commissions and all legal fees and expenses of legal counsel for the investors, except for reasonable and documented fees and expenses in an amount not to exceed $30,000 of the investors that hold a majority in interest of the registrable securities in connection with the review of the registration statement) incident to our obligations under the Registration Rights Agreement.
Cash Flows
The following table summarizes our sources and uses of cash for each of the periods presented:
Year Ended December 31,
2023
2022
Cash used in operating activities
$
(19,808
)
$
(24,865
)
Cash provided by investing activities
16,196
26,459
Cash provided by financing activities
15,794
—
Effect of exchange rate changes on cash and cash equivalents
(63
)
—
Net increase in cash, cash equivalents and restricted cash
$
12,119
$
1,594
Operating Activities
During the year ended December 31, 2023, operating activities used $19.8 million of cash, primarily resulting from our net loss of $15.7 million and cash provided by the change in operating assets and liabilities of $5.4 million offset by non-cash charges of $1.3 million. Non-cash charges resulted primarily from stock-based compensation expense of $1.2 million. Changes in our operating assets and liabilities during the year ended December 31, 2023 consisted primarily of an increase of $5.0 million in accounts payable, and $0.4 million in accrued expenses and other current liabilities.
During the year ended December 31, 2022, operating activities used $24.9 million of cash, primarily resulting from our net loss of $27.3 million and cash provided by the change in operating assets and liabilities of $0.4 million offset by non-cash charges of $2.0 million. Non-cash charges resulted primarily from stock-based compensation expense. Changes in our operating assets and liabilities during the year ended December 31, 2022 consisted primarily of a decrease of $1.6 million in accrued expenses and other current liabilities, a decrease of $1.6 million in prepaid expense and other assets, and an increase of $0.5 million in accounts payable.
Investing Activities
During the year ended December 31, 2023, investing activities provided $16.2 million of cash. We received $16.3 million of proceeds from the maturities of investments, offset by $0.1 million of cash and cash equivalents from the Lung Acquisition.
During the year ended December 31, 2022, investing activities provided $26.5 million of cash. We received $48.3 million of proceeds from the sale of investments, offset by $21.9 million of purchases of investments.
Financing Activities
During the year ended December 31, 2023, net cash provided by financing activities was $15.8 million due to the proceeds of $15.8 million from the Financing in October 2023.
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During the year ended December 31, 2022, net cash provided by financing activities was $0 million.
Off-Balance Sheet Arrangements
As of December 31, 2023 and 2022 and in the periods presented, we did not have any off-balance sheet arrangements, as defined in the rules and regulations of the SEC.
Critical Accounting Estimates
Our management’s discussion and analysis of financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States. The preparation of our consolidated financial statements and related disclosures requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, costs, and expenses and the disclosure of contingent assets and liabilities in our consolidated financial statements. We base our estimates on historical experience, known trends and events and various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. We evaluate our estimates and assumptions on an ongoing basis. Our actual results may differ from these estimates under different assumptions or conditions.
Accrued Research and Development Expenses
As part of the process of preparing our financial statements, we are required to estimate our accrued research and development expenses. This process involves reviewing open contract and purchase orders, communicating with our personnel to identify services that have been performed on our behalf and estimating the level of service performed and the associated costs incurred for the services when we have not yet been invoiced or otherwise notified of the actual costs. Some of our service providers invoice us in arrears for services performed, on a pre-determined schedule or when contractual milestones are met; however, some require advanced payments. We make estimates of our accrued expenses as of each balance sheet date in our financial statements based on facts and circumstances known to us at that time. Examples of estimated accrued research and development expenses include fees paid to:
• vendors in connection with preclinical and clinical development activities;
• CROs in connection with performing research activities on our behalf and conducting preclinical studies and clinical trials on our behalf;
• investigative sites or other service providers in connection with clinical trials; and
• CMOs or other vendors in connection with the production of preclinical and clinical trial materials.
We base our expenses related to preclinical studies and clinical trials on our estimates of the services received and efforts expended pursuant to quotes and contracts with multiple CMOs and CROs that supply, conduct and manage clinical trials and preclinical studies on our behalf. The financial terms of these agreements are subject to negotiation, vary from contract to contract and may result in uneven payment flows. There may be instances in which payments made to our vendors will exceed the level of services provided and result in a prepayment of the expense. Payments under some of these contracts depend on factors such as the successful enrollment of patients and the completion of clinical trial milestones. In recording accrued or prepaid service fees, we estimate the time period over which services will be performed, enrollment of patients, number of sites activated and the level of effort to be expended in each period. If the actual timing of the performance of services or the level of effort varies from our estimate, we adjust the accrual or amount of prepaid expense accordingly.
Although we do not expect our estimates to be materially different from amounts actually incurred, our understanding of the status and timing of services performed relative to the actual status and timing of services performed may vary and may result in us reporting amounts that are too high or too low in any particular period. To date, we have not made any material adjustments to our prior estimates of accrued research and development expenses.
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Stock-Based Compensation
We account for stock-based compensation awards in accordance with ASC Topic 718, Compensation—Stock Compensation, or ASC 718. ASC 718 requires all stock-based payments, including grants of stock options and restricted stock, to be recognized in the statements of operations and comprehensive loss based on their fair values. We measure stock-based awards based on their fair value on the date of grant and recognize compensation expense for those awards over the requisite service period, which is generally the vesting period of the respective award. We apply the straight-line method of expense recognition to all awards with only service-based vesting conditions and apply the graded-vesting method to all awards with performance-based vesting conditions or to awards with both service-based and performance-based vesting conditions.
We estimate the fair value of each stock option grant at the date of grant using the Black-Scholes option pricing model and the fair value of each restricted common stock award is estimated on the date of grant based on the fair value of our common stock on that same date. The Black-Scholes option-pricing model requires inputs based on certain subjective assumptions including the volatility of our common stock, 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. Changes to these assumptions can materially affect the fair value of stock options and ultimately the amount of stock-based compensation expense recognized in our consolidated financial statements.
We account for stock option forfeitures during the period in which they occur.
Income Taxes
We account for income taxes using the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the financial statements or in our tax returns. Deferred taxes are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse.
We assess the likelihood that our deferred tax assets will be recovered from future taxable income and, to the extent we believe, based upon the weight of available evidence, that it is more likely than not that all or a portion of the deferred tax assets will not be realized, a valuation allowance is established through a charge to income tax expense. Changes in valuation allowances from period to period are included in our tax provision in the period of change. Potential for recovery of deferred tax assets is evaluated by estimating the future taxable profits expected and considering prudent and feasible tax planning strategies.
We account for uncertainty in income taxes recognized in the consolidated financial statements by applying a two-step process to determine the amount of tax benefit to be recognized. First, the tax position must be evaluated to determine the likelihood that it will be sustained upon external examination by the taxing authorities. If the tax position is deemed more-likely-than-not to be sustained, the tax position is then assessed to determine the amount of benefit to recognize in the financial statements. The amount of the benefit that may be recognized is the largest amount that has a greater than 50% likelihood of being realized upon ultimate settlement. The provision for income taxes includes the effects of any resulting tax reserves, or unrecognized tax benefits, that are considered appropriate as well as the related net interest and penalties.
The recognition and measurement of tax benefits requires significant judgment, especially in assessing uncertain tax positions. Judgments concerning the recognition and measurement of our tax benefits, as well as limitations surrounding their realizability, might change as new information becomes available.
Contractual Obligations
Our wholly owned subsidiary, Lung Therapeutics LLC, leased a facility containing 6,455 square feet of office space located at 3801 S. Capital of Texas Hwy, Suite 330, Austin, Texas, which expired on March 31, 2024. We do not plan on renewing the lease. Following expiration of the lease, we plan to operate virtually.
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Our remaining contractual rent commitment under this lease was less than $0.1 million as of December 31, 2023. For a description of our lease obligations, refer to Note 15 to our consolidated financial statements appearing in this Annual Report on Form 10-K.
Emerging Growth Company Status
We ceased to qualify as an emerging growth company as of December 31, 2022, and are now subject to Section 14A(a) and (b) of the Securities Exchange Act of 1934, as amended, or the Exchange Act, beginning with our fiscal year that started January 1, 2023. However, notwithstanding the loss of our status as an emerging growth company, we will continue to be exempt from Section 404(b) of the Sarbanes-Oxley Act of 2002 for so long as we are neither a “large accelerated filer” nor an “accelerated filer” as those terms are defined in Rule 12b-2 under the Exchange Act.
We are a “smaller reporting company” as defined in Rule 12b-2 under the Exchange Act. We may continue to be a smaller reporting company if either (i) the market value of our shares held by non-affiliates is less than $250.0 million or (ii) our annual revenue was less than $100.0 million during the most recently completed fiscal year and the market value of our shares held by non-affiliates is less than $700.0 million. For so long as we continue to be a smaller reporting company, we may continue to rely on exemptions from certain disclosure requirements that are available to smaller reporting companies.
Recently Issued Accounting Pronouncements
We have reviewed all recently issued standards and have determined that, other than as disclosed in Note 2 to our consolidated financial statements appearing at the end of this Annual Report on Form 10-K, such standards will not have a material impact on our consolidated financial statements or do not otherwise apply to our operations.
Item 7A. Quantitative and Qualitati ve Disclosures About Market Risk
We are a smaller reporting company, as defined in Rule 12b-2 under the Securities Exchange Act of 1934, as amended, for this reporting period and are not required to provide the information required under this item.
Item 8. Financial Statement s and Supplementary Data
The consolidated financial statements required to be filed pursuant to this Item 8 are appended to this Annual Report on Form 10-K. An index of those consolidated financial statements is found in Item 15 of Part IV of this Annual Report on Form 10-K.
Item 9. Changes in and Disagreements with Accou ntants on Accounting and Financial Disclosure
None.